Turning green thinking into green growth

Investors and business leaders are not only recognising the materiality of Environmental, Social and Governance (ESG) factors in the assessment of long-term growth and risk, but are now taking action to protect their interests.  

In this article, we explore why ESG factors are particularly relevant to the Built Environment sector, and how early identification of ESG factors and appropriate risk management can convert green thinking into opportunity.  

What is "ESG"?

ESG factors are a broad and flexible collection of risks, including:

• Environmental: climate change, environmental damage, resource depletion
• Social: slavery, indigenous communities, diversity, health and safety
• Governance: executive pay, bribery and corruption, diversity of boards, tax

Individual ESG factors regularly make the news headlines.  An article in the Financial Times pointed out that the increase in the disclosure of ESG-related data has made it easier to assess the financial impact of ESG risks, and has facilitated the incorporation of these risks into investment models.¹ The article refers to a study by Boston Consulting Group which showed that companies with more ethical operations make larger profits.² The increase in ESG-related information can be directly linked to investor interest and action through share prices, and individual events have greater potential to affect an entire industry.³

ESG factors are also increasingly interconnected with other global risks.  The World Economic Forum's 2018 Global Risks Report⁴ highlights not only the growing prominence of environmental risks, but also the systemic challenge of the increasing interconnectedness of environmental and other global risk factors, including disruption to critical infrastructure.

Why is ESG particularly relevant to the Built Environment sector?

There are a number of indicators that expectations are changing in the Built Environment sector, including the development and uptake of disclosure tools and guidance.  In 2017, 850 property companies and funds participated in the Global Real Estate Sustainability Benchmark (GRESB) Real Estate Assessment, suggesting that ESG disclosure is becoming market standard in the Built Environment sector.⁵ The GRESB Assessment is a key tool for providing information to investors.  Information is collected through GRESB Assessments, which are completed by the company by providing ESG data, which GRESB then validates, scores and benchmarks.⁶ New RICS professional standards and guidance will also come into effect from May 2018 and will focus on the whole carbon life cycle, including the construction and use of real estate.⁷ This will feed into broader assessments such as the BREEAM sustainability assessment for buildings.  Public interest has also played a part in driving ESG in the Built Environment sector.  For example, the WELL Building Standard can be attributed at least in part to public demand and people's desire to live and work in environmentally friendly buildings that promote health and wellbeing.  

More broadly, investors are concerned about a range of ESG-related issues.  For example, if a portfolio company fails to take into account ESG factors in its business strategy, it may no longer be in a position to meet its financial objectives, or may fail to retain its best employees who are attracted to more innovative working environments or business models.  Investors may also fear the consequences of reputational damage if public opinion about a portfolio company's supply chain or wider business activities turns negative, or if the company has failed to put in place preventative measures to safeguard against foreseeable ESG risks.  

ESG reporting and due diligence

Investors are a key driving force behind the increased focus on ESG.  The six Principles for Responsible Investment are a set of voluntary and aspirational principles for investors, launched in April 2006, which now have more than 1,800 signatories from over 50 countries representing approximately US$70 trillion of assets.⁸  The six Principles include commitments to incorporate ESG issues into investment analysis and decision-making processes, and report on activities and progress towards implementing the Principles.

The Equator Principles, originally launched in June 2003, also act as a guide for financial institutions to determine, assess and manage the environmental and social impact of projects, in particular during the due diligence process.  Project companies need to demonstrate to lenders that they are identifying ESG-related risks and taking mitigating action to ensure that their approach to ESG can withstand the scrutiny of increasingly well-informed and demanding investors. 

There are also mandatory reporting requirements for ESG, including the UK Corporate Governance Code, the EU Non-Financial Reporting Directive and the UK Companies Act 2006.  The EU Non-Financial Reporting Directive requires large companies (companies with over 500 employees and whose activities are of significant interest to the public) to produce reports on the social and environmental impacts of their business, including its operations and how the company manages social and environmental challenges.  The Companies Act 2006 requires companies who have a duty to prepare a strategic report to include environmental matters where these affect the development, performance or position of the company; and also requires quoted companies to report on greenhouse gas emissions in their directors' reports.

Green enough?

