by Patrick Rogers, Senior Sustainability & Energy Analyst

Disclosure requirements and ESG risk: Understanding changes in sustainable finance

The effects of climate change are being seen in ever-increasing clarity this summer: wildfires and heatwaves across the world have begun earlier in the season and with greater intensity, with burnt area as of July in the Mediterranean four times greater than 2006-2021 averages. The need to reach net zero carbon emissions as soon as possible has never been clearer.

Meeting global climate goals will require a paradigm shift in our understanding of traditional performance metrics and commensurate buy-in from the financial community. Globally, asset managers and owners are under increasing pressure from policymakers and customers to provide information on the Environmental, Social and Governance (ESG) impact of their funds and investment holdings as part of a broader push towards net zero carbon emissions.

In recognition of the significant contribution of real estate to climate change – accounting for roughly 40% of global emissions – there is a growing obligation for lenders operating in the real estate sector to develop responsible investment strategies which incorporate ESG factors such as emissions reduction and climate resilience of assets into investment decisions.

As argued in a recent article by Hugh Falcon, Senior Analyst at Longevity Partners, increasingly stringent legislative requirements in the UK and Europe are progressing the need for comprehensive ESG due diligence on prospective investments to ensure compliance and mitigate future regulatory risk.

In the UK, mandatory reporting on climate-related financial information (TCFD reporting) was introduced in April 2022 for UK traded companies, banks and insurers, as well as private companies with over 500 employees and £500 million in turnover. The UK is the first G20 country to enshrine this kind of reporting into law, with G7 governments all pledging to make this mandatory in the coming years.

At the EU level, the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy Regulation have strengthened transparency requirements for financial products and codified the rules around the definition of a ‘sustainable’ economic activity. Lenders targeting Article 8 or 9 classification for their funds under SFDR will need to disclose and consistently report against clear sustainability indicators to show investors that they are delivering on their green claims.

In the US, the recent proposal by the Securities and Exchange Commission to mandate climate risk disclosures in annual reporting demonstrates that ESG transparency laws are fast becoming the global standard beyond Europe.

The effect of these regulations will be to increase the amount of ESG-related information on the market, which will help to delineate firms and assets with strong ESG performance from those without. This is intended to raise market standards as well as to facilitate long-term thinking and the channelling of capital towards legitimately sustainable investments. As a consequence, firms with poor ESG reputations may find it difficult to attract funding from an investment community who increasingly demand high levels of environmental and social stewardship. For companies to remain competitive against their peers, turning these reputational risks into opportunities will be key.  

Embedding ESG risk analysis into the due diligence process is one way to do that, giving lenders a clear understanding of a given transaction’s impact on the environment and society. Given the evidence that strong ESG performance is associated with reduced default risk, these analyses can also help to inform risk profiles and associated interest rates.

Longevity Partners offers ESG Risk Due Diligence services at both corporate and asset level using criteria developed from industry leading institutions such as UNPRI, GRI, BRE, and the TCFD. Our screening tool reveals the ESG credentials of prospective investments, raises red flags, and identifies opportunities for the use of sustainable debt instruments where appropriate.

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