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Slavery Statement
Environmental, social, and governance (ESG) concerns have taken on increased significance over the past few years. Construction is one of the sectors most exposed to ESG considerations. Decarbonisation is a particular concern, as commonly used construction materials – as well as shipping, freight and heavy vehicles – account for a significant percentage of carbon emissions. In 2020, the United Nations Environment Programme calculated that the building sector was responsible for 38% of global energy-related CO2 emissions – and that annual progress in decarbonisation had halved between 2016 and 2019. Successful decarbonisation will require major changes in the sector, with much greater levels of both investment and innovation. Here we highlight ten top-level steps for construction companies that want to maximise their ESG performance and benefits.
ESG: Ten steps to success for construction companies
Understanding the ESG landscape
1. Ahead of the regulatory curve
3. Assess and manage ESG risk
4. Focus on the human factor
2. Pivot to ESG funding
5. Supply chain management
7. Engage with stakeholders
8. Identify ESG baselines and KPIs
6. ESG-compliant procurement
9. Collect good data
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10. Monitoring & reporting
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Emma Schaafsma Partner
Construction is one of the sectors most exposed to ESG considerations. Decarbonisation is a particular concern, as commonly used construction materials account for a significant percentage of carbon emissions. But ESG is not just about climate change, and the construction industry faces many other challenges. While in many countries it is already heavily regulated in areas such as health and safety, modern slavery, competition, and anti-bribery and corruption, it faces significant problems in others, including equality, diversity and inclusion. Governance issues too – not least transparency, data security, risk management, internal controls and shareholder rights – are increasingly on the agenda.
Businesses increasingly find themselves under pressure from various quarters – including governments, investors, employees and the wider community – to set and achieve ESG goals. The direction of travel towards more regulation in this area and greater urgency in the delivery of tangible results. Decision-making in businesses is increasingly informed and shaped by ESG considerations, in both the boardroom and the c-suite.
Stronger ESG scores also translate to a roughly 10% lower cost of capital.
The good news is that – as well as being justifiable on ethical grounds – strong ESG performance increasingly appears to correlate with stronger business performance. McKinsey reported in 2020 that around 70% of over 2,000 academic studies had found a positive relationship between ESG scores and financial returns (whether measured by equity returns or profitability or valuation multiples), with emerging evidence that stronger ESG scores also translate to a roughly 10% lower cost of capital, reflecting the reduced risk that comes with a strong ESG proposition.
In any company, the requirement to consider the long-term consequences of decisions means that sustainability, essential for the long-term success of the company, should be at the forefront of directors’ minds. And sustainability Here we highlight 10 top-level steps for construction companies that want to maximise their ESG performance and benefits. is ever more closely linked to ESG performance. We would be pleased to discuss any of this with you in greater depth.
Shona Frame Partner
Governments across the world are invested in ESG through their Paris Climate Accord and COP26 commitments, and gender, racial, and socio-economic diversity goals, policies and legislation, as well as the corporate governance and anti-bribery and corruption regulation of companies operating in their jurisdictions. To take just two specific examples that are highly relevant to construction companies:
The trend of direct government action is very firmly towards higher ESG standards. Proactive businesses are likely to find it easier to bring themselves into compliance with future government regulation than those that do not prioritise ESG.
1. Get ahead of the regulatory curve
The UK government is removing the construction industry’s ability to use the lower-duty but more polluting red diesel, forcing it to use the more expensive but less-polluting white diesel. The EU is planning to add an additional tax to imports to account for the carbon used in certain foreign manufacturing processes.
Some aspects of ESG reporting are already mandatory for many businesses: e.g. greenhouse gas emissions, energy use, gender pay gap, modern slavery, and payment practices. In the UK others, such as climate-related disclosures (to the standards of the Task Force on Climate-related Financial Disclosures), are in the pipeline, and regulation is only likely to increase in this area. As we suggest throughout this publication, companies that perform well against ESG metrics will enjoy a variety of advantages. One of these it to anticipate – and often exceed – levels of performance that may ultimately be made mandatory. Those that do may also be in a better position to help shape future regulations, through their example and through consultation.
