ESG and Real Estate E-Book

Christiane Conrads

• Herausgeber: Haufe Lexware
• Kategorie: Fachliteratur
• Sprache: Englisch

Veröffentlichungsjahr: 2022

Beschreibung

This is the first comprehensive practical handbook on the topic of "Environmental Social Governance" (ESG) and its impact on the real estate industry. The sustainability megatrend is still in its early stages in the real estate sector, and there is a lack of standards, practical examples and data. The development is very dynamic and sometimes confusing, and new, complex, requirements and regulations are constantly being added.  The authors – an expert team of economists, lawyers, investors, asset managers and engineers – provide an overview of national and European regulatory requirements as well as current market developments. They show what role ESG plays not only in the areas of new construction, renovation and real estate management, but also in investment processes and real estate valuations.  Contents: - ESG and the real estate market - ESG and regulatory environment  - ESG and real estate management - ESG in urban and project development

Leseprobe

[5]Contents

Hinweis zum UrheberrechtImpressumForewordForeword by the editorsPart I ESG and the real estate market1 Policy and regulation in the area of tension between shaping the ESG transformation and growing regulatory pressure1.1 Introduction1.2 Milestones at international, European and national level1.2.1 International framework for solving the core problems of global change1.2.2 ESG measures at European level1.2.3 National sustainability measures1.3 Increasing importance of sustainability in society: Science and jurisprudence1.3.1 Social rethinking1.3.2 The establishment of sustainability science1.3.3 Climate and environmental protection jurisprudence1.4 Summary and outlook2 Market trends and value drivers2.1 Introduction2.2 Market-oriented real estate management2.2.1 Exogenous parameters of influence on a revolutionizing financial system2.2.2 ESG-oriented real estate management in the context of the financial revolution2.3 Valuable real estate management2.3.1 Simplified relationship between the assets or capital, the value and the purchase price of a company and/or a enterprise2.3.2 Strategic dimension of value-based real estate management2.3.3 Operational dimension of value-based real estate management2.3.4 Control-oriented dimension of value-based real estate management2.4 Outlook3 ESG in the international context3.1 Introduction3.2 Elements of sustainable investment policy and regulation3.2.1 Disclosure of ESG criteria by companies3.2.2 Stewardship codes3.2.3 ESG requirements for investors3.2.4 Taxonomy3.2.5 National strategies for sustainable finance3.3 Implementations of ESG regulations in selected countries3.3.1 United States3.3.2 Australia3.3.3 The Netherlands3.3.4 United Kingdom3.3.5 Japan3.3.6 China3.4 Summary and outlook4 Climate risks and benchmarking4.1 Amazing momentum among the public, governments and investors4.2 Climate risks4.2.1 Causes of climate risks4.2.2 Physical climate change risks4.2.3 Transitory climate change risks4.2.4 Understanding risk4.3 Benchmarking4.3.1 Challenges4.3.2 New building4.3.3 Redevelopment projects4.3.4 Operating real estate4.3.5 Stranded assets4.3.6 Value-at-risk approach for all properties4.3.7 Ratings4.4 OutlookReferences5 Digitization as a prerequisite and instrument of ESG transformation5.1 Introduction5.2 State of digitization and increasing pressure to act through politics and regulation5.3 Overview of existing initiatives, scoring and ratings to measure sustainability5.4 Use of new technologies for data management and transparency on the financial market5.4.1 Collection of ESG-relevant real estate data5.4.2 Data availability and processing5.4.3 ESG as a driver of the PropTech universe5.5 The tension between digitalization and legal requirements5.5.1 Fundamental rights relevance of the protection of personal data5.5.2 Scope of data protection law and definitions5.5.3 Duties of the responsible person5.5.4 The Metering Point Operation Act5.5.5 Processing of measurement data within the scope of application of the MsbG by real estate companies5.5.6 The Business Secrets Protection Act5.5.7 Challenges in the processing of ESG-relevant inventory data5.6 The digital ESG transformation in corporate managementPart II ESG and regulatory environment6 Impact of climate change on the real estate industry6.1 Trend topic climate in the real estate industry: What’s behind it?6.2 Climate risks and their impact: The double materiality6.3 Emerging risk and climate scenario analysis6.3.1 Risk factors and their scientific basis6.3.2 Methodological approach: Climate scenario analysis6.4 Generated risk and decarbonization targets6.5 Example of key figure management for climate risks6.6 Outlook for climate risk management in the real estate industry7 ESG criteria measurement tools and taxonomy7.1 General background7.2 Sustainable building certificates7.3 Green rating – GRESB7.4 EU decarbonization pathway – CRREM8 Special features of energy law and economics in the context of ESG 8.1 Introduction8.2 The trends in the energy industry and their impact on real estate8.2.1 Energy law: A brief introduction8.2.2 Decarbonization 8.2.3 Decentralization8.2.4 Digitization8.3 Conclusion9 Impact investing in the real estate industry9.1 Introduction9.2 Impact investing in interaction with the UN Sustainable Development Goals (SDGs)9.3 Differentiation of sustainable investment forms9.4 What are impact investments and how are they measured?9.5 Implementation of impact investments in practice9.6 Social impact investing as a special form of impact investment9.7 Conclusion and outlook for real estate impact investments10 ESG – tax law requirements and effects10.1 Tax and ESG – responsible tax policy10.1.1 Fiscal sustainability reporting10.1.2 Excursus on public Country by Country Reporting10.1.3 Application of the GRI Tax Standard in the real estate industry10.2 Real estate and environmental taxes, government subsidies and support programmes with a tax reference10.2.1 International level: OECD/IMF Tax Policy and Climate Change report10.2.2 European level – draft of the new guidelines for climate, environmental and energy aid and decision of the European Climate Change Act10.2.3 Legislation in Germany11 ESG in the context of real estate insurance11.1 Sustainability in the insurance industry11.2 Demand for sustainable insurance products in the real estate industry11.2.1 Private customers11.2.2 Industrial and commercial customers11.3 Challenges in the design of sustainable property insurance11.4 Possible sustainable insurance products for the real estate industry11.4.1 Product structure in the insurance market11.4.2 Market offer11.5 The property insurance of the futurePart III ESG and real estate management12 Practical experience in the development and implementation of sustainability strategies12.1 Preliminary considerations12.2 Problem12.2.1 Real estate in the light of corporate strategy12.2.2 Different priorities and potential conflicts of interest12.2.3 Different risk dimensions12.2.4 Long-lived asset versus granularity of data12.3 Strategy development12.3.1 Transfer to the real estate segment12.3.2 Interaction of reporting and standards12.4 Strategy