A police raid in May on the Frankfurt offices of DWS and its majority owner Deutsche Bank to investigate allegations of greenwashing by the German asset manager has sent a wave of worry over financial markets.

According to the Financial Times, the Frankfurt public prosecutor said the search was triggered by media reports that green financial products had been sold by DWS as ‘greener’ or ‘more sustainable’ than they were – allegations that DWS denies. The raid shows that financial watchdogs are getting serious about environmental, social and governance matters.

For real estate investors and lenders, this comes as they grapple with a sharp pivot towards ESG principles.

But many in the industry argue that there have been no cohesive standards or guidance amid what has been a rapid shift to embrace the ESG agenda, including through green lending. As a result, lenders risk issuing debt against properties that turn out to not be as green as initially promised, bringing refinancing risk. It also means financiers that label property loans as green are likely to themselves face greater scrutiny.

In the wake of the DWS raid, Peter Cosmetatos, chief executive of property finance industry body CREFC Europe, is seeing lenders become more circumspect and cautious.

“We’re hearing of cases where the fear of greenwashing accusations is outweighing the desire to undertake green lending. Lenders will be extra careful now,” he says. “But without core data or standards, what are the options? You either cannot market properly or you risk overselling.”

Jim Gott, head of asset diligence, surveillance and ESG at Mount Street, a loan servicer, says lenders need to know exactly what they are financing. “The complexity for lenders is that you are one step removed [from the property] but it is imperative for debt providers to interrogate and audit to build a precise picture of an asset in order to avoid being greenwashed, to ensure people are doing what they promise.

“It is also important to remember that what is classed as green today may well not be in five years’ time.”

Green ambition

Property debt specialists agree it can be difficult to understand exactly what regulators are seeking when it comes to ESG standards for real estate.

Katie Moretti, managing director, real estate debt, at investment manager Barings, says the business is grappling with these uncertainties by working closely with Kristina Arsenievich, its director of European real estate ESG. These conversations help the firm’s lending group to “get educated on what is required”.

“It is still so case-by-case in terms of each property,” Moretti says. “We are just starting to get to grips with what properties are simply ticking boxes, which are meeting regulations and what can be pushed to genuinely create assets that make a difference. Everybody is learning.”

Barings is keen to build awareness of regulatory requirements for real estate, especially around what lenders and developers should do when improving existing assets.

“While the regulatory frameworks, such as the EU Taxonomy, are key for driving improvement across the sector, the way in which they are written is incomprehensible to most developers,” says Arsenievich. “In light of greenwashing becoming a significant reputational risk factor, lenders are now under pressure to primarily direct capital to those assets that are achieving the highest level of green ambition possible, ie, ‘net zero’ new builds. However, this isn’t where the work needs to be done. The majority of greenhouse gas emissions associated with the built environment are coming from existing inefficient assets – EPC C and below – which require significant investment to mitigate transitional risk and where improvements can make the biggest difference.”

Schroders Capital’s European debt funds are Article 8-accredited under EU Sustainable Finance Disclosure Regulation, which requires they promote environmental or social characteristics. To achieve this, the manager has created a bespoke ESG screening and score card, based on a questionnaire of ESG elements across both the borrower and asset, to which the borrower can only give one of five answers with supporting evidence.

This, says Schroders’ Kristina Foster, a fund manager for real estate debt, is to ensure that borrowers “cannot make up the answers”.

“This was designed with support from internal sustainability real estate experts, third-party environmental and sustainability specialists, plus internal and external legal advisers to ensure that what we are doing is aligned to Article 8, and with what we say we are doing,” she explains.

“We are conscious, we do worry about greenwashing, but the strategy we have designed works for us. What I am more concerned about, however, is the fast pace of change around what is required. You can’t create an ESG strategy and say it is finished; it has to evolve. We have regular updates with our internal specialists to make sure we keep on top of it to ensure our approach is relevant when the guidance isn’t clear. The risk is around interpretation.”

Defining green

While the property industry has been evolving its definition of ‘green’ buildings for decades, with the benefit of third-party certifications such as BREEAM and GRESB ratings, their use is not compulsory. Owners have been able to interpret guidelines to suit their strategies.

Oliver Light, director and real estate lead at Carbon Intelligence, which helps businesses set and achieve sustainability targets, cited an example of what he views as consistent greenwashing in the sector. “You get real estate investors who believe it is as simple as removing a gas boiler or spending thousands on offsetting and then claim they have net-zero buildings. The list goes on,” he says.

For lenders, particularly debt fund managers, ensuring that underlying real estate is genuinely green will be crucial when credit funds are marketed to investors as ESG-focused. Some say liberal interpretations of ESG principles are especially problematic in light of SFDR, which came into force in March 2021. Its UK counterpart, Sustainability Disclosure Requirements, is being finalised by the UK’s Financial Conduct Authority with the latest consultation on the proposals expected this autumn.