Companies that exceed anticipated levels of performance will be in a better position to help shape future regulations.
1. Get ahead of the
We are already seeing the development of a gap in access to funding (and in the cost of borrowing) between borrowers and projects with strong ESG credentials and those with a sub-par ESG profile. Some construction companies have begun agreeing loan facilities whose interest rates depend on their success in meeting ESG targets. Others have successfully issued ‘green bonds. Asset managers are rushing to find high-quality ESG investments, in response to a rapid increase in demand for ESG-based funds. Even where the terms of a loan are not tied to ESG performance, banks are looking ever more closely at the ESG records of prospective borrowers – not only because they increasingly seek to undertake ethical lending, but also because successful ESG strategies are typically an indicator of focused and effective management and the longer-term prospects of the company as a whole.
These funders and investors will be looking not only at the nature of any development for which funding is sought but also at all aspects of the supply chains which will deliver the project. They are also concerned about the value of the asset once built. There is an increasing focus on the impact of ESG on valuations. The RICS has published its ‘Red Book Global Standards’ effective from 31 January 2021, which provides guidance on this to assist in putting ESG credentials on the radar as an aspect of value.
ESG’s rise to become a primary concern of funders, investors and shareholders has been evident over the past few years. Funders and institutional investors are looking closely at their own ESG approach with a view to ensuring their investments are resilient and sustainable in the long term. This means they are imposing requirements as part of investment decision-making related to ESG.
Banks are looking ever more closely at the ESG records of prospective borrowers.
ESG risk issues can also affect the availability and cost of insurance. There is research to suggest that companies with higher ESG ratings expose insurers to less risk. A 2018 study by AGCS and the Value Group found that ESG performance was directly linked to a company’s probability of experiencing workforce accidents, controversies, or fines from regulators. Insurers are also concerned about reputational risk arising from their association with businesses they insure. In 2021, for example, Canadian oil pipeline operator Trans Mountain successfully applied to have its insurer’s name redacted from public documents to shield them from the negative publicity of insuring fossil fuel companies. At that time, the number of insurers willing to cover Trans Mountain was falling and insurance was only available at “significantly higher cost”. One key aspect of ESG risk management is how businesses – and societies – adapt to alleviate the impact of an already changing climate on their activity. This may range from taking account of higher temperatures by changing working patterns, through relocating operations, to finding new sources of materials if existing sources are at risk of disruption. As climate change is a global problem with different local impacts, businesses operating in multiple geographies are likely to require a portfolio of approaches.
A multiplicity of risks relate to ESG issues. Most obviously, as ESG regulation increases, businesses have little choice but to incorporate relevant factors into their risk management frameworks. But seen more broadly, many ESG issues may pose wider risks to businesses that fail to address them.
There is research to suggest that companies with higher ESG ratings expose insurers to less risk.
To take one example, new buildings will certainly be expected to observe low carbon principles. But they also need to take account of climate change. Even if global warming is limited to less than two degrees, in line with the Paris Accord, it will still likely result in a far larger number of extreme weather events, an increased chance of flooding, and other problems. Inadequate consideration of these risks in the design and construction of new buildings would not only be a failure of ESG principles but could also increase the likelihood of disputes and claims against the businesses involved. More than ever, developers, designers and contractors will have to assess the lifetime ESG impact of projects – not only with regard to climate change, but also considering aspects of ESG such as public health and the ability to serve a changing demographic. ESG risk issues can also affect the availability and cost of insurance. There is research to suggest that companies with higher ESG ratings expose insurers to less risk. A 2018 study by AGCS and the Value Group found that ESG performance was directly linked to a company’s probability of experiencing workforce accidents, controversies, or fines from regulators.
