How to use ESG Due Diligence to Improve Decision Making
This blog gives an overview of key ESG factors to incorporate into Due Diligence (DD) to ensure risks, liabilities and opportunities are identified. A key aspect of ESG DD is to enable clients to understand whether the asset currently complies with current regulations and legislation. By initiating the consideration of ESG at the earliest possible stage the information can be used during asset management.
ESG is not a one size fits all, certain aspects will be relevant to individual investors and their decision making, as it is decided what is material for each case. Materiality will differ due to a range of factors including asset class, client sustainability targets and risk apatite. Currently a key consideration within the commercial real estate industry is the Minimum Energy Efficiency Standards (MEES) to meet tightening Energy Performance Certificate (EPC) regulations. However, a more comprehensive approach is required including considering water consumption, operational energy use / gas consumption, CO2 and GHG emissions and waste.
Investors need to ensure they can measure and understand social and governance elements as well as environmental changes to they can review ESG Key Performance Indicator (KPI) at asset level and determine high priority improvement opportunities. By incorporating all three factors at the DD stage, and as early as possible, there are several beneficial opportunities.
- Early informed decision making
- Protection of medium to long term asset value
- Effective governance and sustainability leadership
Why should we use Environmental Key Performance Indicators (KPIs)?
Environmental KPIs are quantifiable measures reflecting the environmental performance of an organisation in the context of achieving wider goals and objectives. The focus is on key measures i.e., those measures most important to an understanding of an asset. KPIs are beneficial due to cost savings and productivity gains, increased attractiveness to the investment community and employee recruitment. This will inform fund level reporting, ensure governance, and increase investor confidence.
A key consideration at DD stage is the availability of data to provide a suitable and robust assessment, the larger the wealth of data the better the picture of ESG risk can be built. There are a variety of sources for ESG factors.
Sources for ESG factors include:
- Raw data – Utility bills, building management systems and logbooks
- Third party reports – Energy audit reports and certification reports
- Independent databases and vendors – Geospatial database, green rating systems and flood records
- Site walkover – A qualified professional to determine status and identify risks/opportunities
Once the information is collated, it can be reviewed and put in context and then recommendations and conclusions can be determined.
Key Considerations for ESG
Below are several of the key considerations to be reviewed for environmental, social and governance factors. There are other considerations not mentioned that can be applied for each factor.
5 Environmental Considerations
- Regulatory Energy Performance – Review of the EPC to determine if achieving an EPC of ‘C’ by 2027 and ‘B’ by 2030 is feasible, determining opportunities for improvement and associated CAPEX.
- Operational Performance – Evidence shows that there is almost no correlation between a building’s EPC rating and actual energy and carbon emissions. Understanding the current performance of building by using Energy Use Intensity (EUI) benchmarks and determining the level of investment needed to improve energy efficiency, lower bills, and enhance asset value;
- Climate Change – Overheating and flooding are two of the main physical risks for buildings, reviewing the Environmental Agency (EA) stress maps to determine high-level risk to buildings allows for consideration to be given to future mitigation or an understanding of the requirements to adapt to the potential risks.
- Waste – ‘Reduce, Reuse & Recycle targets on site are eliminating plastic waste and preventing Marine Plastic Pollution (MPP), DD includes onsite waste audit to identify risks associated with hazardous waste streams and identify opportunities to improve current practices.
- Land Contamination – A Phase I environmental survey identifies risks to human health and the environment onsite, as land contamination can be a critical investment criteria
3 Social Considerations
- Occupational Wellbeing – There is a demand for ‘green buildings’ which can result in increased occupier attraction retention and asset value. Auditing the asset and any previous assessments as well as reviewing this information against available standards such as the WELL building standard will enable a greater understanding of how current and future occupiers will interact with the building and where opportunities for improvements may be present.
- Transport and Accessibility – Location and accessibility influence occupant travel patterns, encouraging/supporting active commuting and increasing walking/cycling/public transport to work.
- Biodiversity – Biodiversity Net Gain and Task force for Nature-related Financial Disclosures (TNFD) facilitating biodiversity targets through the existence of green walls, beehives, and bird boxes on site
3 Governance Considerations
- Current Governance of Site Practices – Good governance can enhance ESG performance and the health and wellbeing of a building’s occupants. Determining what processes are in place, recorded KPIs (such as energy usage and tenant engagement) and identifying current onsite energy user education measures provides vital information to identify opportunities during asset management.
- Ozone Depleting Substance (ODS) and Fluorinated Gas (F-Gas) – Identifying the use of ODS and F-Gases as they can provide an early indication of future refurbishment requirements. Any presence of these substances should be kept in and F-Gas logbook available for review
- Certification – A formal system for managing environmental risks as a requirement of various rating/certification schemes i.e., ISO 14001, BREEAM and LEED
Material ESG factors can differ between clients, however, this blog has summarised how some of these factors can be considered at the DD stage, putting into context material ESG risks and liabilities, protecting the medium-long term value of assets when considering the changing investor, occupier and owner requirements.
Furthermore, by incorporating thorough ESG DD, effective governance and sustainability leadership which may attract additional capital, investors and partnerships is demonstrated prior to mandatory regulation.
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