implementation12.4.1 Practical excursus: Operation Optimization and Energy Controlling project (BOEC)12.4.2 Costs and profitability set the pace12.4.3 Integrating data platform and uniform data language as the key12.4.4 Digital twin as nucleus12.4.5 Transparency as the highest premise and benchmarking as the goal12.5 Closing words – or because it’s just the right thing to do13 ESG in asset management13.1 In the beginning is the vision13.1.1 Individual target definition13.1.2 Strategy definition13.2 From vision to implementation13.2.1 Requirements13.2.2 Responsibility13.3 Stakeholder involvement13.3.1 Service provider13.3.2 Tenants and users13.3.3 Investors13.4 Practical implementation13.4.1 Data flow13.4.2 Profitability calculation13.4.3 Pilot projects13.4.4 Outlook13.5 Vision14 ESG due diligence as a value driver for real estate acquisition and portfolio management14.1 Why ESG due diligence?14.2 For whom does ESG due diligence make sense?14.2.1 Who can?14.2.2 Who must?14.3 At what stage in the transaction process should ESG due diligence be conducted?14.4 What is analyzed in ESG? 14.4.1 General14.4.2 Environmental: What are the environmental features of the building?14.4.3 Social: What are the social features of the building?14.4.4 Governance: Are stakeholders behaving properly?14.5 Opportunities/risks14.6 Outlook15 ESG integration in investment management15.1 Setting the Scene15.1.1 The New ESG imperative15.1.2 Mitigating sustainability risks through transaction management15.1.3 Sustainability first15.2 Sustainability assessment in the acquisition process15.2.1 Everyday practice15.2.2 Dealing with new taxonomy requirements15.2.3 Mind the gap15.2.4 Built before »Green Day«, 1 January 202115.2.5 Allocation of capital to sustainable refurbishments15.2.6 Above it all hovers »do no significant harm«15.3 Conclusion and outlook16 ESG criteria in ESG real estate finance16.1 Introduction16.2 Importance of real estate and real estate investments in achieving the climate goals of the EU and Germany16.3 Sustainable finance and ESG integration16.3.1 Sustainable finance as a contribution of financial markets to the transformation of social, environmental and economic factors16.3.2 Integration of ESG criteria for sustainability classification16.4 Sustainable finance strategy at EU level and ESG integration16.5 Status quo on ESG integration: From voluntary commitment to the goal of uniform classification standards for sustainability16.6 Selection of existing self-commitment standards on sustainability goals16.6.1 UN PRI – Principles for Responsible Investment16.6.2 Agenda 2030: 17 Sustainable Development Goals (SDGs)16.7 German Sustainable Finance Strategy16.7.1 Structure of the German Sustainable Finance Strategy16.7.2 Field of action: Strengthening sustainable finance at the global and European level16.7.3 Field of action: Improving transparency16.7.4 Field of action: Strengthening risk management and supervision16.7.5 Field of action: Improving and implementing impact assessment methods16.7.6 Field of action: Financing transformation16.7.7 Field of action: The German federal government in capital markets16.7.8 Field of action: Strengthening institutions, generating and sharing knowledge16.7.9 Field of action: Creating efficient structures for implementing the Sustainable Finance Strategy16.8 Summary and outlook17 ESG in real estate valuation17.1 Introduction17.2 Valuation basis17.2.1 Assessment occasions17.2.2 Value and price17.2.3 Value concepts and value definitions17.2.4 Evaluation process17.3 Framework conditions and Real Estate Valuation Ordinance17.3.1 Standardized procedures (ImmoWertV)17.3.2 Basic principles for the valuation of land17.4 Valuation of buildings and outdoor facilities17.4.1 Comparison method17.4.2 Capitalized earnings method17.4.3 Depreciated cost method17.4.4 Non-standardized methods and DCF methods17.5 ESG in real estate valuation17.5.1 Consideration of the EU taxonomy in the real estate industry17.5.2 ESG impact on the value of real estate companies17.5.3 Impact on property valuation17.5.4 Impact on gross income17.5.5 Operating costs17.5.6 Useful life17.5.7 Capitalization rate/property rate17.5.8 Interim conclusion17.5.9 Procedure for the adjustment of the interest rate17.6 Summary18 Implementation of ESG criteria in real estate contracts18.1 Introduction18.2 General considerations18.2.1 Legal requirements18.2.2 Regulation of common understanding in relation to ESG 18.2.3 Increase transparency and ensure reporting and benchmarking18.2.4 Compliance (social and governance clauses)18.2.5 Adjustment of current contracts to changed/higher ESG requirements18.3 Special features of individual contract types18.3.1 Purchase contracts18.3.2 Rental agreements18.3.3 Management contracts (property and facility management)18.4 Recommendations for the design of projects and contract negotiations18.5 Outlook19 Compliance and risk management19.1 Introduction19.1.1 Classification19.1.2 Definition of compliance19.1.3 Compliance in the context of ESG 19.2 Framework conditions for sustainable compliance19.2.1 Creation of a sustainable corporate structure (governance in the narrow sense)19.2.2 Sustainable compliance organization19.3 ConclusionPart IV ESG in urban and project development20 ESG project development – planning and construction processes20.1 Introduction20.2 A classification20.3 Sustainability: From the introduction of the term until today20.4 The »Green Deal« as a driving force20.5 The dovetailing with the project development of new construction and refurbishment20.6 Certification systems as guides20.7 Encourage and challenge20.8 Planning measures20.9 Conclusion21 ESG and property development – Legal requirements for construction and planning contracts21.1 Introduction21.2 Property development – legal classification of contracts21.3 Construction phases21.4 Define targets and align with ESG strategy early on21.5 Sustainability requirements beyond EU taxonomy21.6 Certification: Contracts with certification body and auditor (DGNB)21.7 Performance descriptions in construction and planning contracts21.8 Data preparation and collection21.9 Building Information Modelling (BIM)21.10 Excursus: Monument protection and § 105 German Building Energy Act (GEG)21.11 Excursus: Photovoltaics21.12 Miscellaneous21.13 Summary and outlook22 Sustainable urban development Constantin Alexander22.1 Human settlements22.2 From forestry into more and more areas of the economy and society22.3 Long-term and holistic22.4 Effective and efficient interventions22.5 Many stakeholders with high diversity22.6 Many factors for resilience22.7 Nothing succeeds without positive externalities22.8 Planning and development intertwine22.9 Anti-fragile, sustainable systems are good for life – and for businessThe editorial teamThe authors

[1]

Hinweis zum Urheberrecht:

Alle Inhalte dieses eBooks sind urheberrechtlich geschützt.

Bitte respektieren Sie die Rechte der Autorinnen und Autoren, indem sie keine ungenehmigten Kopien in Umlauf bringen.

Dafür vielen Dank!

Haufe Lexware GmbH & Co KG

[4]Bibliographical Information of the German National Library

The German National Library lists this publication in the German National Bibliography. Detailed bibliographical data can be accessed on the internet at http://dnb.dnb.de.

