Regulation: Shaping the TCFD metrics for commercial real estate

In the year ahead, the commercial real estate industry has a unique opportunity to influence the way that the Task Force on Climate-related Financial Disclosures (TCFD) reporting guidelines are applied to property assets and funds.

The UK’s Financial Conduct Authority (FCA) continues to take a leading role on environmental, social and governance (ESG) issues. Large UK pension funds and fund managers have to comply with the TCFD guidelines across all asset classes, and the FCA is looking to expand and broaden the guidelines through its Sustainability Disclosure Requirements (SDR). The time to make sure these frameworks work well for commercial real estate assets is now.

Fortunately, the TCFD Secretariat recognises that it is not an industry standard setter, and encourages initiatives by industries to take the TCFD guidelines and influence the development of industry-specific metrics.

The commercial real estate industry must take forward this initiative and address the quantitative and qualitative components that are unique to the sector. In the coming months we need to have a debate within our industry, develop consensual solutions for appropriate metrics, engage with regulators at an early stage of their policy formulation process and arrive at clearly defined and comprehensive reporting criteria to enable robust peer comparison.

UK/EU differences and key issues to resolve

In parallel to the UK introducing TCFD aligned disclosures, the European Commission plans compliance with the disclosure requirements on principal adverse impacts under its Sustainable Finance Disclosure Regulation (SFDR) by 30 June 2023 (the first annual reference period under the regulatory technical standards commencing on 1 January 2022). SFDR has a broader sustainability coverage than the TCFD guidelines – the latter focuses on climate change.

The FCA recognises that there are “some differences in the calculation methodologies between the TCFD’s recommendations and the EU SFDR” and hence proposes “metrics be calculated according to both the TCFD and SFDR methodologies”. Our industry needs to address these differences – as well as inconsistencies with energy-performance-certificate ratings in the UK and amongst EU states – for us to facilitate consistency of disclosures both across the EU and UK as well as internationally where the TCFD’s recommendations will apply.

We are encouraged that industry organisations, managers, investors, data providers, disclosure consultancies, and others are already collaborating to seek end-to-end solutions to the question of appropriate real estate metrics. Looking ahead we suggest the industry focuses on the following key issues to reach a satisfactory resolution.

 Reflect the TCFD’s recommendation that metrics need to measure both climate-related risks and opportunities

The recommendation signals that the majority of widely used metrics are either explicitly or implicitly directed towards risk. Much depends on the inherent real estate investment strategy, typically categorised as core, value-add and opportunistic. We need metrics that appropriately accommodate each strategy, given that real estate has inherent “wasting investments” attributes, with obsolescence a key valuation factor.

For instance, in the context of the UK government’s target of net zero by 2050 for all sectors, it is expected that approximately 80% of all UK operational buildings in 2050 have already been built. The task is retrofitting existing buildings and determining how to measure and report these decarbonisation efforts. The UK Green Finance Institute has usefully developed Green Home Finance Principles for retrofitting works in domestic buildings. We need an equivalent for commercial real estate.

Metrics for real estate are unique, and this will result in challenges when comparisons are made with metrics for other asset classes

From its reporting data 2020, UN Principles for Responsible Investment discovered that, in commercial real estate, more focus and greater effort are needed on metrics, Scope 1, 2, and 3 greenhouse-gas (GHG) emissions and climate-related targets. This approach means optimising energy used for heating and cooling to help reduce direct GHG emissions followed by assessing all indirect emissions from the value chain – ie Scope 3, that support a single asset or an asset portfolio. This approach will also link many supply-chain factors to the life-cycle analysis and whole-life carbon assessment of physical assets (for both legacy assets and new builds).

We must acknowledge that different metrics are used for a variety of purposes with the accompanying range of impacts and that, as a starting point, a better perspective of the asset(s) can be gained from undertaking a climate scenario analysis. We are attracted by Representative Concentration Pathways from the Intergovernmental Panel on Climate Change and energy scenarios from International Energy Agency to consider how assets will be affected by physical and transition risks in relation to the assets achieving net zero by 2050.

Metrics should separately identify quantitative and qualitative elements

This also involves a holistic measurement: a building’s whole-life carbon and associated ESG impacts via multi-dimensional and comprehensive analysis identifying each of the Scope 1, 2, and 3 elements and utilising credible data, as has been previously elaborated.

This may be supplemented with qualitative risk assessments, particularly where widespread data might not be available and/or there is a lack of confidence in the assumptions underlying the modelling used. Credible sources need to be balanced with coverage: actual with estimates. With the latter, what is the confidence rating of estimated data and action plan to close data gaps with delivery timelines?

Global Real Estate Sustainability Benchmark (GRESB) and Carbon Risk Real Estate Monitor (CRREM) are useful starting points, but these benchmarks will need to be reviewed

The FCA recognises those involved in real estate investment activity utilise the GRESB metrics and CRREM tool. In regard to GRESB, there is a focus on management, performance, and development components with scores, combined with ratings that measure how effectively ESG factors are integrated in the management and practices of participants[13]. However, the GRESB scorecard does not display ESG performance.

CRREM has the merits of being freely available and pre-populated from GRESB reporting[14]. It helps to track the carbon intensity of assets and can be used to identify buildings that require less adaptation capital than others to bring such assets in line with net-zero best practice, as well as highlighting how potential opportunities can be identified.

However, to maximise the value of CRREM, the model could usefully be refined with developing the climate-value-at-risk metrics, incorporating an implied temperature metric (for an aligned metric across different investment classes), improving the CRREM workflow (separating climate risk assessment from the risk mitigation analyses), engineering credibility, and providing estimates for the cost of delivering carbon reduction and the embodied-carbon implications of projects.

Continue the collaboration

With regulators encouraging more detailed ESG analysis and disclosures, institutional real estate investors no doubt scrutinising their ESG scores, taking into account capital expenditure and valuation consequences. This is leading real estate investors to re-evaluate their portfolios given their focus on medium-to-long-term holds linked to capital growth and relative stability of income return. Our industry must continue the collaboration – including with investors and regulators – and find positive solutions to the real estate metrics question.