ESG in Commercial Real Estate Faces a Reckoning Amid Scrutiny Over Measures

Political winds also shifting as GOP tees up standards as issue in midterm elections

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If you expect the criticism engendered by ESG investing to stop it, you’ve got another thing coming, especially in commercial real estate.

“ESG is not going away,” said Peter Miskovich, executive managing director and head of strategy and innovation consulting at JLL, one of the world’s biggest real estate services companies. “As a firm, we’re very committed to ESG principles in terms of real estate investments, as well as long-term ESG-leading practices for our enterprise clients.”

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Regulators around the globe got the same idea pretty much at the same time. That is, that ESG — which stands for Environmental, Social and Corporate Governance, and means that companies are urged to pursue ever more progressive and socially responsible policies for the highest possible rating — has no universally accepted principles behind it. Regulatory agencies everywhere, including the U.S. Securities and Exchange Commission and the International Sustainability Standards Board, have initiated efforts to develop guidelines that rating agencies and others tracking companies’ ESG efforts can use to help investors feel more confident that a high rating actually means something.

Meanwhile, the 20-plus-year push to make companies pursue climate-positive practices, eliminate pollution and seek a more diverse, less prejudicial workforce and executive staff has fomented criticism from both the left and right, an especially decisive prospect with the right expected to score victories in this fall’s midterm elections.

Former Vice President Mike Pence, a Republican stumping for GOP candidates, said he wanted to “rein in” ESG investing, that energy companies being too solicitous to such efforts “allow left-wing radicals to destroy America’s energy producers from within,” according to a New York Times article in May. Billionaire investors Peter Thiel and Bill Ackman have urged companies to back away from environmental, social and political issues. 

The Heritage Foundation and the National Review, a right-leaning think tank and publication, respectively, have published pieces stressing that too much devotion to “woke” causes forces businesses to stray from economist Milton Friedman’s principle that the only purpose of a business is to legally pursue profit.

Last month, leaders in Utah, including Gov. Spencer Cox, co-wrote a letter to Standard & Poor’s Global, one of the rating companies scoring ESG efforts, calling those efforts “counterproductive, misleading, potentially damaging to the entities being rated, and possibly illegal” and blasting “the unreliability and inherently political nature of ESG.”

On the political left, there are articles like a New Republic story in October declaring that “climate-friendly investment funds are a scam” and likened the push for ESG to former Vice President Al Gore’s advocacy of “sustainable capitalism,” in which greed and good, two opposing goals, are purported to work together when they really don’t.

Sometimes ESG ratings are based on the notion that being environmentally or socially progressive better protects a company from lawsuits and regulatory crackdowns and is therefore good for the bottom line. Others believe such policies might attract more capital from investors or funds that want to support forward-thinking companies.

There is big money at stake. A Bloomberg analysis from early 2021  predicted that some $1 trillion will be raised by such investment funds over the subsequent five years.

For commercial real estate, there’s two primary goals: One is for companies to be seen as environmentally and socially progressive themselves, that they operate buildings that are carbon-neutral or better, and that their management and rank-and-file staffs are beyond reproach. The other is to be seen as renting to tenants who share these goals.

Government regulators, being government regulators, can’t just impose standards as if turning on a light switch. They have to submit proposals, wait for public and stakeholder comments, consider those comments, issue revised standards, wait for politicians in an increasingly polarized Congress to chime in, see if the lawmakers want to intervene, and then and only then can regulators issue rules that have the force of law. Maybe.

The SEC is in the midst of setting standards for climate-related disclosures aimed at investors. The rules would normally go into effect following a final vote by the commission, but the 60-day comment period that began in March was extended to June 17, according to an SEC spokeswoman. The rules would require public companies to issue periodic reports on climate-control efforts, including those that “are reasonably likely to have a material impact” on their finances.

“Our core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure,” SEC Chairman Gary Gensler said in a statement  on the initiative.

On May 25, the SEC voted to tighten the rules regarding ESG, which are still subject to public review before they go into effect, according to a story in the Wall Street Journal. One measure would require more scrutiny of the names of funds that promise an ESG focus, the other would increase those funds’ disclosure requirements. 

In other regulatory initiatives, members of Congress have intervened and pushed through measures that halt the regulatory process and/or overrule the proposals. Nothing of that nature has happened yet  in this particular case.  

It’s not just companies whose actions directly impact the environment, either the physical one or social interactions. Banks and insurers, who by funding, lending and insuring such actions play critical roles, are also under pressure to examine their impacts, wrote analysts from Fitch Ratings in an April report. Like S&P, Fitch is a non-government rating agency also keeping score of corporate ESG efforts.

Change in this area may come in the form of “stress testing,” similar to that imposed on financial institutions following the financial meltdown of the late `00s, to see what companies have to do to reduce their climate impacts and how much they will cost. In addition to the SEC and the International Sustainability Standards Board, the European Union is involved in those efforts, as are individual countries such as Brazil, Australia, Canada, Singapore, Malaysia and the United Kingdom.

There’s “a broad-based move towards alignment,” Fitch analyst Marina Petroleka said in the report. “By year-end, we will have a clearer picture emerging on the future ESG disclosure landscape, with 2023 a key year for start of implementation.”

Asked what would happen if Congress flips to Republican control, Petroleka told Commercial Observer “it remains to be seen” if the midterm election thwarts the SEC’s ambition to get the rules in place by year-end. “The SEC has been preparing for the final proposal to face legal challenges, so that has been a risk on the horizon to implementation from the beginning,” she said.

Billy Grayson, executive vice president for Centers and Initiatives at the Urban Land Institute, a Washington, D.C.-based real estate industry think tank, said real estate has a huge interest in how these efforts pan out.

“There is a tremendous amount of value at stake for real estate,” Grayson said. “There’s some level of third-party assurance that reporting is being done effectively, but it’s nowhere near the audit-level quality of financial reporting that we come to expect today. And, as regulation advances, ESG data and reporting is going to have to look a lot more like financial reporting.”

In April, ULI published an article on its website generally supportive of global efforts to regulate greenhouse gas emissions, but warned that “compliance could get complicated.” The article broke down the ways regulating this area could get messy.

These efforts will continue regardless of what happens in the midterm elections, including if the GOP takes over Congress early next year, Grayson said.

“Right now it’s investors, tenants and regulators,” he said. “If people who didn’t believe in regulating this take over, the investors and tenants will continue to drive it. If your cost of capital or access to capital and your ability to attract tenants is predicated upon some level of ESG performance, real estate is still going to have to navigate that landscape.”