Print:

ISBN 978-3-648-16348-1

Order No. 16089-0001

ePub:

ISBN 978-3-648-16349-8

Order No. 16089-0100

ePDF:

ISBN 978-3-648-16350-4

Order No. 16089-0150

Thomas Veith/Christiane Conrads/Florian Hackelberg (eds.)

ESG and Real Estate

1. Edition, June 2022

© 2022 Haufe-Lexware GmbH & Co. KG, Freiburg

haufe.de

[email protected]

Image credits (cover): © jamesteohart, Adobe Stock

Product Management: Bettina Noé

All information/data to the best of our knowledge but with no guarantee for completeness and correctness. All rights, including but not limited to the printing of excerpts, photomechanical reproduction (including microcopy) and analysis using databases, are reserved.

If this publication contains a supplementary online offer, the contents are available for 12 months after the book is after the publication or sale of the book, but at least for two years after the publication of the book, online for at least two years after the publication of the book. There is no entitlement to use beyond this period.

Should this book or the online offer contain links to websites of third parties, we do not assume any liability for their contents and availability. for the contents and availability of these websites. We do not adopt these contents as our own and merely refer to their status at the time of initial publication.

[15]Foreword

Sustainability is the topic of the day – the transformation of thought and actions will change the real estate world.

So many changes, so many challenges, so much transformationclimate change, conflicts, digitalization, the pandemic, life plans, forms of work and much more are not only presenting the entire global economy with new tasks, but are also leading to a reconceptualization of society. The questions of responsibility and impact are measured with new qualitative and quantitative key figures, which also put the framework conditions for business areas and products in the real estate industry under scrutiny.

The increasing complexity creates a degree of uncertainty that makes the formulation of future strategies more difficult. In addition, the impacts of international and national events that regularly lead to new classifications in the context of real estate products that are designed to last for many years. It is a difficult act to balance and identify the right ESG strategy for the most sustainable, and thus also most promising and socially acceptable, business model.

Life, work, and experience all need real estate, but how much and of what kind? Buildings need space, but how to secure biodiversity? The land needs to be provided with energy and other supply and disposal services to be used, but where from and in what way, and how climate-neutral? Building and land policy will undergo a significant change, but which challenges will we encounter? Materials should be sustainable and recyclable, but what is their availability and price? Any property should be integrated into the environment and support new mobility and connectivity, in addition to adding social and societal value, but how can all stakeholders be integrated into this process? Resilience is also an important criterion, with increasing environmental events bringing new risks into focus. And not to forget, real estate is an important asset class as a capital market investment that supports wealth and performance – but how to deal with regulation?

You think too many changes at the same time?

Nevertheless, persisting with traditional structures will not help; the real estate industry has to learn to deal with change and proactively develop and offer solutions.

Unbridled demand for individual asset classes and the unlimited availability of capital still determine market trends, but will this last? This is unlikely. It is important to adapt to the coming changes and user requirements, to plan in a new way and act responsibly.

[16]The goal is clear: it is about preserving and developing assets. However, it is also about complying with environmental and social standards and scoring points with good governance through attitude and transparency. Returns alone will not be enough to survive the transformation. Stakeholder acceptance may become a breaking point and shareholders will have to reflect on the impact of their business and the decisions they make. The same principle applies: ownership obligates!

The risks are manifold: Against the backdrop of change, it is a matter of dealing with the portfolio, project developments, operation and use, as well as the environmental conditions and the future value of the real estate. The costs of this change will be high. But the opportunities will outweigh them, for people, for the planet, for our growth and for the built environment.

I wish you a lot of inspiration for your ESG strategy

when reading the practical handbook and the courage to act in good time.

Susanne Eickermann-Riepe, FRICS

Chair of the Board, RICS European World Regional Board & RICS Advisory Board Germany and ICG Institute

[17]Foreword by the editors

ESG as a solution for the core problems of global change and the implications for the real estate industry

Global change has triggered a process of knowledge and transformation at a rapid pace, especially since the 1980s. The increase in core problems such as climate change, environmental pollution, and social imbalance, especially in emerging and developing countries,1 has led to the idea of sustainability becoming2 established as a global development model.

Probably the best-known definition of the term »sustainable development« dates back to 1987, established by the so-called Brundtland Commission, a special United Nations (UN) commission headed by Norwegian Prime Minister Gro Harlem Brundtland. It states that »development that meets the needs of present generations without compromising the ability of future generations to meet their own needs« is considered sustainable.3 Taking up this basic idea, the UN Conference on Environment and Development in Rio de Janeiro in 1992 set an important course for the importance of sustainable development. Since then, it has been recognized that promoting environmental, social and governance aspects (»ESG«) as equally as possible is the prerequisite for a stable society.

Even though a broad interpretation of environmental and social goals has been established, climate protection measures were subsequently prioritized due to the increasing noticeable consequences of climate change (extreme weather events, floods, etc.).

The Paris Climate Agreement is the first binding climate protection agreement under international law; it was adopted at the Paris Climate Conference (COP21) in December 2015 and entered into force on 4 November 2016. The almost 190 parties agreed to limit the long-term increase in the global average temperature to well below 2°C compared with pre-industrial levels (target: 1.5°C).4

[18]By 2020, the global mean temperature at ground level had already risen by more than 1.2°C compared with 1880.5 Without rapid ambitious action, there is a risk of a significant shortfall in national action plans to implement the Paris climate targets, making the feared instability due to large-scale climate change impacts more likely.

Marc Carney, Governor of the Bank of England, began his landmark speech called »Breaking the tragedy of the horizon – climate change and financial stability« to insurance industry representatives in London in September 2015 with the words: »I am going to give you a speech without a joke, I am afraid …« In his speech, he noted that »once climate change becomes a defining issue for financial stability, it may already be too late«. Looking ahead to the upcoming Paris Climate Conference, he pointed to three risks that could affect financial stability: physical risks, such as damage from floods and storms; liability risks, which could arise when those suffering from the effects of climate change seek compensation from those, they deem responsible; and transitory risks, which arise from the revaluation of assets due to the shift to a carbon-neutral economy.6

The COVID-19 pandemic has brought further challenges in terms of achieving climate change goals and sustainable development more broadly: poverty, hunger and social imbalance have increased globally and significantly worsened the economic outlook regionally.7 UN Secretary-General António Guterres noted in July 2020 that if implementation of the 17 key Sustainable Development Goals (»SDGs«) released at the UN Summit in New York in September 2015 had progressed further, the world would have been more resilient and better prepared for the COVID-19 pandemic.8 Recovery efforts must have the additional goal of »building back better« and reflect the importance of the SDGs for building sustainable and resilient societies.9

The real estate industry plays an important role here. Depending on the estimate, up to 40 per cent of global CO₂ emissions are attributable to the construction and management of real estate.10 Furthermore, half of the total energy and raw material [19]consumption and one-third of the total water consumption and waste generation are attributable to the construction and real estate industry.11

In addition to the consideration of contributions to causation, it must be considered that the real estate industry is also significantly affected by the core problems of global change and can thus make a clear contribution as a shaper of a positive transformation. As a capital- and land-intensive sector, it has a great influence on long-term CO₂-reducing measures and investments, which are becoming increasingly important in the light of the threat of missing climate protection targets.

