GRESB on tackling the EU Taxonomy

GRESB’s real estate associate, Christina Djambazca, assesses the state of play for meeting EU Taxonomy requirements.

Christina Djambazca

In order to reach the Paris Agreement goals and transition to a low-carbon economy, it is essential that investors and financial institutions allocate capital to sustainable projects and activities. But how do we know which economic activities are truly sustainable?

As part of the EU’s suite of sustainable finance regulations, the EU Taxonomy aims to direct capital flows toward sustainable activities by establishing a classification system with clear definitions of what constitutes an environmentally sustainable economic activity. To meet the Taxonomy’s definition of environmentally sustainable, each activity has to substantially contribute to at least one of the EU’s six environmental objectives, do no significant harm to the other objectives, while also meeting the minimum social safeguards.

The Taxonomy details four main economic activities relevant to real estate investments – the construction of new buildings and the renovation, acquisition and ownership of existing buildings – each coming with its own Technical Screening Criteria.

Strive to comply

The introduction of the EU Taxonomy serves as an enabler of future disclosure obligations for companies and investors, mandating them to disclose their share of Taxonomy-aligned activities. While the Taxonomy is already starting to play a key role in driving investments toward a uniform definition of sustainable real estate investments, the ability to showcase compliance with the classification system has proven to be a struggle for many real estate asset owners and managers, with little guidance around how portfolios can confirm whether they are Taxonomy-aligned.

To try to better understand the challenges that many of GRESB’s European members will face when determining their share of Taxonomy-aligned investments, GRESB evaluated the practical applicability of the technical screening criteria for climate change mitigation relevant for the acquisition and ownership of real estate assets.

The technical screening criteria that define the acquisition and ownership of real estate as environmentally sustainable state that an asset:

  • substantially contributes to climate change mitigation by having an Energy Performance Certificate of at least class A, or by adequate evidence is able to confirm an operational energy performance within the top 15 percent of the national building stock;
  • must meet the do-no-significant-harm criteria for climate change adaptation, which includes conducting a robust climate risk and vulnerability assessment, consisting of:
    • screening and assessing the materiality of physical climate risks;
    • an assessment of solutions that can reduce the identified risks.

When analyzing what constitutes a substantial contribution, applying either of the two definitions provided by the Taxonomy raises practical considerations – are those two alternatives the same when it comes to defining a property as environmentally sustainable? The GRESB 2022 asset level dataset shows that this is not the case.

More than 10,000 of all 53,000 European properties reporting to GRESB as part of the 2022 Real Estate Assessment would meet either of the two requirements that identify an asset as substantially contributing to climate change mitigation. However, this share varies significantly when looking at which of the definitions of sustainable contribution are met per country.

Some EU member states have little to no properties with an EPC rating above class A. One reason is the lack of standardization and/or availability of EPCs across countries and sectors, which makes it close to impossible to map existing rating levels across Europe. Even when an EPC rating system is available, we see a class of A or above is not indicative of the same share of assets as the one meeting the definition based on actual energy performance.

While using the EPC-driven definition of substantial contribution leads to inconclusive results, applying the alternative definition of being within the national building stock’s top 15 percent in terms of energy performance does not come without its challenges. One of them is around the construction of valid benchmarks that, by adequate evidence, are able to confirm a building as a top performer in terms of energy demand.

Establishing a benchmark

Using GRESB’s dataset, and assuming it is a fair representation of the building stock in Europe, we were able to construct benchmarks for most countries and main property sectors in the EU. However, the extent to which the GRESB dataset or any alternative source of information can be confirmed as providing adequate evidence in the eyes of the regulator is still unknown. And even if we assume that there is a robust benchmark that defines that top 15 percent threshold, the issue of obtaining actual, accurate data on the energy performance of buildings – a well-known obstacle for many GRESB participants – still persists.

While acknowledging challenges and assumptions about the details of translating the regulation into practice, we arrived at a count of over 10,000 European assets that could meet either of the two definitions of sustainable contribution. The next step now will be to ensure that those properties also do no significant harm to the other environmental objective relevant for the economic activity – climate change adaptation.

As a proxy for this we used portfolio-level information from the 2022 GRESB Real Estate Assessment on whether the organizations that manage each portfolio have a robust process of identifying physical climate risks.

An interesting outcome of the do-no-significant-harm filter is that only 348 out of the 713 portfolios that manage assets that substantially contribute to climate change mitigation have processes in place to identify the physical climate risks to which their portfolio is exposed. This significantly cuts down the number of assets that can be classified as sustainable to just over 6,000.

With some assumptions and practical implications along the way, we were able to estimate that no more than 12 percent of European properties reporting to GRESB in 2022 could be seen as Taxonomy-aligned, should they also meet minimum safeguard requirements. While the application of the Taxonomy can be challenging and there are a few gray areas, what is clear is that real estate managers reporting to GRESB are well accustomed to collecting and reporting structured data around what constitutes an environmentally sustainable operational asset.

Although there is much ground to cover until real estate fully aligns with the Taxonomy, GRESB members and other entities reporting on their ESG practices and sharing disclosures are well positioned to achieve alignment and guide the industry forward.