It is widely recognised that owners and operators of hotels and leisure assets need to identify and improve ESG performance. In this article, we look at why ESG performance is becoming so important (including from a regulatory point of view) and some key points the main parties need to consider.
There is a global focus on ESG that is coming from all angles- from governments through legislation and regulations, from funders and insurers through conditions to access to funding and coverage respectively, and from ESG savvy consumers, who are increasingly spending according to their ESG values. This means that a truly 'green' reputation can have significant financial benefits. Assets that are more sustainable and which use less energy and water (amongst other things) and therefore have lower running costs, are more likely to retain their value and become more appealing to investors in comparison to assets which have not benefited from investment around sustainability. Operators will similarly benefit from improved ESG performance, as it can reduce operating costs, helping to drive up both owner profitability and the operator’s own incentive fees, and also it can make their asset more appealing to guests and personnel (or in any case, allow them to keep up with the competition).
Regulations and goals such as those set by the Paris Agreement, the EU Green Deal and the EU's Energy Efficiency Directive set sustainability and emission targets and over recent years we have already seen a considerable increase in sustainable financing options and bonds.
More recently, broad ESG related reporting obligations have been and continue to be introduced within the EU, through legislation such as: the Sustainable Finance Disclosure Regulation (SFDR), the Non-Financial Reporting Directive (NFRD) as amended by the Corporate Sustainability Reporting Directive (CSRD), the EU Taxonomy Regulation and the anticipated Corporate Sustainability Due Diligence Directive (CSDD). For example, the EU Taxonomy Regulation requires qualifying owners and operators of hospitality assets to start measuring the ESG performance of those assets and to report the results in a uniform and transparent manner in order to adhere to their disclosure obligations.
In the UK the Minimum Energy Efficiency Standards (MEES) mean that commercial leases in England and Wales can only be granted where the property holds an energy performance certificate with a minimum rating of E (with some exceptions), rising to B by 2030. This will be a significant priority for the relevant owners, but also operators that manage assets (under a management agreement) which have an underlying commercial lease. The UK Government has revised its Net Zero Strategy and energy efficiency requirements have been tightened under the amended Building Regulations, with a view to making sure all new buildings are to be ‘net-zero carbon ready’. Climate-related financial directives are making reporting on climate related risks mandatory- and public. The industry is aware that hotels have not historically been particularly energy efficient, and it is generally expected that there will be more significant obligations in due course.
When developing a new asset, it is relatively easy to make sure contractors and suppliers implement measuring technology and other tools to keep track of ESG performance (and also other elements such as defects, need for maintenance). Collecting this data means it is easy to measure performance, and importantly, to demonstrate improvement. We are seeing an increase in obligations around the collection of 'sustainability data' (and rights to the copyright in the same), for example, in our clients’ construction contracts.
Dealing with existing assets can be trickier. A lack of existing data makes it more difficult to determine the best measures to take as the parties will not necessarily have a full view of the situation and there is nothing to benchmark against.
Start collecting data such as energy usage as soon as possible. Typically, an observation period of at least a year is required to measure how an asset performs. This will determine the actual performance of the asset and will record information such as current energy usage levels and should give an indication of where specific improvements or specialist maintenance is necessary or desirable. Having accurate and sufficiently detailed information is key when improving the performance of an asset, as it sets a good basis for technical advisors to determine the current performance of the asset against a set list of KPIs, and to develop an appropriate improvement plan.
Improvement plans are often prepared by technical advisors who work together with contractors and suppliers to identify a range of improvement measures, often adopting new technologies. We are increasingly seeing that both advisors, contractors and suppliers are willing to take part of the risk regarding the performance in exchange for a bonus if they exceed certain KPIs. This means that they are incentivised to achieve the same goals as the owner and operator because they all have “skin in the game”.
Plan carefully. For obvious reasons, operators and owners are keen to prevent any disruptions to the use of the asset during the busiest periods of the year. No operator wants to have their hotel wrapped with scaffolding (or, heaven forbid, even closed) during the wedding season. Making sure improvements are scheduled for an appropriate time (e.g. at the same time as routine maintenance to minimise disruption) is key.
On this note, the anticipation is that obligations around ESG reporting will evolve into ESG improvement obligations over the coming years. Once this evolution takes place, the obligations will apply to a wide range of assets, causing an increase in demand for advice and improvement services. This may increase the cost and decrease the availability of such resources over time, so being pro-active now may lead to cost savings in the future.
Nothing in life is free and one key consideration is- who pays for this? Hospitality assets are often owned and operated by different parties and as a result there is not always a straightforward answer for which party should foot the bill for ESG improvements. For example, the operator may be reluctant to implement such measures at their own cost because they are not the owner of the asset. On the other hand, owners tend to have fixed maintenance budgets (if they are responsible for maintenance) and it can be a challenge to find enough leeway in the budget to cover the costs.
It's worth noting here that parties taking a longer-term view often see that their interests are more closely aligned: the owner benefits from having a valuable asset that can easily be sold or leased to a third party and potentially better access to funding or decreased funding costs. Especially in a landlord/tenant scenario, the operator can benefit from energy cost savings, and may also be able to charge higher rates, as well as coming across as a more attractive employer in a highly competitive market. This can help keep parties on the same page when it comes to making ESG improvements.
There are various alternative methods of funding that may help the parties reach common ground and we are for example seeing third-party lenders/investors being approached to help allow assets to be improved within shorter timeframes.
The ESG focus in hospitality assets will only grow. Embracing this focus early on allows for more control and for a more cost-efficient approach to improving the ESG performance of an asset. Parties that take a long-term and pro-active view are likely to be better situated and find themselves in a more resilient position in the future.