By signing the Paris Agreement in December 2015, the European Union pledged on behalf of its members to limit global warming. At the same time, one thing quickly became clear: the need to direct investments to activities that would allow for an effective transition to a low-carbon economy.
With this in mind, the European Commission announced in March 2018 its action plan for financing sustainable growth, which linked construction and the EU taxonomy. This plan is based on the European taxonomy, which allows defining and precisely identifying economic activity that can be considered “sustainable”. Therefore, the orientation of financial flows, both public and private, to “sustainable” activities have become more important than ever. And to guide them in the right direction, taxonomy becomes an essential guide.
What is taxonomy?
Taxonomy is a toolkit for determining which types of economic activity are environmentally sustainable. It focuses on private investment, directing it toward a climate-neutral, sustainable and resource-efficient economy. In practice, this is a list of activities that are considered “sustainable”, including technical criteria for evaluating them as such. The European taxonomy is already considered as highly promising by the real estate sector in terms of redirecting capital flows to long-term and ecologically friendly economic activity.
Important environmental issues
Four criteria will now be used to determine whether an activity is “sustainable”:
- minimizing the effects of climate change;
- adapting to climate change;
- protecting water;
- marine resources;
- transition to a more circular economy pollution prevention;
- reduction caused by various sectors ecosystem conservation and restoration.
Thus, activity is termed “sustainable” if it significantly helps to the fulfillment of one of these six goals while not negatively impacting one of the other five.
Redirection of financial flows
To address today’s environmental, social, and societal concerns, it is also vital to change the company performance evaluation grid. In this sense, the taxonomy is the first analytical tool for connecting financial and non-financial data. As a result, it fundamentally alters the criteria that will now be used to decide whether a firm is performing well or not, and this will have a long-term influence on the whole financial sector. These new European standards will now impact firms’ access to finance as well as how they write their statements.
What is the impact on investors and developers?
In the future, we will analyze the consequences and potential of this new law for operators working in the international real estate market in collaboration with a real estate investment specialist.
European taxonomy: who does it concern?
As previously stated, the taxonomy’s objective is to guide investments into “sustainable” financial products, initiatives, and activities. Taxonomy is now more of a guideline than a promise for private investors.
However, it should be noted that Article 8 of the Taxonomy Regulation is mandatory for companies already subject to non-financial reporting under the Non-Financial Reporting Directive (NFRD). By the way, these are enterprises of public interest, in which more than 500 employees issue securities – about 11,000 economic entities in Europe. In particular, these subjects will have to publish:
- the share of their turnover from products/services related to activities that are considered “sustainable”;
- the proportion of their capital expenditure (CapEx) and operating expenditure (OpEx) related to assets/processes related to economic activity that are considered “sustainable”.
Finance companies will also be required to publish these elements that apply to:
- their outstanding amounts (investment companies),
- their balance sheet (credit organizations),
- or an underwriting portfolio (insurance companies).
Moreover, you should know that the latest delegated act proposes to extend the scope of the obliged entities to all listed enterprises of public interest and SMEs. The NFRD will become the CSRD (Corporate Sustainability Reporting Directive) and will increase the number of companies covered by 50,000. Finally, financial products covered by the SFDDR (Sustainable Financial Development Disclosure Regulation) will be subject to specific reporting, depending on the article to which they belong (6, 8 or 9).
What areas of activity are part of the European taxonomy?
Not all types of activities are intended to be part of the green taxonomy. Remember that the purpose of this benchmark is to direct investments to those that have a positive impact on the climate and/or the environment. That is, those that meet at least 1 of the 6 environmental goals outlined above.
Regarding climate change mitigation and adaptation, the taxonomy has already assessed 88 activities belonging to the most emitting sectors (including construction). These activities are divided into 3 categories:
- “Sustainable” activity. That is, a neutral or low-carbon activity that meets the thresholds defined in the taxonomy.
- “Transitional” activities for which there is not yet an economically or technologically viable low-carbon alternative, but which can contribute to the transition to a “zero emissions” economy by 2050. Today, the taxonomy identifies 21 transitional types of activity. Reconstruction of buildings is one of them.
- “Enabling” activities that allow activities other than themselves to contribute to one of the six environmental goals (eg, a company specializing in geoenergy). The taxonomy defines 24 types of activities.
European taxonomy and real estate
The Climate Change Delegated Act, adopted in April 2021, applies from 1 January 2022. In particular, it specifies the technical examination criteria for 4 types of activities in the real estate sector:
- construction of new buildings,
- renovation of existing buildings,
- individual reconstruction measures
- and acquisition and ownership of buildings.
Thus, the act defines as “permanent” so construction after 1 January 2021 should represent a primary energy demand at least 10% below the threshold set by the current regulations. In addition, a renovated building can have improved energy performance (expressed as primary energy) by 30%. And a building in operation, built by 2021, in accordance with the BACS regulation, and which may feature a Class A Energy Performance Diagnostic (EPD) expressed as primary energy or failing to do so, being in the top 15% of the national or regional building stock in terms of primary energy consumption.
Thus, in addition to the EPD (Energy Performance Diagnosis) rating and obtained as part of the Eco scheme, European buildings will have, from 2022, a third regulatory “green” rating.
Aside from the legitimate debate surrounding the definition of what a “green” real estate asset should be, one thing is certain: the right trajectory is sustainability. The less the building consumes, the greener it is.