The EU Taxonomy is setting standards for sustainable real estate across Europe. But it is complex and evolving. PwC’s Christiane Conrads offers some insights. Nicol Dynes.
The importance of EU Taxonomy cannot be overestimated. It has led the way at a global level, but it is complex and still a work in progress. Here, Christiane Conrads, global real Estate ESG leader, one of the foremost experts on the subject to interpret, deciphers the technical aspects and points the way forward.
What can be done now to promote harmonisation with various regulations at national and local level?
EU Taxonomy Regulation defines when an eligible economic activity can be regarded as being sustainable. It is the first instrument of its kind supporting the EU in expanding sustainable investment and implementing the European Green Deal. It is therefore indispensable, but not yet fully developed.
The definition of climate and other environmental requirements, as well as social minimum safeguards is, by its nature, an ambitious and complex legislative project. So is it not surprising that some requirements have not yet been harmonised (especially between member states) and that ambiguous legal terms pose a challenge for market participants.
The European Commission itself appreciates that the EU Taxonomy is a dynamic regulation which will continuously be further developed. In this context, the main focus should be on further specifications and harmonisations of legal requirements. In particular, for thresholds that are based on benchmarking, it is even more important that there are uniform requirements throughout Europe and that transparency is ensured through public databases. The need for solutions ensuring fair competition as well as the great demand for pragmatic solutions has been acknowledged by the legislative bodies.
You have been promoted from an EMEA to a Global role. Is Europe seen as an example of best practice?
The EU is seen by many as a pioneer in the global ESG transformation. With the adoption of the Paris Agreement on Climate Change and the UN Agenda 2030, the EU has committed itself to a sustainable economy and society. In recent years, the EU has introduced various packages of measures that affect all sectors of the economy. In particular, following the EU Sustainable Finance Action Plan and the EU Green Deal, the EU has initiated extensive legislative projects with huge impact that are now gradually coming into force. This has led to many market participants adapting to these regulatory adjustments and developing and implementing their own ESG strategies.
This is amplified by concerns over being exposed to greenwashing accusations. We see in many international projects and understand from our clients that are based, for example, in the US or APAC region that they are monitoring the European market and looking for solutions which they can use as templates. For example, the EU Taxonomy Regulation with definitions of environmental criteria and social minimum standards, is increasingly being recognised as a benchmark in other markets.
However, while the EU is leading the way with its broad ESG approach and pressing legislation for the time being, other countries and markets are targeting individual ESG areas. The US, for example, with the bipartisan infrastructure law of the Biden administration supporting renewable energy projects, and China, which is expected to introduce net-zero laws soon, show that other countries are catching up fast in the race to global ESG standards.
If the EU is to maintain its pioneering role in the long term, it will need to make a number of regulatory trade-offs at the EU level and in member states. These include ensuring data protection while facilitating rigorous reporting, or fiscal hurdles that hinder or slow down the implementation of renewable energy projects
Would you say ESG is at the top of the agenda now in the US or APAC, or is there a long way to go?
ESG has moved up the agenda significantly in these markets. Our recent Emerging Trends in Real Estate study confirms that ESG will be the number one priority for international real estate investors and asset managers in the short, mid-, and long-term. Real estate is a global investment product, so regional standards (like the ones currently being implemented in the EU) have an international impact. In addition, stakeholder requirements have increased worldwide.
‘For real estate capital markets to operate effectively and sustainably, greater clarity is needed to ensure information is comparable and ‘decision useful’ for investors.’Christiane Conrads, PwC
While CO2 emission savings and climate change adaptation measures play an important role, the importance of other environmental goals and the understanding of social standards and targets varies in different markets. For example, Japan is very advanced in the area of circular economy in real estate construction, and Singapore in its approach to restoring biodiversity. Not all of these initiatives are being labelled under the ESG flag. This is also true for the US approach to involve social communities in the urban planning process and promote social businesses in new developments.
Even if measures are not taken under the ESG label, one can clearly see a change in thinking.