Both sets of regulation set out mandatory ESG disclosure requirements for asset managers. One of the most challenging aspects of SFDR is the Principal Adverse Impacts regime, which requires extensive disclosures on ESG-related matters such as greenhouse gas emissions.

“At the moment, demand for ESG funds is sky high and fund managers want to meet that demand with supply,” says Rachel Richardson, head of ESG at law firm Macfarlanes. “The data collection required by regulators is challenging for fund managers, particularly in a market that lacks capacity of talent with the right skills and training to provide it. However, regulators have indicated they are going to get stricter, and if managers don’t get it right then there’s a risk of greenwashing allegations. The risk of claims is growing.”

Paul Sutcliffe, executive director at sustainability consultancy Evora Global, has seen a broad spectrum of green funds being set up under SFDR. “There are Article 8 funds which, in my view, have done the bare minimum to get over the line – an approach we do not support – while others in that category are financing net-zero carbon buildings.”

Sutcliffe says he has been receiving concerned enquiries since the DWS raid: “When clients ask with help in setting up Article 8 funds, they will often stress worries about the potential for greenwashing allegations.”

Aleksandra Njagulj, global head of real estate ESG for DWS, declined to comment on the May raid at the firm. However, on the topic of SFDR, she believes that the regulation has the potential to create confusion for real estate practitioners. “I am by no means against regulation, but it by definition comes at the issues from a high point of view and therefore risks putting apples and oranges in one basket,” she says.

Njagulj says SFDR does not give “a definition, but a vague idea” of what sustainable investments should be, unlike precise criteria in the EU Taxonomy. “There are nearly no measurable criteria (excepting EPC rating in PAI) and yet it is asking for funds to report against a percentage of sustainable assets in a portfolio. In such a situation, each asset manager is forced to ‘invent’ their own definition. That could lead to greenwashing. It will certainly at least make reporting from different managers very hard to compare.”

Across the board, debt providers, including alternative lending platforms as well as traditional bank lenders, seem to want to better align market practices with regulation and work towards standardised debt assessment tools. But in the interim, many are turning to third parties for guidance.

Sutcliffe says Evora Global is seeing this trend. “Interest in our services for provision of ESG debt has grown,” he says. Sutcliffe is also working alongside CREFC Europe to help produce guidance for real estate debt funds in developing lending products for funds that are classified as Article 6, 8 or 9 under SFDR.

Are banks behind the curve?

While much ESG-focused regulation has put pressure on asset managers, including real estate debt fund managers, banks will also need to step up their efforts to demonstrate that their ESG processes are thorough.

Many worldwide are adopting the Basel-based Financial Stability Board’s Task Force on Climate-Related Financial Disclosures framework. For example, in April, TCFD recommendations became mandatory for prime-listed UK banks.

Mount Street’s Gott is concerned that commercial real estate banks are not as ready as they should be. “The debt funds are more on top of what questions they need to ask than the clearing banks, which are behind the curve and taking much longer to ratify new ESG processes,” he warns.

“Some banks are putting broad ESG terms into a finance agreement and have clauses that allow them to take action or make ESG something a borrower should report on each year, but that is a minority,” Gott explains. “In most facilities you will not see ESG terms written in explicitly, and that is going to make it hard for lenders when things change.”

Proactive approach

Although the current situation is confusing, there are steps lenders can take to give their green loans the necessary belts and braces.

Asset selection goes a long way, says Gavin Eustace, co-founder of Silbury Finance, a lender backed by private equity firm Oaktree Capital Management. Keeping financing agreements simple is another.

“We are thinking about greenwashing simply because we are institutionally funded. If we say we are writing a sustainability-linked loan and it isn’t, that is a problem,” Eustace said. “If we say to a developer, we are giving a discount to deliver a sustainably linked product, then those terms need to be fair and simple so that said developer understands it, can deliver a better EPC score, and then benefit from the discount.”

The collection of high-quality data is also seen as a key measure to keep a focus on an asset’s ESG performance. But it can be challenging, says Macfarlanes’ Richardson.

“We may see funds and companies report data in year one. And then in year two, they’ll find that they need to clarify something, or change their methodologies because they have improved or corrected previous data,” explains Richardson. “That’s okay, provided that the business explains it. Hiding mistakes is more likely to trip people up.

“Data collection will often be imperfect. Best practice will be to carefully footnote the data included, explain the methodologies used, where estimates and proxy data are used. If something is missing, explain why.”

Sarah Forster, CEO and co-founder of impact advisory firm The Good Economy Partnership, says the real estate industry can be very metric-focused. She argues that data collection should not become an end in itself. “There is a lot of noise about disclosures and day-to-day data, but what needs to come first is why you are gathering it and what purpose it serves?”

Adopting a clear ESG and impact strategy is essential, Forster argues, for organisations to set objectives and related targets that will have an impact on the quality of people’s lives and the planet.

“The data is important in supporting the selection and implementation of strategic outcomes, it isn’t the strategy in itself. Since positive social impact is about improving quality of life – wellbeing, fulfilment, self-esteem – the data measures need to be qualitative, not just quantitative, in order to offer a meaningful picture, or many of the impacts will be missed,” she adds.