It also plays an important role in promoting social aspects. Adults in Central Europe spend on average about 80–90 per cent of their time indoors,12 so healthy, environmentally friendly, and affordable living and working spaces are of considerable importance.

Due to increasing regulatory requirements – for example, as a result of the European Union’s action plan for financing sustainable growth13 – and demands of stakeholders, the real estate industry has been focusing more and more on the development and implementation of ESG strategies for several years. Virtually all sub-sectors of the real estate industry are affected, particularly financing, construction, and operation but also investment and accounting. The broad interdisciplinary implications already show the complex and interdependent relationship that is emerging for the real estate industry in connection with ESG. While in some areas the topic of ESG has already gained exponential importance due to regulatory requirements and there are already concrete effects on practice, in other areas the far-reaching effects are still unrecognized – for example, due to a lack of generally recognized valuation standards. This is reinforced not least by the supposedly all-encompassing, but at the same time also unclear, definition of the term, which is still associated with opaque effects on sub-sectors of the real estate industry for individual players.

The aim of this book is to explain the developments and effects of ESG on the real estate industry, and in particular the different sub-aspects of the industry, in a scientifically sound and at the same time practical manner, and in a structured way.

[20]The individual contributions illuminate the topic of ESG in an interdisciplinary manner with the focus respectively on the different legal, economic, and technical dimensions, as well as from the perspective of different management perspectives.

The book is intended to serve as a handbook for academics and practitioners alike to explain the ESG transformation taking place in the real estate industry in a transparent way, addressing the implications for individual sub-sectors of the industry.

In the first part, after a basic introduction to the political and regulatory framework, the effects on the real estate markets are analysed. In addition to general market trends and value drivers, as well as an international outlook, the handling of climate risks and benchmarking possibilities are addressed, and the contribution of digitalization is presented.

The second part deals with specific regulatory aspects in the real estate industry. In addition to certification and rating systems, the focus is on tax aspects, special features of energy law and the energy industry, as well as the effects of ESG on real estate funds and insurance companies.

The third part deals with the influence of ESG on real estate management aspects. In addition to strategic considerations and asset management aspects, these include the influence of ESG on the financing, valuation, and transaction process of real estate.

In the fourth and last part of the book, the impact of ESG on urban development concepts as well as project development is examined. In addition to procedural and constructional requirements, the legal requirements for construction and planning contracts are explained.

Due to the multi-layered effects of the topic of ESG, this book would not have been possible in its breadth and, above all, professional depth without the interaction of the many authors from the various sub-disciplines of the real estate industry. It was only through their extensive knowledge and, above all, their practical experience in implementing ESG criteria in their respective fields that this book was able come into being. Therefore, our special thanks go to all authors who contributed. Furthermore, our thanks go to Bettina Noé from Haufe Lexware Verlag for her tireless support and long-suffering dedication to this project.

We, the editors, are very concerned that the internalization of social and ecological consequential costs in the real estate industry is standardized in the short term. It is [21]essential to counteract the market failure that still exists today through effective ESG strategies.

We hope you enjoy reading the articles14 and, above all, that you gain new insights for the development and implementation of ESG criteria in your real estate business activities.

November 2021

Thomas Veith

Christiane Conrads

Florian Hackelberg

1 Cf. on the core problems of global change also the annual reports of the German Advisory Council on Global Change (WBGU) from 1993 to 1996 (https://www.wbgu.de).

2 Michelsen, Grundlagen einer nachhaltigen Entwicklung, Leuphana Universität Lüneburg; https://www.dbu.de/OPAC/ab/DBU-Abschlussbericht-AZ-30564-Studienbrief1.pdf, accessed 17.08.2021, p. 37.

3 Hauff, Our Common Future: The Brundtland Report of the World Commission on Environment and Development, 1987, Greven: Eggenkamp, p. 46.

4 European Commission, Paris Agreement, https://ec.europa.eu/clima/policies/international/negotiations/paris_de, accessed 22.08.2021.

5 Met Office Hadley Centre, Climate Research Unit; model HadCRUT.5.0.1.0.

6 Bank of England, Speech: Breaking the Tragedy of the Horizon – Climate Change and Financial Stability, 2015, https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/breaking-the-tragedy-of-thehorizon-climate-change-and-financial-stability.pdf?la=en&hash=7C67E785651862457D99511147C7424FF5EA0C1A, accessed 22.08.2021.

7 United Nations, Secretary General’s remarks at Roundtable on Sustainable Development, 2020, https://www.un.org/sg/en/content/sg/statement/2020-07-01/secretary-generals-remarks-roundtablesustainable-development-delivered, accessed 22.08.2021.

8 Ibid.

9 Ibid.

10 Catella Group, Market Tracker ESG Investment, 2020, https://www.catella.com/globalassets/global/mixgermany-corporate-finance/catella_market_tracker_esg_q1_2020.pdf, accessed 22.08.2021, p. 2ff.

11 Ibid.

12 Federal Ministry for the Environment, Nature Conservation and Nuclear Safety, Indoor Air, https://www.bmu.de/themen/gesundheit-chemikalien/gesundheit-und-umwelt/innenraumluft/innenraumluft-was-istdas-problem, retrieved 22.08.2021.

13 European Commission, Action Plan: Financing Sustainable Growth, Brussels: 2018, COM, https://eur-lex.europa.eu/legal-content/DE/TXT/PDF/?uri=CELEX:52018DC0097&from=DE, accessed 22.08.2021.

14 Since the present work is a compilation of individual contributions from different perspectives from academia and practice, repetitions have been consciously accepted, as long as they serve the context of the respective contribution. For the aforementioned reason, we have also refrained from standardizing bibliographical references or gender language in order to maintain the different representations in the individual contributions as authentically as possible. Nevertheless, we would like to point out that in places where the female form has not been used, it is explicitly included, but has been omitted for reasons of more favourable readability.

[23]Part I ESG and the real estate market

[25]1Policy and regulation in the area of tension between shaping the ESG transformation and growing regulatory pressure

Christiane Conrads

1.1Introduction

Especially since the UN Summit on Sustainable Development in New York and the Paris Climate Change Conference in 2015, political and regulatory initiatives and measures to promote environmental, social and governance (»ESG«) aspects have increased worldwide. Within the international community and the European Union (EU), and with regard to individual nation-states, there is a clear effort to advance the implementation of ESG criteria in all economic sectors and branches in the short term. The regulatory innovations affect all sub-sectors of the real estate industry and its entire life and investment cycle. Many of the regulations are not (yet) harmonized and coordinated. This lack of harmonization and, in part, still undefined legal terms represent a major challenge for many.