Some say SFDR criteria are too stringent on ESG-compliance. Funds that want to transform brown assets into green would not qualify for Article 8 or 9 status. Should the EU do more to incentivise improving existing stock?
Opinions may indeed be divided whether the requirements of the SFDR (Sustainable Finance Disclosure Regulation) are too strict or too lax to facilitate meaningful metrics for measuring impact. As a result, some market participants have decided to publish two different reports: one that meets the requirements of the SFDR, and another that outlines its positive impact on the environment and/or society. From an environmental impact perspective, the focus should undoubtedly be on renovation of existing buildings rather than demolition and new construction. However, the latter are usually very complex projects where individual specifications and interests must be taken into account.
Developing regulatory disclosure requirements for such projects is therefore not an easy task if one wants to effectively counter greenwashing and create transparency and comparability. With the increasing relevance of a lifecycle approach and the consideration of embodied carbon, the focus will inevitably shift to the existing building stock. However, well-designed solutions on the part of the regulator are preferable to quick and inadequate solutions. The bottom line is to make the actual impact measurable and comparable.
Looking at ESG regulations, there have been complaints of “death by acronym”: too many certifications, institutes, definitions. Do you agree?
The number of ESG frameworks, standards, alliances, regulatory and ‘soft law’ developments, certifications and ratings has grown exponentially in recent years. For real estate capital markets to operate effectively and sustainably, greater clarity is needed to ensure information is comparable and ‘decision useful’ for investors.
We are conducting a regulatory mapping exercise for the Urban Land Institute. This study is intended to help navigate the ‘alphabet soup’ of ESG standards by shedding light on the origin, purpose and coverage of the ESG frameworks most commonly used across the industry.
One of the key conclusions from this study is that while some consolidation is taking place – e.g. TCFD (Task Force on Climate-related Financial Disclosures) and SASB (Sustainability Accounting Standards Board) are actually becoming mandatory in certain countries under the umbrella of the new IFRS (International Financial Reporting Standards) – there is no one-size-fits all reporting standard, either from a thematic perspective, or from a purpose perspective.
This will not change in the short to medium term, as the field of ESG is such a broad and complex one that will continue to evolve as scientific knowledge grows and social norms become more widely accepted. As a result, despite all consolidation efforts, reporting standards and frameworks will evolve and new requirements will emerge. Accordingly, choosing the right standards and metrics that appropriately reflect the requirements of one’s ESG strategy and the demands of stakeholders (i.e., the intended users of the disclosed information) will remain a critical task for market participants.
Is it possible to have one objective definition of what a net-zero energy building is?
There are several definitions of what the term ‘zero-energy building’ means in practice. The understanding varies across countries (with a particular difference in usage between North America and Europe), agencies and cities, so a general knowledge of the concept and its various employments is essential. In general, a net-zero energy building has net-zero energy consumption, meaning the total amount of energy consumed on an annual basis is equal to the amount of renewable energy created onsite or, in other definitions, by offsite renewable energy sources.
‘Real estate is a global investment product, so regional standards (like the ones currently being implemented in the EU) have an international impact.’Christiane Conrads, PwC
Since the requirements for net-zero building operation are largely science-based, an objective definition should theoretically be possible in the near to mid-term future if consent can be reached among the various regulatory bodies. In my view, however, the whole discussion on net-zero energy buildings should not distract from the fact that the goal is to reduce the overall environmental impact and to comply with minimum social standards throughout the entire real estate lifecycle in value and supply chains. In this context, embodied carbon of the construction process and user behaviour should at least also be covered by the respective definition of a net-zero energy building.
The EU wants to go beyond the E in ESG and tackle the S as well. How is the move towards an EU Social Taxonomy progressing?
On 28 February 2022, the Platform on Sustainable Finance (PSF) published its final report on a possible structure of an EU Social Taxonomy. The report recommends taking national legislation as a minimum standard and, in addition, using as a reference framework international rules recognised by all member states, such as the UN Guiding Principles on Business and Human Rights. In terms of congruence with other EU regulations, there is also an overlap with the SFDR on negative sustainability impacts in terms of the data to be reported.