As a traditionally male-dominated sector, construction offers considerable scope for engagement with the diversity and inclusion agenda. In the UK, for example, only 16% of construction jobs are held by women, and there is still a substantial gender pay gap. Businesses can both make a genuine difference and enhance their ESG credentials by, for instance, recruiting more women to apprentice and graduate roles, and ensuring that working practices take account of diversity and inclusion. Progress is being made across the sector. In the UK, for example, the Construction Leadership Council is developing proposals to introduce a common set of equality, diversity and inclusion metrics. However, companies should still press ahead with their own initiatives and seek to be industry leaders – pursuing stronger ESG performance in this typically reflects not only a wish to ‘do the right thing’ but also enlightened self-interest, as businesses with a good record will tend to have fewer recruitment and retention problems.
H&S is rightly a major concern on construction sites, and in many places the industry has significantly improved its safety record. It is also, of course, subject to a range of health and safety legislation and regulation. But it remains one of the most dangerous sectors to work in, in terms of both fatalities and its relatively high levels of non-fatal injuries and cases of work-related ill health. Businesses may risk prosecution as a result of any H&S failure. But there is a range of other risks: for example, as in other ESG areas, a poor record may deter potential investors or funders. Particularly when skilled labour is at a premium, it may also compound the difficulties experienced by businesses in attracting the people they need.
The urgent need for decarbonisation often overshadows other factors in discussions of ESG in the construction industry. In fact, though, construction is subject to most of the same issues as other sectors. Aspects of ESG as various as community impact, skills training, health and wellbeing, inclusion and labour relations are all highly relevant to construction companies, sometimes straddling the divisions between social and governance in ESG taxonomies.
Construction offers considerable scope for engagement with the diversity and inclusion agenda.
5. Enhance your supply chain management
A construction company’s ESG strategy will have an impact on aspects of its supply chain, particularly with regard to the use of sustainable materials and acceptable labour policies. But even a company that is not implementing its own ESG initiatives in such areas will have to take account of the ESG standards of its stakeholders, including clients and investors. Any inability to show that products are appropriately sourced, or conform to appropriate standards of sustainability, could cause problems. Audit trails are an essential part of ESG. Businesses are also becoming more aware of the need to include waste management and the end-of-life treatment of materials as another part of the overall supply chains.
Existing modern slavery, health and safety and anti-bribery and corruption legislation already require careful supply chain due diligence and management to ensure compliance. Similar processes will need to be established for other ESG metrics that flow through the supply chain. For example, we can expect to see more environmental and sustainability requirements for projects, not only in terms of the built facility or infrastructure, but also in terms of the materials and utilities used for construction. These will need to be adopted at every level of the supply chain, with consideration given to issues such as the extent to which the choice of materials and their source can be influenced by designers and contractors; identifying a local material source as opposed to long-distance importing; whether there is a more sustainable alternative product or method of working; and whether more environmentally friendly vehicles and equipment are available. Such consideration should go hand-in-hand with a holistic view of the issues, to ensure that problems such as carbon emissions or employee abuse are not simply shifted from one part of a supply chain to another.
The Covid pandemic has highlighted stresses to many of the supply networks that have been developed in recent years, leading to the rapid rise of supply chain security in the list of common corporate concerns. ESG factors too are key to supply chain sustainability, with businesses that have inadequate data on their suppliers or that have ‘nested’ relationships with a cascade of sub-contractors at particular risk.
Any inability to show that products are appropriately sourced, or conform to appropriate standards of sustainability, could cause problems. Audit trails are an essential part of ESG.
6. Be ready for ESG-compliant procurement
A growing focus on ESG is also a feature of private sector procurement where developers have a close eye on the ESG credentials of a development. Weak ESG credentials could result in the development later becoming classed as a distressed asset. Developers will therefore look ever more closely at this in the round: from the procurement process, through the design and build, to the credentials of those carrying out that work. This therefore requires businesses not only to look at their own ESG credentials but also those of their supply chain.
Developers will look more closely at ESG credentials in the round: from the procurement process, through the design and build, to the credentials of those carrying out that work.
