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EU's new sustainability standards involve modelling the financial risks and opportunities

June 13, 2023

This article has been prepared in co-operation with Petri Suutarinen (Finreim Oy).

Interested in sustainability and practical business cases? We invite you to take part in the related FREE upcoming webinar (in Finnish), which is organized by Datapartner Oy in partnership with Finreim Oy. Register

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Where are we now? The two most significant ways to reduce the carbon footprint of real estate investors and developers

Your organization may have already set a low-carbon or even carbon-neutral target for 2030-2035. A concrete science-based carbon roadmap for reaching the target may also have already been drawn up.

However, many organizations struggle to combine sustainability with the financial figures of their business.

In the real estate sector, the key investments to be modelled in carbon management are the profitability of energy efficiency projects. Energy efficiency investments have recently been the best investments for real estate investors. But now that energy price volatility has increased, there is also a need for broader sensitivity analyses with key variables. When the low-hanging fruit has already been picked, there is a risk that the next energy efficiency projects, even those that are still very profitable, will not be implemented.

With the cash flow calculation of an energy efficiency project made using Invest for Excel, you can perform sensitivity analyses of the investment's payback period, the internal interest rate, and, most importantly, how the value of the property will increase in different scenarios. It is also worthwhile to assess the reduction of carbon risk at different levels of emission trade prices (or the company's internal carbon price) because how do you know when the carbon footprint of commercial properties will be taxed in one way or another in the EU?

Improving energy efficiency has been the most important way to reduce the portfolio's carbon footprint so far. Already today, measures will also be needed to reduce emissions from construction materials in construction projects. Today, low-carbon building materials may still require additional investments, which should be presented at the investment decision stage. Additional investments in low-carbon building materials should, of course, be targeted at those projects and building systems with the greatest CO₂e reduction potential in the building's life cycle.

Why will many large companies have to make renewed cash flow calculations in the coming years?

The European Commission published the delegated act supplementing the Accounting Directive, as amended by the Corporate Sustainability Reporting Directive, on June 9th, 2023. The act is open for consultation until July 7th.

From ANNEX I (EUROPEAN SUSTAINABILITY REPORTING STANDARDS), you can find examples of why large companies must have the ability to make renewed cash flow calculations (simplified and condensed from the draft Annex 1):

• A sustainability impact may be financially material from inception or become financially material when it could reasonably be expected to affect the company's cash flows over the short, medium, or long term.
• The identification of climate-related risks and opportunities that have a material influence on the company's cash flows over the short, medium, or long term is the starting point for financial materiality assessment.
• Anticipated financial effects due to climate change material physical risks and transition risks are meant to provide an understanding of how these risks have a material influence on the company's cash flows over the short, medium, and long term.

Currently, there is no commonly accepted methodology to assess or measure how material physical risks and transition risks (and climate-related opportunities!) may affect the company's future cash flows. Therefore, the disclosure of the financial effects will depend on the company's internal methodology and the exercise of significant judgment in determining the inputs and assumptions needed to quantify their anticipated financial effects.

The standards are not only limited to climate change, but cash flow reviews must also be done for:

• Material pollution-related impacts, risks, and opportunities.
• Marine resources-related impacts, risks, and opportunities.
• Biodiversity and ecosystem-related impacts, risks, and opportunities.
• Circular economy-related impacts.

By combining sustainability reporting with financial reporting, investors and all other stakeholders get valuable information about the company's future. The new standards do not determine what a good level of sustainable development (for any industry) is. The EU Taxonomy, which is already in use, has been prepared for that purpose. We predict a tightening of its technical criteria at the beginning of the next upcoming boom.

Petri Suutarinen (Finreim Oy) is a professional sustainability consultant who develops net zero/low-carbon property investments and assists companies in their corporate sustainability work and ESG strategy implementation. Petri has been using the Invest for Excel software in his work for almost ten years.

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