According to this report, the Social Taxonomy should promote three main targets for three different stakeholder groups who shall be at the centre of the new regulations:
- Decent work (including value-chain workers);
- Adequate living standards and well-being for end-users; and
- Inclusive and sustainable communities and societies.
Whereas social aspects are now also emerging in the foreground of other European regulations, mostly in form of social minimum safeguards, a Social Taxonomy should provide for a framework promoting capital flows into investments with a main social objective so that private capital can be directed towards socially valuable activities. The final draft by the PSF highlights that almost all ecological measures not only have an environmental impact, but also a social one.
What impact would it have on the real estate sector?
As one of the largest economic sectors, the real estate industry plays a crucial role in people’s everyday lives and in the development of society as a whole and, therefore, bears a high level of responsibility to society. The introduction of a Social Taxonomy would not only give the industry an opportunity to position itself as one of the most important sectors, but also to improve its image, and give companies the chance to develop competitive advantages.
Matters such as creating liveable urban neighbourhoods, social justice, living together in the social space, and further improving diversity, should be addressed and, hopefully, they will be given greater focus with a Social Taxonomy. Uniformity across the EU regarding labour and social standards is a goal to be pursued. Achieving this will be a major challenge in the future, which needs to be overcome to push forward the S in the ESG.
Would you say ESG is now seen by companies as a value component rather than a cost or a burden?
Various initiatives aim to further develop traditional real estate valuation methods to include ESG criteria, but setting appropriate standards will take time. At the corporate level, however, a range of economic benefits for ESG-compliant real estate investments are already evident, such as better access to financing and equity in a tight market environment. In addition, changing tenant requirements have led to a different understanding of value-creating factors. Increasingly, we see that buildings must not only meet current regulatory requirements, but also the individual ESG strategies of tenants for the entire lease term. The risk of stranded assets is also increasingly coming into focus.
Many investors and asset managers are no longer primarily concerned with the costs of implementing ESG criteria. They are increasingly looking at the costs and risks that arise when standards are not met. The sustainability of real estate for the duration of the holding period and at the time of sale has come into focus against a backdrop of increasing physical and transitory risks. This effect will become even more significant with increasing transparency requirements on sustainability risks for the investment itself and its impact on the environment and society.
Greenwashing has been a persistent problem, which the EU is trying to combat by tightening the rules. How is that going?
As public awareness of the issue grows, companies are subject to increased scrutiny from consumer associations, their peers, other stakeholders, and ordinary citizens. In tandem with greater public awareness is the development of more stringent regulations and sanctions. This dual pressure is set to be a catalyst for increased compliance: it is in a company’s own interest to not only act in accordance with the law, but also to be seen to be doing the right thing.
Navigating the field of ESG regulations, often open to interpretation, can be extremely difficult, so a thorough approach is recommended. Only disclose and market what you actually fulfil, have documented proof and make sure names of products and services are not misleading.
In addition to increasing regulatory requirements, stakeholder demands are also important. Furthermore, consumer protection associations spend a lot of effort on detecting greenwashing by well-known companies. Greenwashing allegations bear an enormous risk. In addition to claims for compensation for damages (by investors or clients, for example) and/or fines imposed by supervisory bodies, companies risk exposure in the media. Reputational damage is often very hard and costly to restore.
Where will we stand in 10 years?
Environmental crises and, in particular, the progression of climate change, will have a much more noticeable impact in 10 years. A better knowledge of how the various crises are interrelated will be needed to manage them. I am confident that further awareness, collaborations and research will lead to this knowledge development and that we will have taken a big step forward towards a climate-neutral, resource-efficient and just global economy.
A decade from now more ESG standards will be an integral part of all real estate processes at asset and company level. Increasing regulatory requirements and stakeholder demands will be a catalyst. We are currently seeing more and more technical solutions in the area of impact technology. This will also increase significantly over the next few years and play a crucial role in helping us master the upcoming challenges.