The regulatory process has led to a changed understanding of sustainability1 and is often seen as a driver of the ESG transformation. However, new research results, such as the current report of the IPCC (Intergovernmental Panel on Climate Change)2 and the increasingly noticeable effects of climate change, have led to a social rethinking. Through various initiatives, which are no longer limited to environmental organizations, the political agenda has changed in many countries. The political pressure on legislative bodies to enact further effective climate and environmental protection measures in the short term, while respecting minimum social standards and ensuring intergenerational justice, is growing steadily. The recent decision of the Federal Constitutional Court on the Climate Protection Act3 contains a clear order to the legislature to enact concrete regulations on climate protection for the period from 2030. Cases of so-called strategic litigation have gained in importance worldwide. Beyond the respective individual case (and its outcome), these court cases aim to raise social [26]awareness of the negative impacts of climate change, and thus generate pressure on political decision-makers and market participants.

In view of this development, further political and regulatory measures to increase sustainability requirements are to be expected in the short term. This is a multi-layered and dynamic process. The central criterion of successful ESG strategies is the regular analysis of social, political, and regulatory developments. Only then can new or changed regulatory and stakeholder requirements be recognized at an early stage and considered in the context of strategy adjustments. The following presentation does not claim to be exhaustive but is rather intended to help classify the political and regulatory background and provide an overview of current topics – such as the phenomenon of climate protection lawsuits – that are regularly relevant in the creation, implementation, and adaptation of effective ESG strategies. Even though international and European milestones are addressed, the focus of the chapter is the German real estate market.

1.2Milestones at international, European and national level

1.2.1International framework for solving the core problems of global change

In addition to treaties that are binding under international law, the global framework for sustainable development is formed by various measures of political relevance (socalled soft law). International treaties often require a long-term process of ratification and implementation into the national law of the signatory states. Against the background of the temporally pressing challenges of global change – especially environmental pollution and climate change – and the spatial divergence of the cause-effect relationship, political declarations, recommendations, resolutions, and declarations of the international community of states, etc. have increased in recent years. The following presentation provides both an overview of the main treaties under international law and international political milestones.

1.2.1.1UNCED Conference in Rio de Janeiro (1992) and its precursors

The first United Nations Conference on the Environment took place in Stockholm in 1972. The desire of emerging and developing countries for rapid industrialization was contrasted by the interest of industrialized countries in agreeing on measures to limit industrial pollution and protect ecosystems.4 In the end, it was agreed that there was [27]no contradiction between environmental pollution and development, and5 that environmental problems could not be solved without taking social and economic aspects into account. The Action Plan for Human Environment was adopted, and the United Nations envisaged the establishment of a separate United Nations Environmental Programme (UNEP), based in Nairobi, Kenya, to implement it.6

In the 1980s, the understanding increasingly prevailed that the industrialized countries had7 the greatest share of responsibility, and thus also the main burden, for solving many environmental issues and socio-economic problems. In addition to what is probably the best-known definition of the term »sustainable development«, the 1987 final report of the United Nations Special Commission headed by Gro Harlem Brundtland is widely believed to have brought8 the idea of sustainability to a wider public as a global development model for the first time.

One of the subjects of the UN Conference on Environment and Development in Rio de Janeiro in 1992 was the implementation of the need for action identified in the Brundtland Report. Since then, it has been recognized that economic efficiency, social justice and safeguarding natural livelihoods are essential interests that are of equal value and complement each other. The results of the conference (the so-called Rio9 Declaration, Agenda 2110 and three conventions on climate protection,11 biodiversity12 and combating desertification that are binding under international law13), together with the Forest Principles Declaration, formed the foundation for a qualitatively new political and international means of legal cooperation in international environment and development policy.14

[28]1.2.1.2Kyoto Protocol

The Kyoto15 Protocol, which was adopted in Japan in 1997 and entered into force on 16 February 2005, is an additional protocol to the United Nations Framework Convention on Climate Change (UNFCCC)16 adopted in Rio de Janeiro in 1992. The Protocol was adopted at the Third Conference of the Parties to the Framework Convention on Climate Change in Kyoto in 1997 (COP 3).17 Its final version, adopted in 2002, is considered a milestone in international climate policy and for the first time contains legally binding emission reduction commitments for industrialized countries. It provides for three market-based mechanisms (emissions trading, joint implementation measures and the Clean Development Mechanism) to achieve the targets in two commitment periods until the end of 2020, which can be applied voluntarily by the Parties.18

Formally, the targets of the first commitment period were achieved, but this is widely believed to be due to the financial and economic crisis and the collapse of the Eastern European economies, as well as the withdrawal of the original signatory states Canada and the United States. Overall, global CO2 emissions increased from around 30 gigatons to 37 gigatons between 2008 and 2018.19 One of the main criticisms of the Kyoto Protocol was that it failed to hold the states that emit the largest amounts of greenhouse gases accountable. This was addressed by the Paris Climate Change Convention of 2015 for the period from 2020.20

1.2.1.3UN Sustainable Development Goals

Parallel to climate protection goals, the United Nations pursued the further development of sustainability transformation in a broader sense. A milestone is the 2030 Agenda for Sustainable Development with its 17 main Sustainable Development Goals (SDGs).21 These were published in September 2015 at the UN Summit on Sustainable [29]Development in New York and set goals and priorities until the year 2030. The SDGs are intended to enable equitable development with equal consideration of environmental, economic, and social aspects, and have been in force since 2016 with a term of 15 years. Each of the SDGs has its own sub-goals, the achievement of which is measured with indicators.22

Fig. 1.1: SDG Goals Source: https://www.un.org/sustainabledevelopment/news/communications-material/.

The SDGs apply to industrialized countries, and emerging and developing countries, which must implement them in national action plans, programmes and initiatives. Although they are primarily aimed at governments, they are designed in such a way that they can be23 used by various organizations and companies as a basis for their own sustainable projects. In the context of ESG strategy projects, the SDGs with their broad approach regularly form the starting point and provide the interpretative framework.

