Environmental, social and governance (ESG) has been bandied about with increasing vigor for decades, but what was once an optional form of risk management and valuation has now come under the scrutiny of the U.S. Securities and Exchange Commission (SEC).
In recent months, the European Commission has enacted climate disclosure rules to strengthen and standardize climate-related disclosures among public companies and public offerings, a move with significant implications for the commercial real estate (CRE) industry, as stakeholders are specifically urged to reassess their portfolios and operations to ensure ESG compliance.
However, many US states, non-governmental organisations (NGOs) and climate advocacy groups were not prepared to sleep peacefully without a fight and challenged the recently adopted SEC rules. The SEC was flooded with objections and the Commission voluntarily stayed implementation of the rules less than a month after they went into effect, pending the completion of judicial review by the Court of Appeals.
Understanding ESG
To better understand where the SEC’s climate disclosure rules stand on this crossroads, it helps to have a deeper understanding of ESG and how we got to this point.
The term “ESG” is said to have first appeared in the 2004 United Nations report “Who Cares Wins: Connecting Financial Markets to a Changing World,” which proposed recommendations and guidelines on how to “better integrate environmental, social and corporate governance issues into asset management, securities brokerage services and related research functions.”
ESG is a three-pronged consideration that looks at a company's overall sustainability. Environmental refers to the company's impact on the environment, Social refers to stakeholder relationships and well-being, and Governance refers to the ethical running of the company. ESG is good for business and is expected to deliver significant savings and value, especially for CRE.
ESG gained further political power in the international climate debate when the United Nations released the 2030 Agenda for Sustainable Development in 2015, which laid out a comprehensive blueprint of 17 sustainability goals, including industrialization and infrastructure, clean energy, and healthy cities.
The Paris Agreement, an international treaty on climate change, was further adopted in 2015. More recently, the 2023 European Sustainability Reporting Standard was introduced, which established a benchmark for ESG reporting for companies within the European Union (EU). The measure came into force at the beginning of 2024.
Also in 2023, the International Sustainability Standards Board issued updated sustainability disclosure standards to “increase trust and confidence in corporate sustainability disclosures that inform investment decisions” and, for the first time, “create a common language for disclosing the impact of climate-related risks and opportunities on a company’s prospects.”
As part of rejoining the Paris Agreement, the White House announced its own ambitious goal in 2021 to achieve net-zero emissions across the economy by 2050 through a whole-of-government approach that considers standards, incentives, programs, and support for innovation.
In California, Governor Gavin Newsom made headlines last year when he signed a bill that was the first in the nation to require thousands of companies to disclose “climate-related financial risks and the measures they have taken to mitigate and adapt to climate-related financial risks” by 2026.
A new layer of SEC compliance — still under review
In March 2024, the SEC released updated standards to strengthen and standardize climate-related disclosures for public companies and initial public offerings. According to the SEC, “The rule reflects the Commission's efforts to respond to investor demand for more consistent, comparable, and reliable information about how registrants are managing those risks, while balancing concerns about the financial impact of climate-related risks on a registrant's business and mitigating the associated costs of the rule.”
SEC Chairman Gary Gensler added: “These final rules reinforce past requirements by requiring material climate risk disclosures by public companies and public offerings. The rules provide investors with consistent, comparable and decision-useful information and provide clear reporting requirements for issuers. They also prescribe specifically what companies must disclose, providing more useful information than what investors see today. And by requiring climate risk disclosures to be included in SEC filings such as annual reports and registration statements rather than on company websites, they help provide greater credibility.”
As mentioned above, the newly enacted standards are already facing legal challenges, and the current stay, set for April 4, 2024, will give companies, particularly large accelerated filers (LAFs), extended preparation time until the litigation is finally resolved. Under the originally adopted timeline, compliance was set to take effect in phased deadlines depending on the company's classification and the information reported. These included:
Large Accelerated Filers (LAFs): Disclosure and financial statement requirements are effective for FY2025 and FY2026. GHG reporting and assurance requirements are effective for FY2026, followed by FY2029 (limited assurance) and FY2033 (reasonable assurance). Accelerated Filers (AFs): Disclosure and financial statement requirements are effective for FY2026 and FY2027. GHG reporting and assurance requirements are effective for FY2028, followed by FY2031 (limited assurance). Non-Accelerated Filers (NAFs), Small Reporting Companies (SRCs), and Emerging Growth Companies (EGCs): Disclosure and financial statement requirements are effective for FY2027 and FY2028. Reporting of GHG emissions is not mandatory. For example, KBS's portfolio of funds falls into the NAF category and will not be subject to disclosure and financial statement impact audits until the 2027 fiscal year.
CRE SEC Regulation and Beyond
CRE has long been under regulatory scrutiny because it has one of the largest impacts on climate change. Research shows that the industry is responsible for roughly 40% of global carbon emissions, with roughly 70% of emissions coming from building operations and 30% from construction. This means that most property owners have plenty of room to cut the excess, so to speak. With this insight, CRE has plenty of room to develop and shape strategies to comply with SEC regulations.
For example, KBS is furthering its efforts to be an ESG leader in the industry, setting a goal to reduce greenhouse gas emissions by 5% by 2025. This includes emissions under the company's direct control as well as on-site emissions generated by tenants in properties managed by KBS.
Demonstrating its ongoing commitment to ESG transparency and performance improvement, KBS has been recognised for its sustainability by receiving Green Star certification in the 2023 GRESB Real Estate Assessment.
Through 16 separate accounts and six combined funds for government and corporate pension funds, KBS and its affiliates have completed over $44.9 billion of transaction activity on behalf of retail and institutional investors worldwide. In addition, KBS sponsors five sovereign wealth funds and seven SEC-registered unlisted REITs, as well as a publicly listed Singapore REIT.
“As a real estate owner and operator, KBS considers sustainability to be one of its most important values, and our GRESB ranking validates the work we've done over the past several years,” said Mark DeLuca, KBS CEO and Eastern Region President. “We are honored to be recognized as one of the world's largest real estate companies.”
Summary on SEC Regulatory Compliance
Despite current delays on SEC climate disclosure rules, regulation is inevitable and it is only a matter of time before deadlines that impede progress expire. Data will undoubtedly become even more important in the future of reporting and compliance. Regulatory inspectors will not be interested in anecdotes; rather, they will be interested in comprehensive analyses that provide clear insights into the ESG impacts of buildings, CRE portfolios, and even a company's entire operations.
All this means a new pulse is beating with the promise of a more sustainable, resilient and green future.
For more information, visit KBS.com/Insights.