While we continue to navigate our way through the uncharted waters brought about by the COVID-19 pandemic, one item has continued its climb up the boardroom agenda: ESG. It stands for environmental, social and governance, referring to the three central factors in measuring the sustainability and societal impact of an investment in a company or business. Evidence suggests that having ESG considerations integrated into the strategy of a fund leads to a better performance. By examining ESG issues, investors gain a better understanding of not just what companies do, but how they do it.
How does this affect Scottish real estate?
Significantly. In Scotland, we have recently seen the Scottish Government setting itself a legally-binding target to cut greenhouse gas emissions to net zero by 2045, five years ahead of the date set for the UK as a whole (Climate Change (Emissions Reductions Targets) (Scotland) Act 2019). These are among the most ambitious targets set by any government anywhere in the world. The built environment continues to be one of the biggest consumers of energy and is responsible for roughly one third of all carbon dioxide emissions. Given that people can spend between 80-90% of their time indoors, the built environment also has an enormous impact on the health and wellbeing of our communities. Such factors, coupled with the increasing demands being placed on all businesses by civil society, make ESG one of the most relevant and important concepts for Scottish real estate today.
The E, the S and the G
The range of factors which can be included under any one of these three heads is extensive. Factors relevant to one sector may be less so to another, and there is an inevitable amount of overlap between the categories, but if we look at real estate specifically:
- Environment: think energy efficiency and building emissions, use of materials and resources, and climate change resilience. Good environmental performance can assist property owners in securing profitable tenants, most of whom now have their own ESG agenda to fulfil and investors to satisfy. In Scotland, we have seen an increased demand for more energy-efficient buildings, legislation which demands physical improvements to older buildings and a range of proposals in both the domestic and non-domestic sphere to steadily tighten existing measures. In terms of climate change, Scotland may not have the same range of physical threats seen in other parts of the world, but it is particularly susceptible to flood risk (the Met Office forecasts that intense rainfall associated with severe flash flooding could become almost five times more likely by the end of this century), making climate resilience a very real concern.
- Social: covers matters such as occupier and community relations; health, safety and security; accessibility and socio-demographic changes. COVID-19 has undoubtedly heightened the focus on the S in ESG. How companies manage the health, safety and welfare of an anxious returning workforce, for example, is hugely demonstrable of more general employee welfare issues. Closed and empty premises, as a result of insolvency brought about by the ravages of the pandemic, are - and will be for some time - a reality for parts of the Scottish real estate market.
- Governance: this would include issues such as company culture, reputation, conduct and diversity – all of which are critically important to any business, real estate focused or not. The power of social media and the speed at which information is now disseminated around the world means there are few places to hide for businesses that get it wrong. Share price is normally the first to suffer in the throes of bad publicity.
The legal context
The legal framework around ESG is very much in its infancy, both at a European and at a UK/Scottish level. While it is easy to point to legislation in the environmental and energy efficiency spaces, regulation which attempts to encompass any more than one of the three central ESG pillars is somewhat scarce. The ESG concept itself has its roots in the demands and expectations of civil society. The problem with this is that civil society continues to outpace governments around the world when it comes to the expectation of environmental and social performance of corporations; in other words, the law is struggling to keep up.
Nevertheless, we are starting to see some real progress. Summer 2020 saw the adoption by the European Parliament of the so-called Taxonomy Regulation (Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020) which establishes an EU-wide classification framework to enable financial market participants to identify which economic activities and investments can be treated as "environmentally sustainable" by reference to six specific environmental objectives. Similarly, the EU's Disclosure Regulation (Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019) will require financial market participants and financial advisers to provide investors with ESG information in relation to certain financial products; this will enable investors to make informed decisions based on ESG-related factors. Although the position remains somewhat unclear, the UK government has expressed its intention to follow certain key EU financial services regulations post-Brexit. There is also a range of certain specific industry obligations already applicable to, for example, pension funds and insurers, which cover the consideration of ESG in investment strategies.
ESG is here to stay. It is starting to form an integral part of investment strategies around the globe. Scotland, like the rest of the UK, must keep pace with European developments in this space. Managing the built environment has been, and always will be, a key focus for ESG.