Unlike international treaties, the 2030 Agenda is not binding, but as so-called soft law it is of great political importance. The effect of the SDGs, which is based on de facto acceptance, is increasingly gaining normative significance (cf. free trade agreement between Japan and the EU [JEFTA]).24

[30]In the area of human rights, the 2030 Agenda largely reproduces existing international law. A global regulatory framework is also emerging in this area through the increasing importance of corporate social responsibility (CSR) in the private sector.25

1.2.1.4The Paris Agreement on Climate Change and the 6th Assessment Report of the IPCC

On 12 December 2015, at the UN Climate Change Conference (COP21), the Paris Agreement26 was concluded by 195 Parties to the UNFCCC with the aim of regulating climate protection for the period after the Kyoto Protocol. While the Kyoto Protocol is concerned primarily with reducing greenhouse gas emissions in industrialized countries, Paris also considered the increasing capacity of developing countries and their rising emissions. The primary goal of the Paris climate protection agreement is to limit global warming compared with pre-industrial levels to well below 2 degrees, ideally to 1.5 degrees.27

The agreement entered into force on 4 November 2016 after being ratified by 55 countries that account for at least 55 per cent of global emissions. As of 13 May 2018, 176 countries had ratified28 the agreement. The United States initially withdrew from the agreement under the Trump administration. President Joe Biden reversed the withdrawal on 20 January 2021, the first day of his term.29

Implementation takes place through national action plans for reducing emissions (nationally determined contributions, or NDCs). Furthermore, the Parties have agreed to meet every five years to assess and inform each other of progress.30

The implementation package adopted at the UN Climate Change Conference (COP24) in Katowice in December 2018 contains further detailed rules, procedures, and guidelines for the implementation of the Paris Climate Agreement. Parties are also given the opportunity to gradually increase their climate protection targets.31

[31]Even though the agreement represents an important milestone in the field of climate protection and is based on a strong political foundation due to the planned review mechanisms, criticism of the agreements has been increasing recently. The respective measures do not go far enough and are too slow to achieve the goals set. Moreover, exceeding maximum targets – for example, for emissions – would not be linked to sanctions.32

By the end of 2020, the Parties had to submit their new targets for the period until 2030. Due to the COVID-19 pandemic, the 26th UN Climate Change Conference in Glasgow (COP 26) had to be postponed to the end of 2021. Very high expectations are placed on this conference.33

This expectation is reinforced by the most recent report of the IPCC of 9 August 2021,34 which in the opinion of many media is the most urgent warning of the IPCC to date and was produced with the participation of 234 scientists. The IPCC projects that the range of likely temperature increases will be between 1.5°C and 5°C, with a 1.5°C increase likely to be reached before 2040. Extreme weather events are also expected to increase in line with the temperature rise and to amplify each other. As a result, extreme weather events will have a greater impact on society. According to the report, a warming of 1.5 or 2 degrees can only be avoided if greenhouse gas emissions are drastically reduced.35

1.2.1.5UN Global Compact

The United Nations Global Compact is a voluntary pact between companies, organizations and the United Nations that was officially offered to interested business enterprises on 31 January 1999 at the World Economic Conference. Under the auspices of the United Nations, participating companies and organizations commit to (i) human rights, (ii) fair labour conditions, (iii) environmental protection and (iv) anti-corruption. The pact contains ten principles to which the participating companies commit and that are established and continuously developed through initiatives, projects, guidelines, and educational measures.36

[32]The Global Compact pursues two complementary goals: first, the ten principles are to be integrated into corporate practice worldwide; second, measures are promoted that support the overarching goals of the United Nations (e.g. SDGs).37

The UN Global Compact primarily has a learning and dialogue function. Participating companies must publish their social commitment annually in the form of reports on the Global Compact homepage (Communication on Progress, or CoP). In addition to the status of the implementation of the ten principles, they must report on activities to promote sustainable development in written form.38

The principles are partly seen as too weak and ineffective.39 In addition, the lack of effective sanctions has been criticized.40 However, with more than 17,500 companies and organizations having signed the UN Global Compact worldwide, it is one of the best-known international initiatives to promote responsible corporate practices.41 In recent times, the principles have increasingly found their way into private written contracts (such as service and rental contracts), and have thus gained significant importance over civil law.

1.2.1.6Principles for Responsible Investment

The Principles for Responsible Investment (PRI), a voluntary commitment by companies in the financial industry, are also increasingly being incorporated into private-sector contracts. This is an international investor initiative supported by the United Nations, which was founded in April 2006 in cooperation between the Finance Initiative of the UN Environment Programme (UNEP) and the UN Global Compact. The signatories commit to the following six principles for responsible investment and want to contribute to a sustainable global financial system:

Incorporate ESG issues into investment analysis and decision-making processes; Active ownership and integration of ESG issues into ownership policies and practices; appropriate disclosure of ESG issues in companies in which investments are made;[33]Drive acceptance and implementation of the Principles in the investment industry; Working together to increase effectiveness in implementing the Principles; and Reporting on activities and progress in implementing the principles.42

Progress is assessed annually by the PRI based on transparency reports from participating companies, taking into account, among other things, investment practices and active stewardship. The PRI has been signed by over 3,500 companies to date.43

1.2.2ESG measures at European level

The European Union (EU) sees itself as a pioneer in the global ESG transformation.44 The goal of sustainable development in Europe is enshrined in Article 3 p. 2 of the Treaty on European Union. With the adoption of the UN Agenda 2030 and the Paris Agreement on Climate Change, the EU has also committed itself to a sustainable economy and society. By 2030, greenhouse gas emissions in the EU are to be reduced by 55 per cent compared with 1990 levels. In recent years, the EU has introduced various packages of measures that affect all sectors of the economy. For example, ESG regulation for the financial sector and sustainability requirements for real estate have been tightened.45

One characteristic of the law of the EU as a supranational organization is the power to adopt legal acts that have direct legal effects (e.g., regulations) for natural and legal persons in the member states. On the other hand, there are legal acts (such as directives) that still require transposition into national law by the member states.46 In conjunction with numerous, partly parallel national initiatives to implement their own ESG goals, a regulatory jungle has emerged that many market participants perceive as still poorly coordinated and harmonized. An end to this development does not appear to be in sight. Rather, further comprehensive packages of measures are to be expected. Just like the examination of the international framework, an intensive examination of the measures given at the European level is therefore indispensable for an effective ESG strategy. This is the only way to anticipate future legal requirements and market developments in addition to creating an overview of current requirements.

[34]The following is a general overview of European financial market regulation and its impact on the real estate industry. Regulatory projects of other economic sectors that also have an impact on real estate investments – such as the energy industry or governance requirements – are left out or partly dealt with in more detail elsewhere in this book.

Excursus

The EU legislative process is a multi-stage, partly dynamic and complex process:

The basic act (Level 1 legislation)

At the first stage, the European Parliament and the Council adopt a legislative act on the proposal of the EU Commission (enactment and amendments of primary law in the form of regulations or directives, so-called Level 1 legislation). Examples of this are the EU taxonomy, EU disclosure and CO2 benchmarking regulations presented below.