Forster, whose organisation aims to make sure its real estate investment clients are aligned with emerging international standards, is adamant about the fundamental importance of staying ahead of regulation.

“It is about understanding and meaningfully recording real world outcomes and taking end-user and stakeholders’ perspectives into account, which is important to the narrative and performance management of any responsible business,” she explains.

It is also key that data is pegged against industry-recognised net-zero goals, advises Carbon Intelligence’s Light, who is also working on the FCA consultation on the SDR. “What lenders really need to be doing is understanding what key information is and how it will align with broader net zero or ESG requirements that link with regulations such as SFDR and SDR,” says Light.

Those assets deemed to be in line with construction and property industry body the UK Green Building Council’s pathway to net zero are an indicator of credibility, advises Light. This framework was designed to help the industry transition buildings to net zero by 2050, in line with the ambitions of the Paris Climate Accords. It also outlines how claims should be evidenced and measured. “Lenders also need to understand historic data around energy trends and how that data factors into the energy intensity of the asset,” he adds.

Efforts to define green real estate

In April, industry body the Association of Real Estate Funds,
along with other associations and organisations including Pensions for Purpose and The Good Economy, submitted proposals to the UK’s FCA to aid its development of real estate-specific metrics for ESG that align with TCFD guidelines and the SDR.

ESG benchmark provider GRESB is understood to be re-launching an effort to build a benchmarking tool for lenders that aims to consolidate loan origination policies, due diligence and stakeholder engagement processes, property-level collateral monitoring methods and asset upgrade financing offerings.

Impact advisory firm The Good Economy, in conjunction with a broad group of housing associations and lenders, launched the Sustainability Reporting Standard for Social Housing to provide transparent, consistent and comparable ESG criteria and metrics for the UK social housing sector.

CREFC Europe formed its own ESG working group, comprised of lenders, and published a climate-related due diligence guide for CRE lenders in May. The downloadable guide supports lender conversations with borrowers about asset-level climate resilience and climate impact, as well as sponsor management and governance of environmental and sustainability matters.

A greener future

More scrutiny of the ESG credentials of a building or development during the due diligence process is a crucial way for lenders to ensure they do not become victims of greenwashing or stand accused themselves of overclaiming their loans’ greenness.

Gregor Bamert, head of real estate debt for UK manager Aviva Investors, argues that while the due diligence process involves more work than it did previously, many real estate owners are now further along in their sustainability journey.

“It used to be considered an oddity for a lender to ask a borrower for the EPC data of an asset, whereas now it is almost seen as the minimum ask as part of the due diligence process,” he says.

But Bamert agrees that ongoing assessment and engagement, to better understand owners’ plans for individual assets, is key. Aviva uses external second-party verification and accreditation to ensure it is complying with the Loan Market Association’s sustainability-linked loan principles, for example.

Similarly, Schroders’ Foster says the firm holds portfolio risk reviews every quarter, then once a year goes to the borrower to ensure that it is following current ESG guidance. Mount Street, meanwhile, devised 100 questions for lenders to put to borrowers. Gott recommends undertaking climate risk modelling, too, though he says that very few parties do this.

“We forward-model what might happen to that asset in five-year time slots and see what will happen to that building under certain extreme weather conditions,” says Gott. “If there is a risk in that timeframe, then the lender and borrower need to ensure there is capex set aside for renovation. Lenders need to be mindful that a lot they are being presented with now might be classed as greenwashing in the future. It is about looking ahead.”

A critical part of the conversation around green lending is thinking about what comes next. Projecting a valuation for a property based on its green credentials is becoming more common, although it may seem like a reverse approach to standard methods of valuation as it looks at future values.

Simon Todd, group head of real estate services at Crestbridge, a global administration, management and corporate governance solutions business, argues that borrowers are engaging in similar legwork, with the most proactive institutions on the equity side getting individual reports for each asset in their portfolio to identify potential shortfalls from a green perspective. “Their rationale is that it is the right thing to do from a saleability perspective and because it makes those assets acceptable to banks.”

There is undoubtedly a strong desire across the European real estate industry, including among lenders, to prioritise sustainability, even if regulation and expectations have been difficult to read. Growing momentum can, with the support of a clear regulatory framework, drive the decarbonisation of commercial real estate. CREFC Europe’s Cosmetatos urges onlookers to recognise that ESG is “an iterative journey” for everyone, including regulators.

While some in the industry have undoubtedly taken advantage of loose definitions around ESG to overclaim their green credentials, the overwhelming understanding among lenders and sponsors is that tightening regulation, as well as more discerning investors and tenants, means those engaging in greenwashing will become increasingly apparent.

For Foster, despite the challenges inherent in green lending, she welcomes the opportunity for firms such as Schroders to help shape the future landscape. “It is an exciting thing for lenders to be part of, and we can really make a difference. Lenders can be in the driving seat.”