Navigating the global ESG regulatory landscape

by Adam Branson

reading time: 14 minutes

26. February 2024

For years now, it has been apparent that leading property funds and developers have been significantly ahead of government when it comes to environmental sustainability. In short, regulation has failed to keep pace with advances at the upper echelons of the market.

Now, however, that is starting to change, with many governments realising that they have to set tougher regulatory frameworks for carbon reduction in the real estate industry if they are going to have any chance of hitting their commitments in terms of the 2015 Paris Agreement, in particular.

The problem is that there is no unified global standard, resulting in a complex landscape which is difficult to navigate and tricky for investors to judge and compare performance. Rather, individual countries and groups of countries are putting in place their own rules. The EU does at least set bloc-wide directives but, even here, their adoption as national laws diverge. All are chasing the same basic aims, but how they are seeking to achieve them differs significantly.

So, how are the various regulatory regimes evolving? How do they dovetail with PATRIZIA’s own strategy when it comes to sustainability? And how does the company cope with the need to keep on top of multiple regimes given its global investment profile?

The Paris Agreement catalyst

According to Edward Pugh, Director of Sustainability at PATRIZIA, environmental, social and governance (ESG) regulation has increased exponentially since the 2015 agreement and since members signed up to the United Nations’ (UN’s) sustainable development goals (SDGs). “The regulatory landscape is getting more and more complicated and more difficult to navigate,” says Edward.

“It all really kicked off from 2015 when 196 parties, including every European country, made legally binding commitments to get to net zero by 2050. In Europe, that was followed by the Green Deal in 2019, which is a package of different policy initiatives to drive that 2050 target, as well as the EU Sustainable Finance Framework, which is essentially trying to decouple economic growth in Europe from the destruction of the environment by increasing transparency and driving investment towards sustainability.”

Further overarching directives followed and more will be forthcoming. The revision of the Energy Performance of Buildings Directive (EPBD) – the main EU directive relating to energy efficiency requirements for most buildings, including existing stock – is a good example. That is potentially a gamechanger given that 75% of buildings in the EU are considered inefficient, up to 95% of the buildings that exist today are expected to still be around in 2050 and the renovation rate currently stands at around 1%.

“A few months ago, the European co-legislators reached a provisional agreement on the revision, which will introduce far stricter renovation requirements for buildings, including minimum energy efficiency standards, that will take effect in the next 5-10 years,” says Edward. “The exact requirements are subject to national implementation plans but it will likely take effect as soon as 2026, which is very soon from a real estate perspective. It’s going to be very significant.”

According to the European Commission’s impact analysis, investment in building renovation is expected to sharply increase after 2025, when new standards come into force, requiring up to €275 billion in additional investment each year.

Edward Pugh, Director of Sustainability at PATRIZIA

UK promises to keep pace but approach remains uncertain

That’s the situation in the EU, which Edward says is considered to be leading the way in terms of real estate regulations on the global stage. He adds that since diverging from the EU’s regime, the UK has promised to keep pace, according to its stated plans, but a series of recent delays and U-turns put that into question.

“The EU is seen as being the most ambitious in terms of this wave of regulations coming in and minimum standards and accounting,” says Edward. “But the UK is pretty similar. So far, the UK hasn’t diverged much from the EU, and the UK also wants to position itself as a centre of sustainable finance, so it’s basically coming up with comparable regulations to the EU.” Yet, while the EU has been criticised by industry groups for its hasty implementation of sustainable finance regulations, deemed by some as ineffective, the UK’s approach remains uncertain.

Indeed, in some ways, the UK – alongside the Netherlands – has been slightly ahead of its European neighbours. On 1 April 2023, the Minimum Energy Efficiency Standards (MEES) regulation, which is intended to improve the energy efficiency of commercial property, changed. Before that date, property owners could not grant a tenancy to either new or existing tenants of properties that have an energy performance certificate (EPC) rating of F or G – the two lowest ratings.

From the beginning of April 2023, however, property owners could no longer legally continue to let properties that have an EPC rating of F or G. It is likely that the regime will be toughened up significantly and, in real estate terms, very quickly: the most recent UK Energy White Paper, after all, proposed that the minimum standard for commercial leases will rise to a C rating in 2027 and a B rating in 2030, with fines for non-compliance also likely to strengthen.

Calling upon local knowledge and expertise

That’s just the picture in the EU and the UK. Of course, regimes in other key real assets territories, such as North America and Asia Pacific (APAC), in which PATRIZIA has investments, are progressing in different ways and to different timetables. Keeping on top of the changes and ensuring good governance is clearly challenging, but Edward believes that the regime the company has put in place is robust.

Edward is part of a global team which leads on PATRIZIA’s sustainability strategy, with 16 employees in all tasked with a core remit to implement ESG across the business. However, he says that sustainability and regulatory expertise is knitted into the organisation at every level. “It‘s difficult for us as a central sustainability team to stay on top of the country-specific regulations and the different interpretations and implementation of the EU directives,” he says.

“But PATRIZIA has local knowledge and expertise in each jurisdiction. For example, we have regional ESG Managers and a network of ESG champions with specialists in each country. That’s just one way in which we can pool our knowledge of local requirements. And then our role in the central sustainability team and on PATRIZIA’s ESG Committee is more about looking at those overarching directives and regulations that affect the whole business.”

Horizon-scanning

While dependent on the expertise that PATRIZIA has on the ground, the role of Edward’s team is clearly critical. “Our job is to do a horizon scan and introduce the new upcoming regulations to our ESG Committee, which has representatives from all relevant business departments,” he explains. “We then come up with a central strategy for addressing the situation, which might then require the local teams to get more involved.

“It’s really important that we have that central data strategy and a platform that can accommodate all of these different data points to allow us to do the level of analysis that’s required.”

Edward PughDirector of Sustainability at PATRIZIA

“We also rely on our value chain; for example, the property managers that we instruct in different jurisdictions. We expect them to stay on top of buildings’ specific legislation, for example. So, there are different levels of regulation that come into play and that we need to manage.”

It’s certainly a complicated situation to manage, but one made easier by the fact that PATRIZIA is actively involved in numerous industry associations and is investing heavily in digital technology that makes compliance in multiple jurisdictions far easier.

“All of these different frameworks and disclosure requirements, as well as the number of different data points that you need to capture to accurately track risks and opportunities across all the different levels of the business, require quite a robust data strategy and data collection,” says Edward.

“There’s a whole range of technology solutions that we use. We need a multifaceted approach in order to get investment-grade data. It’s really important that we have that central data strategy and a platform that can accommodate all of these different data points to allow us to do the level of analysis that’s required.”

It also helps that PATRIZIA’s own sustainability strategy already aligns with the Paris Agreement and the UN SDGs. “If you go back to the Agreement and the SDGs, everything is working in the same direction, which is towards achieving carbon neutrality by 2050,” says Edward.

“That is also the basis of our internal strategy. So, all these regulations that are going to be driving activity are already in line with our commitments to be net zero by 2040, which is ahead of the legally binding commitments of each country in which we operate. Our strategy is very well aligned with what the regulations are trying to achieve.”