Delegated and implementing acts (Level 2 legislation)

Primary legislative acts may also provide for a delegation of powers to the EU Commission (delegated acts pursuant to Article 290 of the Treaty on the Functioning of the EU, TFEU, or implementing acts pursuant to Article 291 TFEU). While delegated acts serve to supplement or amend certain non-essential provisions of the primary legislative act, implementing acts are intended to ensure uniform implementation.

Binding technical standards as well as guidelines and recommendations (Level 3 legislation)

The EU Commission also has the power to issue binding technical standards for the further development and harmonization of legal acts, with the involvement of the European supervisory authorities (EBA, EIOPA and ESMA). These enter into force after approval by the European Parliament and the Council of Ministers.

In addition, the European Supervisory Authorities (ESAs) can issue guidelines and recommendations pursuant to Article 16 of the respective ESA Regulation without the involvement of the EU Commission. These serve to interpret and concretize Level 1 and Level 2 legal acts and to ensure uniform application.47

[35]1.2.2.1EU Action Plan on Financing Sustainable Growth

On 8 March 2018, the European Commission published its Action Plan on Financing Sustainable Growth48 with recommendations for financing the Paris Climate Change Targets and the SDGs. The Action Plan has three objectives: (1) redirecting capital flows towards sustainable investments; (2) addressing financial risks arising from climate change, environmental degradation and social problems; and (3) promoting transparency and long-termism in finance and economic activity.49

Concrete action points and important regulatory changes are proposed for implementation:

Establish a uniform classification system for sustainable activities (e.g. EU Taxonomy Regulation); Develop standards and labels for green financial products (e.g. EU Green Bond Standard); Promote investments in sustainable projects (such as more efficient design of funding instruments and sustainable infrastructure projects); Consider sustainability in financial advice (e.g. EU Disclosure Regulation); Develop sustainability benchmarks (i.e. Improving the transparency of methods and characteristics of climate benchmarks); Better integrate sustainability in ratings and market research; Clarify the duties of institutional and asset managers; Include sustainability in the regulatory requirements of banks and insurance companies; Increase transparency and revise the CSR Directive; and Promote sustainable corporate governance and mitigate short-termism in capital markets.50

[36]

Fig. 1.2: Regularities of legislation resulting from the EU Action Plan on Financing Sustainable Growth Source: PwC Legal AG.

[37]With the EU Action Plan, the EU Commission put Sustainable Finance on the political agenda for the first time. In its wake, extensive legislative projects were initiated, the full implementation of which will take some time.51 On 6 July 2021, the EU Commission published a renewed Sustainable Finance Strategy, announcing its intention to develop minimum requirements for Article 8 products of the EU Disclosure52 Regulation.53 It also proposed a new green bond standard.54

1.2.2.2The European Green Deal

On 11 December 2019, the European Commission launched the European Green Deal,55 a comprehensive growth strategy for a climate-neutral and resource-efficient economy. In particular, the Green Deal provides for targets and measures in the areas of (i) climate change and mitigation, (ii) environmental protection and legislation, (iii) energy and (iv) transport, with the greatest focus on climate protection. In addition to climate neutrality in 2050, greenhouse gas emissions in the EU are to be reduced by 50–55 per cent by 2030 compared with 1990 levels. Shortly before the virtual climate conference organized by US President Joe Biden, representatives of the member states and the EU Parliament reached a final and binding agreement on 21 April 2021 on a tightening of the climate target for 2030, according to which the EU’s greenhouse gases are to be reduced by at least 55 per cent compared with 1990 levels.56

In addition, the Green Deal aims to facilitate a more efficient use of resources through the transition to a clean and circular economy and to promote the restoration of biodiversity and the fight against pollution. All sectors and branches of the economy are called upon to actively contribute to the achievement of these goals.57

[38]On 14 July 2021, the EU Commission presented a comprehensive package of interrelated proposals for the implementation of the Green Deal, which is aimed at a comprehensive reorientation of the economy and society.58 In particular, the following measures are to be used:

emissions trading for new sectors and stricter requirements for the existing European emissions trading system;increased use of renewable energies;more energy efficiency;faster introduction of low-emission modes of transport together with the associated infrastructure and fuels;tax policy to be aligned with the goals of the Green Deal;measures to prevent CO2 leakage; andinstruments to preserve and increase natural CO2 sinks in Europe.59

To support the transition, the EU intends to provide both financial support and technical assistance.60 For example, at least €100 billion will be mobilized for the most affected regions over the period 2021–2027. On 7 June 2021, the Council of the European Union adopted the regulation establishing a Just Transition Fund, which will be endowed with €17.5 billion and will benefit states and regions that face major socio-economic consequences because of the implementation of the Green Deal due to their previous economic structure. The funds are to support, among others, small and medium-sized enterprises (SMEs), start-ups, the creation of new businesses, people finding jobs and adapting to new employment models, and social inclusion.61

1.2.2.3EU Taxonomy Regulation

Regulation (EU) 2020/852 Taxonomy Regulation62 (»EU Taxonomy Regulation«), which entered into force on 12 July 2020, is a cornerstone of both the EU Action Plan on Financing Sustainable Growth and the Green Deal.

[39]1.2.2.3.1The EU Taxonomy Regulation at a glance

The EU Taxonomy Regulation provides for a classification system for environmentally sustainable economic activities. It no longer requires implementation through national law and defines when an economic activity, and thus also an investment in this activity, is considered »environmentally sustainable«. In addition, the EU Taxonomy Regulation forms the basis for standardized technical screening and disclosure requirements.

The EU Taxonomy Regulation pursues the promotion of economic activities that make a positive contribution to at least one of the following six environmental objectives:

mitigation of climate change; adaptation to climate change; sustainable use and protection of water and marine resources; transition to a circular economy; pollution prevention and control; and protection and restoration of biodiversity and ecosystems.63

Investments are considered environmentally sustainable or »taxonomy compliant« if they:

contribute significantly to one of the six sustainability goals;do not significantly harm any other target (»Do Not Significant Harm« criterion);comply with certain minimum social standards (»Minimum Social Safeguard« criterion, e.g. for the protection of human and labour rights); andmeet the technical test criteria.64

The four criteria mentioned must each be fulfilled cumulatively.

In addition to (i) activities that already make a significant contribution to an environmental objective, the Taxonomy Regulation also covers (ii) transitional activities (i.e. activities for which there is not yet a low-carbon alternative but which support the transition to a carbon neutral economy) and (iii) enabling activities (i.e. activities that enable one of the two aforementioned activities).

[40]1.2.2.3.2User group

The EU Taxonomy Regulation is aimed at:

the EU member states and the EU itself; financial market participants providing financial products (including financial advisors); companies that are required to publish non-financial statements (e.g. as part of annual reports) (i.e. in particular European issuers of securities traded on capital markets – such as shares and bonds).65

As expected, the Taxonomy Regulation will indirectly affect more companies, as companies covered by its scope will regularly rely on information from business partners and customers.

