ESG-related regulation is seen as a challenge by players in the real estate market.
Requirements governing ESG reporting and practices are covered mostly by EU sources of law. Slovak ESG rules are fragmented in partial legislation or wait for implementation based on EU law, making the legal framework perceived to be too complex and unclear.
Many companies still see the ESG requirements as a minimum standard they need to comply with. They think of ESG as a “to-do list” they should “tick as done” to be compliant with the law. This is yet another piece of evidence of their misunderstanding of the principle of ESG. Many of them see ESG as a costly burden to their business activities and as an additional cost that they cannot transfer, e.g., to tenants or customers yet. Those will be likely outperformed by their competitors, which perceive ESG as an opportunity and proactively go “above and beyond the minimum”. They are using ESG as a tool to create the long-term value of a real estate project.
Capital is adopting net-zero approaches to portfolio selection. ESG due diligence has become an important part of real estate opportunity investment assessment in addition to legal and financial due diligence. The results of the CMS European M&A Study for 2024 indicate that it may take longer for ESG-specific provisions to become integral in transaction documentation than it will take for ESG due diligence to become a key part of transaction due diligence. We note an increase in the number of deals involving specific ESG due diligence (up to 47% from 33% last year), although the amount of specific ESG provisions in long-form documents remains low (35%). The increase in ESG due diligence suggests that buyers, in particular investors, continue to carry out ESG investigations to uphold their governance standards across industries and sectors. By contrast, the decrease in the number of deals with ESG provisions in the SPA suggests there is not yet enough confidence amongst buyers that sellers will accept the transfer of ESG risk onto them.
Link to the CMS European M&A Study for 2024: https://cms.law/en/int/publication/cms-european-m-a-study-2024
Key ESG Challenges
Our practical experience working with multiple clients across different industries tells us that companies tend to face similar challenges when it comes to ESG topics. Below, we summarise the most frequent ones:
- Sustainable financing. The financial sector is playing an important role in promoting ESG topics. European banks are obligated to report and be aligned with the EU Taxonomy. Thus, banks are changing their lending policies to improve their loan portfolios by preferring taxonomy-compliant economic activities. Those who wish to obtain external financing from banks will be forced to present their sustainability within the credit approval process. Thus, some borrowers tend to fear whether the project or business activity they undertake will be bankable in the future and on what commercial terms. Sustainability targets or key performance indicators (KPIs) will be agreed upon jointly by the bank and the borrower during the loan documentation negotiations. The criteria will differ per business industry, as well as the data available for the sector and the project. Subsequent verification of compliance with KPIs over the life of the loan may result in penalisation of the borrower.
- Managing supply chain compliance. New sustainability obligations will affect not only large companies but also their suppliers – small and medium-sized companies, which, as a part of value chains, will also have to comply with the defined sustainability standards. According to the European Commission, the following EU directives are real game changers in the way companies conduct their business activities throughout the supply chain: (i) the Corporate Sustainability Reporting Directive (CSRD), which has already been adopted and requires certain companies to report on sustainability, and (ii) the Corporate Sustainability Due Diligence Directive (CSDDD), which is in the legislative process and would require companies to monitor actual or potential adverse impacts on human rights and the environment within their value chains.
- New Emissions Targets for Buildings and Tightening of EU Buildings Law. The revision of the Energy Performance of Buildings Directive will impact buildings’ whole life-cycle carbon emissions, including manufacturing, construction, and use. It will also increase the costs of construction and renovation projects and ongoing operating expenses.
- Mitigating Climate Change Through Energy Transition. Businesses focus on economically sustainable energy consumption, energy efficiency services fitting existing buildings with more efficient heating and cooling systems, installing solar panels, green roofs, and smart operation of buildings (in particular in logistics and office segments).
- Green Leases. Many tenants are changing their strategy towards ESG and renting in a green building in order to achieve their own sustainability goals. ESG buildings are expected to gain momentum in terms of tenant demand and market rents. Tenants, especially large corporate tenants, indicate that they are particularly interested in green certification. A specific law in the Slovak Republic does not yet regulate green leases. Landlords, instead, develop their own set of guidelines regarding sustainable asset management, energy savings, green cleaning, indoor air cleaning, quality, sustainable purchasing, solid waste management, and water protection.
- Risk of Green Claims. Risk of lawsuits based on the new legal developments in the field of ESG is increasing. On 6 March 2024, the EU published the first directive to combat greenwashing – Empowering Consumers Directive. Among other things, law covers significantly stricter regulations for the admissibility of environmental claims in advertising. For example, there will be new specific per se bans on the use of sustainability labels, (generic) environmental claims and claims based on greenhouse gas emissions offsetting. In addition, concrete requirements for the use of environmental claims related to future environmental performance will be established for the first time. The use of self-created sustainability labels will no longer be permitted in future. On 12 March 2024, the European Parliament adopted its position on the Green Claims Directive and positioned itself in favor of strong legal regime for environmental claims. Link to more details on the latest sustainability claims trends and developments: https://cms.law/en/int/publication/cms-green-globe#news
- An Immense Bureaucratic Burden. Implementing ESG into daily operations and numerous legal developments in the field of ESG have led to greater pressure on talent and the workforce and proper processes. The high demand for education in the business community led to the creation of various platforms to network, share know-how, and learn from each other on matters of ESG disclosures and reporting regulations.
- ‘S’ in ‘ESG’. Originally, real estate placed more emphasis on the E (environmental) element in ESG than on the S (social) or G (governance) elements. However, the importance of the social aspect of ESG is being increased by the generational shift of wealth to millennials, who are much more concerned about climate change and social issues than older generations. By 2030, millennials will create and own the majority of assets and be the largest segment of the workforce, creating unprecedented pressure on companies to reflect their values. ‘S’ brings to mind a wide variety of topics such as fair working conditions, remuneration schemes, health and safety (including healthy work practices, life balance and mental well-being) and employee relations. All of these topics are shaping the workplace and are reflected in the design of office buildings.
Where to start?
We would recommend that you:
- conduct a thorough process that starts with a top-down risk analysis of all the relevant risks that the company faces
- review governance maps with respect to sustainability ownership
- identify any existing business practices that could be improved to demonstrate due diligence
- pay explicit attention to ESG requirements when entering into new contracts or renewing existing ones
- amend your contracts in terms of ESG obligations, incorporate your contractual partners’ obligations regarding ESG disclosures and statements, and stipulate ESG criteria in the contract
- create ESG task forces focusing on developing a corporate ESG due diligence checklist and procedures on how to report on sustainability claims and prevent greenwashing to avoid reputational damage.
Summary
Real estate is increasingly falling under the ESG spotlight. ESG is the new GDPR. ESG requirements force Slovak companies to rethink their strategies, internal processes, and manner of reporting and collecting data, just like it was a few years ago when the topic of the GDPR popped up. History is circling back to wearing ESG clothes.
Under pressure from tenants, employees, contractors, customers, regulators, and investors who involve ESG in their decision-making, also Slovak companies that are still hesitating will have to behave more responsibly and sustainably. Our experience continues to indicate that ESG aspects are becoming a fundamental component of investors’ decision-making processes and strategic decisions.
Author of the article:
Soňa Hanková, Partner, Attorney-at-law, CMS Slovakia, law firm
Email: sona.hankova@cms-rrh.com
This article has been brought to you by CMS Slovakia. .