What is the EU Taxonomy and its legislative framework?
The EU Taxonomy does not pose obligations for companies to change their business model nor to conduct their business in a more sustainable way. Instead, it provides a common framework that aims to determine what underlying economic activities performed by the companies can be considered sustainable. The EU Taxonomy Regulation is directly applicable to the national legislation in the format adopted at the European level. However, directives are to be transposed by Member States, in the way that national governments would feel the most appropriate to their own objectives providing that they meet minimal standards.
Besides the EU Taxonomy Regulation, there are two delegated regulations relevant for the listed real estate sector: the EU Technical Taxonomy and the EU Taxonomy-related Disclosure.
How does the EU Taxonomy apply to listed property companies?
The EU Regulation applies to certain large listed property companies, including REITs, which are under the scope of the Non-Financial Reporting Directive (NFRD). It requires them to include in their non-financial statement how and to what extent the undertaking’s activities are associated with economic activities that qualify as environmentally sustainable under this Regulation. More specifically, companies will be required to disclose this information using the three specific financial KPIs: turnover, CapEx & OpEx.
Details of how this should be done will be addressed in the second delegated regulation which is due in June 2021. In the meantime, the European Commission published on Friday 20 November its final draft Delegated Regulation, establishing technical screening criteria on sustainable economic activities.
It was mentioned earlier that the Taxonomy is meant to determine which economic activities can be considered environmentally sustainable. To that end, the activity must substantially contribute to at least one of the six environmental objectives as defined in the Regulation while not doing any significant harm to any of the remaining five others . Strictly speaking, anything outside this scope will no longer be considered sustainable, or at least not for the purpose of attracting sustainable finance. This will bring a significant change to what the industry has been doing so far.
The question is whether the Taxonomy got this part right, and if not, what to do next if certain activities would, in effect, substantially contribute to e.g. climate change mitigation, but the Taxonomy does not recognise it. Because then, listed property companies would not be able to claim those promising activities as sustainable to their investors, resulting in not only being deprived of the possibility to attract the ‘green’ capital, but most importantly, the capital flows will not be re-oriented to where it matters the most. Since this is the core objective of the EU Taxonomy, getting the technical screening criteria right is of high consequence.
What does it mean exactly for the real estate sector?
For the real estate sector, seven specifically listed economic activities have a direct and immediate impact on the real estate. Here we will look into 1) Construction of new buildings; 2) Renovations; and 3) Acquisition and Ownership.
In the table above, the key focus of the Commission has been set on new buildings. Out of the three major economic activities, two of them are exclusively focused on the constructing or acquiring new buildings; and only the latter is an option for listed property investment companies, since it seems not possible to construct a sustainable new building for own portfolio. No doubt that there is a flaw in design. Therefore, the EU Taxonomy still needs further dedication and deeper understanding of the underlying economic activities which are meant to help substantially mitigate climate change.
Is the EU Taxonomy draft delivering on its promise for the real estate industry?
There is a significant challenge ahead of us in the coming years. The challenge is here not only for the EU policy makers and legislators, but also for the real estate industry: to construct new buildings and accelerate renovating the existing ones in a sustainable and affordable way. The measures need to remain effective and meaningful for the property owners and investors, as well as affordable for the tenants, especially in the residential sector.
This is an extraordinary opportunity to work together on Sustainable Finance in a fruitful way, aligned with the European Green Deal’s and the Renovation Wave’s missions. Therefore it must be said out loud: the EU Taxonomy is failing to deliver on its promise.