EU Regulatory Environment Changes (SFDR, EU Taxonomy)
Published on 26 May 2021
Our industry is engaged in an important dialogue to improve sustainability through ESG transparency and industry collaboration. This article is a contribution to this larger conversation and does not necessarily reflect GRESB’s position. Please refer to official GRESB documents for assessment related guidance.
The European Green Deal has launched an ambitious plan to transform the EU economy to a sustainable, climate neutral economy by 2050. To support the plan a range of working groups, action plans and new regulations have been established. All parts of the Green Deal are relevant to real estate, but in particular the outcomes of the EU Action Plan on Sustainable Finance are worth paying close attention to in the coming months. In recognition of the crucial transition role to be played by private finance, the Action Plan was developed to direct private investment to support the transition to a sustainable economy. Put simply, ten key actions were identified and working groups were established to deliver three overarching goals:
Re-orientate capital flows towards sustainable investment
Mainstream sustainability into risk management
Foster transparency and long termism
Two resulting regulations from the Action Plan are gaining interest and raising many questions for the commercial real estate investment sector. Below we will review both regulations; their objectives, key dates, provide advice and demonstrate how they relate to one another.
EU Taxonomy is a standardised classification system designed to help users determine what is environmentally sustainable. To achieve this the Taxonomy sets out a common set of criteria under which activities can be screened. Sector specific guidance and criteria is available, including real estate standing assets, refurbishment and construction. The overarching goal of the Taxonomy is to set minimum thresholds, facilitate comparison, and ultimately prevent ‘greenwashing’. The foundation of the Taxonomy is based on six environmental objectives:
Climate Change Mitigation
Climate Change Adaptation
Protection of Water and Marine Resources
Circular Economy Transition
Pollution Prevention & Control
Biodiversity & Ecosystem Protection
Under the Taxonomy an economic activity is considered environmentally sustainable if it makes a substantial contribution to one of the six objectives above, while doing no significant harm to the remaining five objectives. The main challenge posed by the Taxonomy, is the fact it is still in development. In April 2021, detailed screening criteria for a substantial contribution to climate change mitigation and climate change adaptation was published but is technically still in draft format. For both objectives technical screening criteria specific to the real estate sector is available and entities are encouraged to incorporate the criteria into minimum standards and best practice. Guidance for the remaining four objectives is in development, with draft criteria expected in the latter half of 2021. The scope of the Taxonomy is substantial and screening criteria available to date is considered just the beginning. For anyone asking, ‘what about the social side?’ A separate working group is developing a complimentary Social Taxonomy following the same structure and approach. The purpose of the Social Taxonomy is to support an equitable and just transition for the EU economy. More information on the Social Taxonomy is highly anticipated and expected by Q3 2021.
Sustainable Finance Disclosure (SFDR)
The Taxonomy is connected to and will support disclosure requirements under the Sustainable Finance Disclosure (SFDR) regulation. On 10th March 2021, SFDR came into effect, marking the start of a significant transition for the financial services sector. SFDR introduces obligations on financial market participants and financial advisors to disclose how they integrate ESG factors in their risk processes and in turn, impacts how they market their products. Requirements of the regulation will apply to both ‘corporate’ and ‘product’ level, for real estate, funds are considered products. As of 10th March 2021, financial market participants are expected to have published risk policies on their websites, disclosed how sustainability considerations are incorporated into remuneration and established a mechanism to disclose adverse sustainability impacts in pre-contractual documents. At the ‘product’ or fund level pre-contract disclosure and marketing actions required are dependent on Article alignment – Article 6, 8 or 9.
Article 6 – (Basic) comply or explain.
description of how sustainability risks are integrated into investment decisions.
results of the assessment of the likely impacts of sustainability risks on the returns.
Article 8 – the fund promotes environmental or social characteristics.
detailed information on how those characteristics are met.
Article 9 – sustainable investment as the fund’s objective
detailed information on how the objectives will be met. Including methodologies to measure and monitor the sustainable investment.
From a pragmatic point the SFDR regulation, regulatory technical standards (RTS) and backing guidance are far from complete. Across the wider financial services sector there are still many questions and a lot of uncertainty surrounding the regulatory requirements. As of March 10th many financial market participants and funds are following available information to comply or explain under a best effort approach. Many are struggling to unpick the differences between the terminology of Article 8 ‘characteristics’ and Article 9 ‘objectives’ with the line between both somewhat blurred. More guidance is expected but, in the immediacy, specialised advice and peer review is advised to make a start.
Both SFDR and The Taxonomy reflect the scale and ambition of the European Green Deal, but there is still a lot of work remaining before either is considered complete. Many industry bodies, financial market participants and real estate funds have expressed concerns over the current and near future regulatory requirements, citing incomplete guidance as a significant challenge to compliance. That said, action is required; seek specialist support (legal advisors and ESG experts), review your requirements under both regulations, develop a framework to support compliance and communicate key dates to stakeholders.
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