The responsibility of developed countries towards climate change will have been one of the main topics of discussion at COP27, which ends in Sharm el-Sheikh. Negotiations could keep going this weekend, after the official end of the COP, due to the heated debate over the management of losses and damages due to climate change concerning vulnerable countries of the South. These discussions have led to compensation from some of the countries involved. These can be considered as revealing gestures of a paradigm shift, which would carry a new risk of transition. Are real estate companies exposed to it?
Loss and damages compensation
A few days ahead of the end of the COP27 in Charm el-Cheikh, Egypt, the discussions are still going on about the losses and damages. The potential compensation from industrialized countries towards developing countries, regarding the damages and losses suffered by developing countries due to climate change has been at the heart of the debate all two weeks long.
The responding attitudes change from a developed country to another. Some European countries have already announced that they would contribute to a fund financing adaptation in the developing countries. For instance, Austria announced $50 million, Germany announced $170 million and Belgium €2.5 million, specifically for Mozambique, which suffered terrible losses last year due to extreme rains.
On November the 14th a joint initiative of the G7 and the V20 Group of 20 vulnerable countries, was launched: the Global Shield Against Climate Risks. This new initiative aims at helping the most vulnerable countries and improve their capacities to adapt to climate change. The solution will, among other things, support the design and deployment of social protection an insurance solution for local communities, businesses, and households. Bangladesh, Costa Rica, Fiji, Ghana, Pakistan, the Philippines, and Senegal will be among the first countries to benefit from the Global Shield.
But the subject has been pushed further by the Prime Minister of Barbados, Mia Mottley, the spokesperson of the Southern countries endangered by climate change. She plead for a tax of at least 10% on the profits of fossil fuel companies. According to her it would represent 37 billion dollars, which is roughly equivalent to the economic losses caused by the floods in Pakistan.
A paradigm shift
For the first time on the international scene, the question of the responsibility of the industrialized countries towards climate change is taking on such importance. The compensation of the losses and damages suffered by the countries most exposed to the consequences of climate change has become inevitable.
This new approach is not only evident at COP27. In Europe, since the beginning of the energy crisis, demands have emerged for a tax on the super-profits of energy companies to limit the impact of rising prices on the poorest households and the most fragile companies. Here again, the principle is that of compensation or balancing.
These claims can be explained by a paradigm shift. In a world of finite resources, it is not possible to maintain a business-as-usual pace while financing actions to fight climate change. The necessary resources must be taken somewhere else, and at the expense of another activity. Eyes are naturally turned to those whose impact is the most significant. The European energy crisis has initiated this paradigm shift in the collective mindset.
A transition risk?
For a few years now, legislation has tended to enhance reporting standards especially regarding non-financial aspects. Several studies have shown that the global economy is largely exposed to potential consequences of climate change and biodiversity collapse. The development of non-financial report is supposed to enable financial institutions to redirect their investments towards a more resilient economy.
The European regulation “Sustainable Financial Disclosure Reporting” (SFDR), which came into effect in March 2021 , has strengthened the expectations regarding non-financial reporting, especially when it comes to risks’ management and anticipation. Since then, companies must consider the risks that climate change could represent for their activities. Among these risks, they are encouraged to pay attention to transition risks. Transition risks are those associated with the consequences of potential developments of societies, legislations, and markets due to adaptation to climate change.
The emerging compensation demands could represent a transition risk, for companies, and one could expect some companies to be asked for compensation for the impact of their past projects or current exploitations. As a major contributor to artificialization, and accounting for 30% to 40% of the world GHG emissions, the real estate industry could be exposed to such a risk.
The outlook for the real estate sector
First of all, the real estate sector has long since integrated the direct compensation mechanism. Climate impacts, such as those caused to biodiversity, are more and more regulated by legislation and are often linked to offsetting.
However, the current compensation mechanisms do not always guarantee a good equivalence between damage done and benefits restored. Secondly, they only cover a part of the value chain, and do not touch the production of materials, for example, thus obscuring a whole part of the impact of the sector. To cover this transition risk, which tends to reinforce compensatory mechanisms, it is essential to map the impacts of projects throughout their life cycle.
Finally, in this context, the most important issue remains limiting companies’ negative impacts. In this regard, questioning building decisions should be an option whenever possible. The lesser the impact would be, the lesser the potential drawbacks and compensations. It is thus essential to invest as much as possible in the rehabilitation of existing buildings, enhance renovation standards to reach energetic performance and to limit as much as possible the artificialization and destruction of new ecosystems and territories.
The real estate industry is by nature on the front line when it comes to losses and damages due to climate change, and this aspect should become more important every year. If the different compensation mechanisms announced at Sharm el-Sheikh would be deployed it would be an unprecedented evolution, and potentially the emergence of a new transition risk. More than ever, the main levers seem to be sobriety and adaptation. As essential as it is to compensate damages, it is as much urgent to reduce exposition with necessary engagements towards adaptation. In this regard the recent decision from the EU to shift its ambition of GHG emissions reduction from 55% to 57% until 2030 is a positive signal.