UK and continental European real estate fund managers need more comprehensive ESG disclosures up and down the fund value chain – and supportive regulation, writes Melville Rodrigues
There is marked trend of real estate fund managers wishing to promote their products’ ESG or sustainability credentials. The products have the potential to make a positive difference, but we need managers to demonstrate these credentials with consistent, transparent and efficient disclosure practices – supported by regulation. A key overall goal is to reduce emissions associated with the whole lifecycle of a fund’s underlying real estate, as well as within fund structure operations and other elements of the supply chain.
Within the wider funds sector, the Net Zero Asset Managers Commitment states that “there is an urgent need to accelerate the transition towards global net zero emissions and for asset managers to play [their] part to help deliver the goals of the Paris Agreement and ensure a just transition”. This involves supporting the goal of net-zero greenhouse gas (GHG) emissions by 2050, in line with global efforts to limit warming to 1.5°C.
The problem of carbon emissions is particularly acute in the real estate sector. It is estimated that buildings are currently responsible for 39% of global energy-related carbon emissions: 28% from operational emissions, from energy needed to heat, cool and power them, and the remaining 11% from materials and construction (known as embodied carbon). It is therefore mission-critical that real estate fund managers accelerate and attract capital required to bridge green performance and delivery gaps and to progress other transition strategies.
Encouragingly, there has already been much progress among UK and European real estate fund managers to address the challenges presented by carbon emissions at the portfolio level. It is useful that this progress has dovetailed with evolving regulation focused on funds.
The EU has led on the regulatory policy front with the introduction of the Sustainable Finance Disclosure Regulation (SFDR), albeit there are challenges. The European Commission designed SFDR as a disclosure framework; however, market participants are using it as a product labelling scheme for which the regulation is ill-suited. The EU regulators’ review of SFDR, expected in the third quarter of this year, will hopefully result in a more targeted, user-centric approach to disclosures at entity and product levels and other solutions requested by our sector. For instance, the SFDR mandatory principal adverse impact “exposure to energy-inefficient assets” focuses on a snapshot of the operational sustainability characteristics of the underlying assets, rather than on the ambition for, and progress towards, the transition of such assets.
Last month, the UK enshrined into legislation that the government and regulator, the Financial Conduct Authority (FCA), is entitled to make and revise disclosure requirements in relation to sustainability via a Sustainability Disclosure Requirements (SDR) policy statement. Hopefully, the FCA’s SDR policy statement – expected in the fourth quarter this year – will endorse representations from our sector for appropriate real estate metrics that support robust, transparent and comparable disclosure which will enable investors to understand both climate and holistic ESG performance.
The market’s focus must be on portfolio Scope 1 and 2 emissions and, to the extent possible, Scope 3 emissions. With regard to credible GHG emissions information, for example, the market should aim to facilitate the assessment of “climate-related transition risks in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), set science-based targets, inform their strategies for climate action, and disclose progress to relevant stakeholders”.
For instance, the UK Green Building Council’s useful Scope 3 guide should be appropriately revised to cover residential real estate. It should also cover funds – the guide refers to “companies”, which could be construed as restricting the guide to operational real estate.
Our sector must reduce GHG emissions from fund promotion through to fund structuring and operations. This approach could result in a fund manager that promotes the ESG credentials of a fund, preferring the fund to be operated domestically rather than on a cross-border basis – the latter may involve regular flights for board meeting and substance purposes. In addition, the optics of such flights seems inconsistent with a fund promoting ESG credentials.
It should go without saying that real estate fund managers that proclaim their products’ sustainability credentials must also operate the funds sustainably. Let us adapt our whole fund cycle practices with emission efficiencies in mind. Let us also continue constructive engagement with regulators to facilitate achieving pressing emission reduction and other ESG goals.
The Greenhouse Gas Protocol, which provides widely recognised accounting standards, categorises GHG emissions into three scopes. Scope 1 covers direct emissions from owned or controlled sources. Scope 2 covers indirect emissions from the purchase and use of electricity, steam, heating and cooling. By using the energy, an organisation is indirectly responsible for the release of these GHG emissions. Scope 3 includes all other indirect emissions that occur in the upstream and downstream activities of an organisation.