Analysis of gaps in mandatory reporting undertaken to date suggest that ESG risks could be more thoroughly assessed and acted upon by companies.  PwC found that only 21 per cent of investors surveyed were "somewhat satisfied" and 72 per cent were "neutral" or "somewhat dissatisfied" with the ESG reporting of portfolio companies.⁹ This is also reflected in an HSBC survey which showed that two-thirds of institutional investors consider that they lack the right information to increase their climate-friendly investments, and would like to do so.¹⁰ In a move to mitigate some of these problems, the UK Government has acknowledged that streamlining energy and carbon reporting would be beneficial, and has proposed the introduction of a simplified reporting framework by April 2019.  

On the horizon, further significant developments to ESG reporting include:

• The European Commission is currently considering whether material ESG factors and long-term sustainability should be explicitly integrated into the fiduciary duties of institutional investors and asset managers.¹¹ 
• The Law Commission's report, "Fiduciary Duties of Investment Intermediaries", recommends that trustees should consider sustainability and ESG factors to the extent that they represent a risk to investment.¹² 
• The G20's Task Force on Climate-related Financial Disclosures report, published in June 2017, sets out the task force's recommendations for helping businesses to disclose climate-related financial information for the purposes of enabling this information to be considered in business and investment decisions, and to demonstrate that a company is considering climate issues.¹³

Turning green thinking into green growth

Making decisions in line with ESG factors can be financially advantageous.  For example, reducing waste and improving energy efficiency can lead to long-term savings, and exercising good corporate governance can help to avoid the consequences of reputational damage.  A UK Green Building Council member poll identified the eleven most common value drivers for businesses in the Built Environment industry.  At the top of this list were cost savings, talent attraction and retention, and customer attraction and satisfaction.¹⁴

The UK Green Building Council has also set out six steps that companies can take to maximise the impact of ESG activities:¹⁵

1. Ascertain scope of sustainable business activities: undertake a materiality assessment to identify key sustainability issues and sustainability activities.  ESG screening tools can also be used at this stage to identify future opportunities as well as risks for the business.
2. Identify key value drivers: identify the most important drivers of value for the business.
3. Develop performance indicators: based on sustainable activities, value drivers and how the information will be used.  Stakeholder engagement will be helpful in this process as it enables companies to identify the information that stakeholders deem important.
4. Metrics of measurement: decide how the data will be analysed and used.  These decisions will reflect the chosen performance indicators and the requirements of the company's stakeholders.
5. Method of data collection and reporting: data needs to be consistent to enable comparison over time.  Due to the importance that investors are placing on ESG information, companies may consider having their data certified or audited.
6. How the data will be acted upon: decide how, when and by whom the data will be used.  This is an integral step in implementing ESG initiatives.  Where data has been collected digitally, companies will have options as to how this information is both used by the company and presented to stakeholders.  

By refining its approach to ESG and producing clear and consistent reporting, the Built Environment sector should be better placed to attract investor and public confidence, identify and manage key risk factors, and deliver sustained financial performance.

ESG is undoubtedly becoming an increasingly important consideration for the global investment community in safeguarding long-term financial performance.  To keep up with this movement, companies need to place ESG factors at the core of their business strategies and budgets, and ensure that ESG risk management can be effectively implemented.  

Co-Author: Joanna Fox

<sup>1. https://www.ft.com/content/80c833ce-b994-11e7-8c12-5661783e5589   
2. https://www.ft.com/content/80c833ce-b994-11e7-8c12-5661783e5589 
3. https://www2.deloitte.com/insights/us/en/deloitte-review/issue-12/finding-the-value-in-environmental-social-and-governance-performance.html
4. http://www3.weforum.org/docs/WEF_GRR18_Report.pdf 
5. https://gresb.com/about/ 
6. https://gresb.com/about/ 
7.http://www.rics.org/Global/Whole_life_carbon_assessment_for_the_BE_PGguidance_2017.pdf
8.https://www.unpri.org/about
9. https://www.pwc.com/us/en/governance-insights-center/publications/assets/investors-corporates-and-esg-bridging-the-gap.pdf 
10. https://www.ft.com/content/0c485f68-96eb-11e7-a652-cde3f882dd7b 
11. https://ec.europa.eu/info/consultations/finance-2017-investors-duties-sustainability_en 
12. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/325509/41342_HC_368_LC350_Print_Ready.pdf 
13. https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Report-062817.pdf 
14. https://www.ukgbc.org/wp-content/uploads/2018/01/Capturing-the-Value-of-Sustainability.pdf
15. https://www.ukgbc.org/wp-content/uploads/2018/01/Capturing-the-Value-of-Sustainability.pdf</sup> 

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