By Mike Parker
Environmental, Social, and Governance (ESG) first gained relevance in the early 2000s. At the time, the United Nations was trying to bring awareness to corporate social responsibility and sustainable development. It was a successful introduction to the concept, but the reporting side was mostly notional at the time. Twenty years later, there is $2.5 trillion (CAD) in ESG-linked assets under professional management in Canadian commercial real estate. And with that, a growing list of global investors who do not just want to measure financial returns from their investments but also their broader societal impact.
Considering the inherent limitations in the current ESG measurement, the question arises: is it time to refine and enhance ESG or separate the three?
Here are three potential challenges specific to real estate:
1. Are you only measuring what is easily attained and ignoring what would be more complex?
Consider greenhouse gas (GHG) emissions measurement. ESG rating agencies have identified firm-level GHG emissions as a crucial Environmental (E) score component. However, the focus is typically on Scope I emissions, which are directly controlled or owned by the management firm or owner of the building. This approach overlooks Scope III emissions produced by suppliers or vendors. As a result, a firm’s ESG rating may present it as more environmentally friendly than it actually is by not accounting for the broader emissions impact.
2. Lack of standardization:
ESG measurement frameworks and criteria can vary significantly between different rating agencies. This lack of standardization leads to inconsistent assessments and makes it difficult for investors to compare properties’ sustainability performance accurately. Inconsistent metrics and benchmarks result in unreliable data, which can mislead investors about the actual environmental, social, and governance impacts of their investments.
The absence of a universally accepted ESG disclosure standard in commercial real estate creates a significant challenge. This lack of standardization leads to inconsistent assessments and underscores the urgent need for a common baseline. Without this, it’s incredibly difficult for investors to compare the sustainability performance of one building to another, let alone an entire portfolio. In a time when clean, reliable data is imperative, the current lack of standardization can mislead investors about their potential investments’ actual environmental, social, and governance impacts.
3. What about social and governance factors:
ESG ratings often place a heavy emphasis on environmental metrics, sometimes at the expense of social and governance aspects. Factors such as tenant health and safety, community impact, and building management practices are crucial for sustainable investment in commercial real estate. However, they may not be adequately reflected in ESG scores. This imbalance can lead to overemphasizing environmental performance while neglecting equally important social and governance considerations. Addressing this imbalance is crucial to ensure a more balanced and comprehensive ESG measurement.
These limitations highlight the need for more comprehensive, standardized, and balanced ESG measurement approaches for investors aiming to make sustainable commercial real estate investments. And while sustainable certification programs can certainly help give potential investors an apples-to-apples comparison, but that is not enough if you are relying on how ESG reporting currently exists.
The most obvious answer is to unbundle ESG into its three separate reportable components across all industries. CEOs would then be able to manage all three independently. This would allow them to deliver on the one(s) their company or industry would most impact. This is not to say the other(s) will be ignored; it is just saying that they can address the one(s) with an obvious advantage in finding success.
This will also allow investors to address their particular investment objectives more effectively. If industries and investors work hand-in-glove with rating firms, mutual funds, investment banks and advisory firms, this could create a more effective and efficient ecosystem. One of the most needed benefits would allow firms to publicly declare their goals and intentions within a guided regulatory framework. This flexibility would encourage companies to be more innovative and responsive to their needs and the good of society. The current cookie-cutter ESG reports would be replaced with ones that reflected the unique needs and opportunities of the companies writing them.