Jan. 7, 2020
This article originally appeared on CoStar on 6 January 2020, written by Lisa Walker, Head of Market Regulation, IPSX.
Environmental, social and governance (ESG) factors are being increasingly recognised within the investment management industry as material to both management performance potential and investor demand. So, how much information should investors expect on ESG factors in the commercial real estate world as we move towards a new decade and how should conduct and disclosure be regulated? asks Lisa Walker, head of regulation at IPSX Group (International Property Securities Exchange), which is proposing to launch the world’s first regulated securities exchange dedicated to commercial property this year.
There is growing pressure on listed property companies to raise their ESG game, with Blackrock and Aviva Investors among the many global institutions increasing the heat on boards to demonstrate their companies’ credentials.
So, let’s first examine the challenges in trying to incorporate ESG policies into asset allocation methodologies and some of the information that IPSX will be providing on single assets to help investors decide which asserts to invest in.
There is no commonly agreed definition of “ESG”, and companies often focus on those factors which can be more easily defined or measured, i.e. environmental performance over social or governance factors. It can also be measured at different levels: ESG factors are relevant to the composition and management practices of the asset managers, as well as the performance of the underlying property assets which are being managed.
Increasingly, companies use the United Nations Sustainable Development Goals (SDGs) as the foundation for ESG reporting. This involves assessing which of the 17 SDGs are applicable to their company and assets.
In respect of companies managing portfolios of commercial real estate, some of the most relevant SDGs to consider would be:
When companies talk about being “SDG compliant”, it can mean very different things – they may have identified the SDGs they want to build into their business strategy, with or without ambitious plans about how they will improve performance against the SDGs. They may also offer differing levels of transparency around their plans and actions. Investors will therefore need to probe companies’ assertions around the application of the SDGs in more detail to determine what “SDG compliant” means for each company.
In respect of environmental factors, the Task Force on Climate-related Financial Disclosures is also helping to increase transparency around how companies identify and respond to climate-related risks and opportunities. Social factors consider internal features of a company, such as ensuring it has a diverse and inclusive workforce, as well as physical and external features, such as ensuring the real estate assets and the company’s activities connect the company in a sustainable way to the community within which it operates.
Governance is another factor which means different things to different investors. Listed real estate companies are required to have effective governance arrangements in place, including at least two independent directors. Effective governance arrangements ensure directors set and oversee the implementation of the business strategy and have regard to a wide range of factors which impact the long-term success of a company.
Investors should rightly expect that effective governance will contribute to the company being better run and that it will take a more sustainable approach to company performance. In real estate, this can also impact decisions on the types of tenants that companies will be willing to accommodate. For example, building managers may prefer tenants whose own business model is committed to diversity, sustainability and carbon reduction.
So, when institutional investors come to make investment decisions, they need to be clear in their own minds about what elements of ESG are important for them, and whether that focus is on the performance of the property assets or the company managing those assets.
Data Despite the definitional challenges, it is clear that investors want more detailed and granular information about the real estate opportunities they are investing in.
Listed companies are required to provide periodic disclosures to the market, principally around their financial performance. But they are also required to disclose non-financial information in the management report, including a review of the company's business and a description of the principal risks and uncertainties facing the company. The management report must include, if appropriate, an analysis using key performance indicators, including information relating to environmental matters and employee matters, where that is necessary to understand the development, performance or position of the business. Each company, in dialogue with investors, will determine what data it discloses in its management report as this is not prescribed and will vary from company to company.
Consistent and comparable ESG data across companies can make asset allocation different, but property valuation reports now include information on BREEAM and Energy Performance Certificate ratings. In addition, a number of organisations such as GRESB are focused on improving sustainability measurement and reporting for real estate and other real assets to increase consistency across the sector.
How will IPSX help investors?
As a Recognised Investment Exchange, IPSX issuers will be subject to the same governance and transparency requirements as all UK listed companies. This ensures regular reporting to shareholders. Listed companies also attract a diverse investor base, which helps to ensure a wider range of interests.
Where investors require a detailed understanding of the ESG performance of the company’s property assets, buying shares in a traditional listed property company with a diverse portfolio of assets will be increasingly difficult. These companies tend not to publish detailed information on the ESG credentials of each asset. For example, imagine the reaction from an ethical investment fund which has bought shares in a listed property vehicle whose portfolio also includes one asset which is exposed as being very environmentally damaging.
This is one of the reasons why institutional and retail investors are demanding more granular investment information from the real estate world, and where IPSX, the new stock exchange for property, will be able to provide the detail required for this new world.
From the New Year, companies owning individual properties with stabilised income – as opposed to property companies with large and opaque asset portfolios - will be admitted to trading on IPSX.
In addition to the standard reporting required of all listed companies, each company listed on IPSX will need to produce and publish a six-monthly asset valuation which will include a Strengths, Weaknesses, Opportunities and Threats (SWOT) analysis that should include disclosure on ESG factors among other matters.
There is a balance to be struck here – whilst wanting to provide transparency around the ESG performance of a company and its assets, we are mindful that being too prescriptive on disclosures could keep asset owners and their real estate assets in private hands and their ESG performance may not improve.
There is no doubt that, in global investors’ eyes, ESG’s time has come – in the real estate world, those investors now want the transparency that IPSX can facilitate.
Opportunities for investors to more effectively engage include:
1. Ensuring firms have, and disclose, policies which describe their commitments for embedding ESG factors into their business practices and management practices.
2. Increased reporting of performance against ESG factors.
3. Continued development of data standards to measure ESG. This will allow effective shareholder engagement to drive greater transparency and improve ESG performance.
IPSX will work in step with the industry as it settles on agreed forms of ESG measures and disclosures.