ESG: Have we been “nudged”?

Started with enthusiasm and now at a dead end? ESG is still the right thing to do – whereby it depends on the value-creating implementation and goal with the fund strategy.

Whipping boy ESG

ESG is under heavy criticism to some extent these days, but in any case, ESG is currently polarizing in the context of regulated investment funds. Complexity and bureaucracy, lack of comparability, data quality and data availability are just a few keywords. The stimulating climate has apparently passed a tipping point. And in this stimulating climate, the central question of the existential justification of ESG is charged: To what extent can it be the task of professional investors to take care not only of capital investment, but also of sustainability issues? In the sense of a regulatory organisation, it is now often pointed out that politicians have a responsibility to shape the future, which is supposed to create framework conditions independently so that institutional investment can return to its already demanding core mission: profitable capital investment.

From the ESG primordial soup to the thick density of the ESG regulatory scheme

In the context of real estate funds, ESG initially consisted of a large number of non-concerted individual measures. This included, for example, green areas (roofs, forecourts), building certificates (BREEAM, DGNB, LEED, HQE) or fund certificates (GRESB, ECORE). These measures were taken comparatively opportunistically, as far as their inclusion in the real estate fund seemed to be appropriate on a case-by-case basis.

This was followed by the nudging phase, triggered by the 2018 EU Action Plan, which shortly afterwards led to the ESG regulatory scheme Disclosure Regulation/Taxonomy Regulation . Nudge is a term in behavioral economics coined by economist Richard Thaler and legal scholar Cass Sunstein and their 2008 book Nudge: Improving Decisions About Health, Wealth and Happiness. For example, what works in the company canteen (really?), that the canteen visitor is offered a wholesome and healthy dish at the same height as the serving point as an additional offer to the unhealthy curry sausage, should now be transferred to the fund industry. Investors should get a nudge to pounce on returns on a variety of products, not just with ravenous appetite. They should start basing their product selections on sustainability ingredients as well.

In the beginning, they didn’t know how to deal with nudging very well. Pushing in itself should not be a problem if there were not a thousand regulatory requirements to be observed. The regulatory scheme was complicated, not thought through to the end in the details of its interdependence, in the constant flow of revision, whereby individual additions by local supervisors were added. The shift from focusing on problems to focusing on opportunities in industry is changing abruptly and abruptly. This is due to the time when the sales department, which is particularly demanding in terms of regulatory issues, sometimes took on the topic even more than the legal department. This has led to a variety of approaches under the Disclosure Regulation, which can be expressed in numbers as 6, 8 and 9 . The product packaging garnished with it was initially gladly accepted, although it already seemed challenging enough to present the associated achievement of – measurable (!) – sustainability features or to mitigate real sustainability risks. However, the key question for the decision-maker of professional real estate investment remained the legitimate question: How much does the packaging label itself contribute to the actual fund strategy? Is there an economic benefit for the investment result associated with the packaging – at least in excess of the costs?

Returning to measurable sustainability goals such as CO2

The EU initiative FIT FOR 55 is now focusing the core of its efforts again on reducing the CO₂ footprint of buildings against the climate crisis as quickly as possible. It is certainly no coincidence that it has become the standard that – as far as the data is available – real estate portfolios are measured using CRREM’s decarbonisation pathway. Market standards as the basis for investor reporting – such as the BVI Fund of Funds Reporting Template – have long been collecting this data and enabling reliable presentation. The inclusion of the building sector in the certificate system effectively results in steering effects for sustainable action that hardly any design of an Article 8 fund could set.

Conclusion – Strategy beats fund packaging

ESG continues to play an essential role in the real estate fund sector, with sustainability strategies presumably being brought together even better with fund strategy and an interest in economic benefits in the future.

This follows:

• Good measurability of the strategy if it is directly aimed at CO₂ reduction in particular
• CO₂ is increasingly a price-forming factor in real estate valuation (“ticket price for CO₂”)
• Investors combine sustainability goals very well with their essentially economic interests in a profitable capital investment, without having to get lost in regulatory details

This helps reduce difficult-to-manage complexities and leads to a return to results that are measurable for sustainability and profitability.