States and local governments across the world are significant purchasers of construction services. The World Economic Forum and the Boston Consulting Group estimate that government procurement accounts for 31% of construction expenditure in the UK, 44% in Germany and 57% in the US. This gives governments a unique place in influencing behaviours – and they are increasingly using that place to promote an ESG agenda. For example, the UK’s Procurement Policy Note 05/21 and the UK government’s Construction Playbook put social value at the heart of government procurement decisions. The Playbook requires that aspects of social value such as encouraging employment opportunities, developing skills and improving environmental sustainability are to attract a minimum weighting of 10% of the total score, making it a differentiating factor in procurements. The Playbook also requires contracting authorities to require that solutions put forward by potential suppliers are accompanied by a whole life carbon assessment reflecting ways to reduce greenhouse gas emissions.
ESG considerations are increasingly part of procurement decisions in both the public and private sectors. Businesses will need to adopt ESG practices to remain competitive in procurement, and will have to be able to demonstrate clearly their ESG credentials.
ESG-compliant procurement
This can manifest itself as opposition from local residents, pressure groups and the general public causing projects to be stalled or even cancelled, and ongoing construction work to suffer delay and disruption. In the context of latent defects – most recently seen in the UK in relation to fire safety considerations – pressure in the form of public opinion, backed by political action, is leading to more stringent safety and quality standards for buildings going forward. Consistent engagement with stakeholders can help to reduce potentially negative impacts around sensitive ESG topics. But it can also offer positive advantages: not merely improving a company’s visibility as an ESG champion but also, in some cases, bringing fresh insights and opportunities to the business. Stakeholder engagement itself is one area of ESG: effectively done, it can benefit many others.
Consistent engagement with stakeholders can improve a company’s visibility as an ESG champion and bring fresh opportunities to the business.
Businesses depend upon their employees. Evidence suggests that employees are increasingly interested in ESG matters and so this is a key factor in both attracting and retaining talent. In 2020 Marsh McLennan reported finding direct positive correlations between ESG performance, employee satisfaction and employees’ perception of the business. Likewise, trade unions are increasingly taking an interest in the ESG policies of organisations and publicly criticising those considered to be inadequate. The influence of public opinion should not be underestimated either. The general public can, and do, litigate against companies for failing to meet ESG criteria, with class actions in climate change litigation a growing trend. However, even short of that, the influence of individuals is an important reputational consideration, given the relative ease with which social media campaigns can be launched and pursued.
Companies that want to maximise the benefits of their ESG strategies need to look at how the engage with their full spectrum of stakeholders – not only investors funders and regulators, but also employees, suppliers, customers and the wider community.
Once the list of issues has been identified, businesses should create benchmarks of how they are currently performing, set targets and establish key performance indicators (KPIs). Setting credible and achievable targets will be key, and there is increasing focus in this area such as SBTi’s recently launched (28 October 2021) Corporate Net Zero Standard that supports companies to set near- and long-term science-based net zero targets.
Businesses should create benchmarks of how they are currently performing, set targets and establish key performance indicators (KPIs).
As well as reflecting national regulatory reporting requirements where these exist, a baseline will need to take account of key non-regulatory requirements relevant to the business and the sector. The strategic priorities of both the business and its main stakeholders will also be important considerations, ensuring that ESG is an integral part of corporate activity rather than ‘nice to have’ add-on. A good starting point is a checklist of existing regulatory and reporting requirements in each jurisdiction in which the business operates. That can be overlaid with any requirements expected to be in the pipeline, based on government announcements, policy commitments, inquiries or consultations and taking into account the direction of travel of employee, union, stakeholder and public opinion. As a further layer, the way the business operates, such as the use of its supply chain and its strategic priorities, should be considered through the ESG lens.
Although standards for ESG metrics are being developed, and regulators are increasingly seeking to make some reporting compulsory, at the moment it remains largely up to individual construction companies to identify both their ESG baseline and the mix of areas they will measure and report on.
As well as enabling better ESG reporting, the effective collection of robust data should improve ESG-related decision-making in the boardroom and the c-suite. It can not only enable business leaders to assess the progress of their ESG programmes and adjust them accordingly, but may also help to highlight other issues that should be addressed, and deeper problems that may manifest themselves in poor ESG performance.
