Rising temperatures, rising sea levels, and rising frequency of extreme weather events capture attention, cause billions in damage, and are now the focus of many investors’ business decisions–with real estate investors demanding complex, comprehensive data that can feed their risk analysis and allow them to better see the impact of climate on their investment decisions.
As investors attempt to quantify the future effects of climate change on their assets and portfolios—estimates rise into the trillions of dollars— authorities around the world are moving to require more widespread, more comprehensive, and more auditable climate disclosure from companies, particularly companies that are publicly listed. The EU’s Sustainable Finance Disclosure Regulation (SFDR) and related upcoming rules; new regulations for publicly traded companies in Japan and Hong Kong; and the recently released U.S. Securities and Exchange Commission proposed climate disclosure rule are raising the stakes for accurately assessing and reporting on climate-related risk across all industries, including real estate.
“Investors are trying to hedge against the downside risk of extreme weather events and the long-term threat of climate change impacting the value of their buildings. And they’re also trying to hedge against the risk that long-term climate regulations and a price on carbon will erode the value of their more energy-intensive buildings,” says Billy Grayson, executive vice president of the ULI Randall Lewis Center for Sustainability in Real Estate. “Being able to accurately identify and reduce that risk through retrofits and mitigation measures, or through repricing those assets or through divestment, is an important part of their larger investment strategy.”
Many publicly-traded companies and funds already voluntarily report some climate data, both in their own materials for investors, such as sustainability reports, and also to international data and benchmark organizations such as GRESB. Investors also contract with third-party climate risk analysis firms such as MSCI, ISS ESG, and Sustainalytics. Those firms not only collect data from companies, but also produce their own climate impact estimates, ratings, screening tools, and more.
“But the idea that climate-related disclosures will be given the same level of scrutiny by investors and regulators as your financial disclosures is a new development,” Grayson says.
Many questions about how investors will use required information and what that means for the real estate industry remain unresolved. How will disclosures such as the SFDR and the proposed SEC rules be incorporated into investment decisions? Will investors treat information about physical risk differently than information about greenhouse gas emissions? How will the disclosures affect the pricing of real estate assets vs. other investments? How will the required disclosures compare with information that investors now get from companies or third-party firms? Can differences across regions be resolved? Will the requirements simplify analysis by improving and aligning data reporting across companies and regions, or will they add layers of complication? Are there steps regulators should consider in fine-tuning disclosure rules in the future?
“As investors, we need high-quality, financially material climate data to help us identify and price investment risks and opportunities,” says Laura Craft, head of global environmental, social, and governance (ESG) strategy at Heitman, a global investment management firm, invested in public and private investments. “The lack of a regulatory standard means many companies are not disclosing climate data and those that do, disclose data inconsistently. Incomplete data sets present challenges for investors as we seek to identify the climate risks and opportunities to price-in. We see new regulations as offering the potential to enhance data disclosure while consolidating ESG methodologies and a number of the voluntary ESG frameworks. As the quality of ESG data advances, analysts will increasingly use the data to derive the value of an asset or a company. Climate risks such as an overexposure to physical risks within an investment will likely lead to a price discount. Conversely, companies that significantly reduce carbon emissions could achieve a price premium.”
Disclosing Climate Risk
Data disclosure requirements are rolling out around the globe. In Japan, for instance, the largest publicly traded companies this spring were required to begin disclosing greenhouse gas emissions and other climate-related data. In Hong Kong, the stock exchange requires listed companies to report regularly in ESG issues, and to either discuss issues related to emissions, climate change, and more, or explain why they can’t provide specifics.
In the EU, the Sustainable Finance Disclosure Regulation (SFDR) requires asset managers and others financial market participants to disclose how environmental, social, and governance (ESG) factors affect them and their products. Investment funds fall under three classifications, meant to describe the degree to which sustainability factors into a fund’s investment strategy. Article 6 funds don’t take sustainability into account in their investment process; Article 8 funds (sometimes casually termed “light green”) include ESG goals among other characteristics; Article 9 funds (“dark green”) target sustainable investments.
The EU is also moving toward requiring large listed companies, banks, and insurers to report climate data as part of the Corporate Sustainability Reporting Directive (CSRD), and to more precisely categorize activities that contribute to environmental objectives via its EU Taxonomy. Other markets, including the UK, Singapore, and New Zealand, also are moving toward disclosure requirements.
In the US, the Securities and Exchange Commission (SEC) in March proposed a regulation that would require publicly listed companies to provide information about climate-related risk that is, according to the SEC, “reasonably likely to have material impacts on its business or consolidated financial statements, and GHG [greenhouse gas] emissions metrics that could help investors assess those risks.”
The proposed SEC rule and many of those used elsewhere in the world are modeled in large part on a framework developed by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD), an international industry-led group charged with identifying information needed to help investors, lenders, and insurers assess and price climate-related risk. The TCFD’s voluntary framework broadly covers disclosures about governance, strategy, risk management, and metrics and targets. It’s meant to help users weigh short-, medium-, and long-term risks.
The SEC’s proposal and others also incorporate the Greenhouse Gas (GHG) Protocol, a widely cited accounting framework for measuring and classifying emissions. It uses the concept of “scopes” to describe emissions:
- Scope 1 emissions are those directly controlled by a company—for instance, the emissions from burning natural gas on-site to heat a building.
- Scope 2 emissions are indirect emissions, in real estate these are largely the GHG emissions associated with generating the electricity buildings use.
- Scope 3 emissions are more complex, defined as those that are a consequence of a company’s operations, but not owned or controlled by the company—for example, the carbon emissions associated with the manufacturing of building materials that go into the construction of buildings.
Many details on rules are still uncertain. In Europe, how will regulators determine whether reporting supports Article 8 or 9 classification? In the US, will the SEC weigh in on whether a real estate owners’ Scope 3 emissions are material? Timetables for which companies will have to report and what they will have to include are still hazy, too. In Europe, negotiations are underway among various EU government entities—the European Commission, the Parliament, and the Member States in Council. In the United States, public comments on the proposed SEC rule closed, but legal challenges to any final rule are expected.
Public comments on the SEC proposal provide insight into the thinking of investors and companies, including companies in the real estate industry. There are tens of thousands of comments via form letter, both pro and con. There are also more than 4,000 signed, detailed comments from individual and institutional investors, investment advisers, trade groups, scientists, politicians, and public companies large and small.
Some commenters adamantly oppose the proposed rules, saying they exceed the SEC’s authority and impose excessive costs on companies. Other comments could be called, “yes, but… .” That is, they applaud the SEC for addressing climate risk and proposing disclosure but take exception to some of the specifics.
For instance, BlackRock, the big asset management firm, has been a vocal proponent of mandatory climate-related disclosures in line with the TCFD. “Because we firmly believe that climate risk is investment risk, we … write to express our strong support for the Commission’s goal of implementing a framework for public issuers to provide investors with more comparable and consistent climate-related disclosures,” BlackRock wrote in its comment letter. “…Investors on behalf of clients are not just looking for more data on climate risk, they need high-quality climate-related information that is (1) relevant to understanding climate-related risks and opportunities, and (2) reliable, timely, and comparable across jurisdictions.” The comment letter, however, goes on to critique parts of the proposed rule that “go beyond or differ from the recommendations of the TCFD.” It says that requiring disclosures that don’t align with that international framework “would obscure what information is material, have limited value to investors, heighten compliance costs and reduce the ability to compare across companies and regions.”
ULI and Heitman will be further researching the topic of climate risk disclosure data for a report to be released in fall 2022. If you would like to weigh in, email Lindsay Brugger at [email protected].