1.2.2.3.3Transparency obligations

The EU Taxonomy Regulation obliges affected companies to publish whether and to what extent taxonomy-compliant economic activities exist. For other financial66 products, the following information must be added to the pre-contractual information and the periodic reports:

»The investments underlying this financial product do not take into account the EU criteria for environmentally sustainable economic activities.«67

If, on the other hand, sustainability is advertised, the EU Taxonomy Regulation provides for various declaration and disclosure obligations in Articles 5–7 in conjunction with the EU Disclosure Regulation as well as in Article 8 in conjunction with the CSR Directive (Directive 2014/95/EU inter alia with requirements of non-financial reporting).68

On 6 July 2021, the European Commission published a delegated act setting out reporting requirements for companies required to publish a non-financial (group) statement or report. In particular, the delegated act clarifies the reporting requirements to report on the environmentally sustainable share of revenue, capital expenditure (Capex) and their operating expenditure (OpEx) from 2022.69

[41]The EU Taxonomy Regulation targets individual activities of companies and not the company. This brings the advantage that companies can gradually adapt individual areas.

For the EU and its member states, the EU Taxonomy Regulation provides direction for all public measures as well as for the labelling of financial market products.

1.2.2.3.4First time use

The disclosure obligation on the first two targets (i.e., climate change mitigation and adaptation) applies from 1 January 202270 for the 2021 reporting period. On 21 April 2021, the European Commission published its final delegated act setting out technical criteria for the two climate change targets.71

Of particular importance for the real estate sector are the technical evaluation criteria listed therein for determining when an economic activity is sustainable within the meaning of the EU Taxonomy Regulation. For example, for new buildings (i.e., completion from 1 January 2021), the primary energy demand must be at least 10 per cent below the national requirements for low-energy buildings. In the area of »acquisition and ownership«, existing buildings must have an energy certificate of class A or alternatively prove that they belong to the best 15 per cent of the national or regional building stock in terms of their primary energy demand.

The European Parliament and the Council have a total of four months after publication to review and, if necessary, file an objection. Amendments, on the other hand, are not possible. The period can be extended once by a further two months. If both institutions do not respond within this period, the legal act is deemed to be confirmed.72

As of 1 January 2023, the obligation to disclose the remaining sustainability targets for the 2022 reporting period begins. In the context of a so-called call for feedback, the EU Commission issued proposals for delegated acts for the targets (3) protection of water and marine resources, (4) circular economy, (5) environmental pollution and (6) biodiversity at the beginning of August 2021, prepared by the Platform on Sustain[42]able Finance.73 The proposals also contain evaluation criteria for eight economic sectors, with a focus on the environmental goals of circular economy and biodiversity for the building sector. With regard to the circular economy objective, for example, new buildings or major renovation projects are required to prepare at least 90 per cent (by weight) of non-hazardous construction waste for reuse or recycling and to carry out a life-cycle assessment covering each phase of the life cycle. Regarding the biodiversity criterion, the explanatory memorandum states, for example, that improving biodiversity at a site is74 a spatially and temporally dynamic process of great complexity. Therefore, a combination of quantitative targets and qualitative, practical criteria is best suited to achieve results that can be considered a significant contribution. It is further emphasized that, given the complexity and temporal aspects of promoting biodiversity in the urban environment, a strategy – comparable to the approach of leading certification schemes – is an essential component for delivering and securing an essential contribution.75

1.2.2.3.5Conclusion and social taxonomy

Capital market participants risk losing access to finance if the EU Taxonomy Regulation is not applied. The above is intended to give a first impression of the complexity of the EU’s intention to develop a legal classification system for sustainable economic activities. Notwithstanding the resulting challenges, the EU Taxonomy Regulation offers a great opportunity to avoid greenwashing and to make significant progress in the transformation process towards sustainable development. Furthermore, the regulation also provides a framework for future EU-level legislative initiatives, possible restrictions, and controls.

In particular, the timetable and level of detail required for taxonomy-compliant reporting pose a major challenge for affected companies. Furthermore, flexible ESG strategies and processes are required to be able to react to yet unpublished details of the EU Taxonomy Regulation and future (further) developments.

Currently, the focus of the EU taxonomy regulation is still on determining the environmental sustainability of an economic activity, but in the long term the measurement of social sustainability of economic activities is also to be comprehensively regulated. [43]In July 2021, the Subgroup on Social Taxonomy of the Platform on Sustainable Finance presented a proposal for the extension of the taxonomy to include social sustainability objectives. The draft report emphasizes that considering the COVID-19 pandemic, outstanding social issues related to advancing sustainable development, persistent human rights abuses, and ever-increasing costs of housing, it is important to identify economic activities that contribute to advancing social goals. Based on international norms and principles such as the SDGs and the UN Guiding Principles on Business and Human Rights, a social taxonomy would help investors to find financing opportunities for decent work, inclusive and sustainable communities, and affordable healthcare and housing.

1.2.2.4EU Disclosure Regulation

As a further building block of the Action Plan for Financing Sustainable Growth, the Regulation on Sustainability-related Disclosures in the Financial Services Sector (»EU Disclosure Regulation«) entered into force at the end of December 2019. The aim is to tighten and harmonize sustainability-related disclosure obligations.

The EU Disclosure Regulation obliges financial market participants to:

incorporate their approaches to integrating sustainability risks into their investment decision-making process; and disclose adverse impacts of investment decisions on certain Principal Adverse Impacts on Sustainability (PAIs), such as environmental, social, and labour concerns, respect for human rights and the fight against corruption and bribery.

These obligations are also associated with an expansion of sustainability-relevant accounting.76

The Federal Financial Supervisory Authority (BaFin) has provided an overview of the start of the individual reporting obligations under the EU Disclosure Regulation and EU Taxonomy Regulation on its website.77

[44]A distinction must be made between the disclosure of information on the website, disclosures in sales projects and in annual reports or periodic reports, whereby obligations arise for the company level as well as the product level:

1.2.2.4.1Disclosure on the Internet

For example, information published on the internet must always be up to date. In the case of changes, a clear explanation of the scope of the change must be added.78 Furthermore, the companies concerned must explain whether adverse effects of investment decisions on sustainability factors are considered or not (»comply or explain«).79 If adverse effects are taken into account, an explanation must be provided, including details of measures taken or planned. If adverse impacts are not taken into account, clear reasons must be given and, if applicable, an explanation must be provided as to whether and when such consideration will take place.

Capital management companies with more than 500 employees must, as of 30 June 2021, make mandatory declarations on their websites about strategies for fulfilling their due diligence obligations in connection with the most significant adverse effects of investment decisions on sustainability factors (PAIs).