The effective collection of robust data should improve ESG-related decision-making in the boardroom and the c-suite.
The key to any demonstration of ESG performance is the credibility of a company’s data. This requires transparency about data sources and the methods used for collecting data, and an open discussion of issues such as reliability and accuracy. It will not always be possible to have rock-solid data for every aspect of ESG in every part of a business. But companies can still promote confidence in reporting such areas by, for example, ensuring that year-on-year comparisons are meaningful, and that the reliability of the data – as well as the data itself – is accurately reported. Companies can also streamline and enhance the collection and handling of data, making possible a much more informative and transformative report on their ESG progress. There are now quite a number of technology-based solutions which can assist in monitoring and reporting ESG commitments, interpreting and analysing data, and using data to make improvements.
Businesses seeking to demonstrate their ESG compliance and achievements need robust tracking and reporting which can be verified through an audit.
10. Monitoring and reporting your progress
In the UK, the Green Technical Advisory Group (GTAG) is advising the government on implementing a taxonomy – a common framework – for assessing parameters for sustainable investment and tackling claims of greenwashing. Businesses can, of course, go beyond the minimum disclosures required in their jurisdictions. Those which are most open – and which ensure that their disclosures are easy to understand – will find this helps to cement their status as ESG champions. Ultimately, credibility is key, and businesses need to ensure that their environmental commitments and credentials have substance and will result in meaningful ESG progress. Companies whose goals are ambitious but achievable will fare better than those that overpromise and those that claim more than they have really delivered.
The media and investors alike are increasingly good at spotting ‘greenwashing’ – and regulators are increasingly seeking to outlaw it.
Although stakeholders have for years been calling for harmonisation in ESG disclosure, there are currently no accepted global standards for ESG reporting. Businesses operating across jurisdictions may be required to disclose different information and meet different standards in different places. There are some pitfalls to avoid in reporting ESG data. In particular, as well as being consistent and as robust as possible, it needs to be presented in a way that does not distort and is not selective. The media and investors alike are increasingly good at spotting ‘greenwashing’ – the promotion of misleading or exaggerated claims about a company’s environmental credentials – and regulators are increasingly seeking to outlaw it. Such misleading claims often involve the abuse of data. Perhaps the nearest thing to a genuinely global standard for ESG reporting is the set of common Stakeholder Capitalism Metrics (SCM) created by World Economic Forum’s International Business Council for the reporting of sustainable value creation. The SCM consist of 21 core and 34 expanded metrics and disclosures based around four pillars: Principles of Governance; Planet; People; and Prosperity. The pillars are aligned with the UN’s Sustainable Development Goals, and the metrics are drawn wherever possible from existing standards and disclosures. The aim of the SCM is to encourage a consistent way for businesses to report in their annual reports on key factors of sustainable value. The consistency allows direct comparison between organisations. It is hoped this will be a catalyst for the creation of a more formal system for reporting on ESG, akin to generally accepted international accounting standards such as IFRS.
The ultimate aim of setting targets, establishing key performance indicators and collecting data is to be able to monitor and report on progress. While some reporting may be purely internal, increasingly reporting is required for company accounts and other shareholder communications, for obtaining and maintaining sustainability linked funding, in tender processes and so forth. Reporting must be robust and defensible.
E shona.frame@cms-cmno.com
T +44 141 304 6379
Shona Frame is a CMS Partner and has been providing strategic advice on the management and resolution of complex construction and infrastructure disputes since 1994. She holds accreditations by the Law Society of Scotland as a specialist in construction law and in arbitration law. She is a Fellow of Chartered Institute of Arbitrators and Honorary Fellow of the Royal Incorporation of Architects in Scotland.
Shona Frame
E emma.schaafsmakratochvilova@cms-cmno.com
T +44 20 7367 2316
Emma Schaafsma (Kratochvilova) is a partner in our dispute resolution team. She has over 20 years’ experience of representing clients in high-value and complex disputes arising on international construction projects in the energy and infrastructure sectors.
Emma Schaafsma
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