The ISR label, or how to integrate extra-financial standards into real estate funds management
The ISR label, or how to integrate extra-financial standards into real estate funds management
Article written by François-Régis Fabre-Falret, partner at LPA-CGR avocats Paris office
Zoom cross path between social and solidarity economy, green finance and impactful real estate, the ISR label (for social and responsible investment) invites itself in the real estate world. It is not an additional label in the already abundant labelling or certifications landscape, but a true aspiration towards sustainably transforming the real estate sector. François-Régis Fabre-Falret, senior associate at LPA-CGR lawyers, deciphers the partition of this new label which requirements may soon be reinforced following a process of renovation that just got started by the minister of the Economy and Finances.
1) The progress initiated by the widening of the ISR Label to real estate funds
Without an adapted referential, the ISR Label created in 2016 under the wing of the government was not open to real estate funds. It is now done, since the order of the 8th of July 2020, which thoroughly re-enacted the existing referential to integrate real estate asset management.
The AIF (alternative investment funds) in commercialised real estate in France and in Europe, affected by the AIFM directive or equivalent for commercialised funds outside the European Union, the management mandate on real estate assets or the discretionary management mandate within the meaning of the L.321-1 article of the monetary and financial Code, can now claim the ISR label.
The goal is to integrate into the investment reflexion – from the construction to the exploitation of the building until its reconversion – environmental, social and governance standards, the famous “ESG” standards.
The particularity of the ISR Label for real estate belongs to the fact that real estate management funds corporations have a key role to play: they have a direct influence upon the real estate underlying because they manage it, they maintain it and they develop it, something which a stock management corporation cannot do, or only in a very indirect way (for example, through the general shareholder assembly).
Since the 23rd of October 2020, the label is a true success. We identify to this day about 690 labelled ISR funds, of which 15 ISR “real estate”.
2) The attribution of the label
The ISR real estate label is granted for a period of three years, renewable.
Such label is delivered following an audit realised by an accredited organisation (AFNOR certification, Deloitte or EY France) which guarantees that the selected standards for the fund match the referential.
The goal for the management corporations is to reach a minimal performance level in every component of the ESG standards. In this regard, every corporation implement an ISR rating system of the funds attributing a threshold rate, with a goal fixed on three years for every building: either the maintaining of the rate for the assets that have a superior rating to the threshold rating (“best in class”), or a goal of improvement (“best in progress”). It is reasonable to consider that a building will in fine be expelled from the portfolio by the manager of the fund if it’s not able anymore, at the end of the three years, of meeting the requirements imposed to reach the threshold rating. To reach the ESG performance of the real estate assets, it will belong to the management corporations to include their partners (tenants, building managers, general enterprises etc.) in their process by contracting the goals and the ways they want to implement to ensure the respect of this performance.
3) The funds that have not sufficiently integrated the ISG challenges risk undergoing investors disaffection
To ensure its efficiency, the ISR labelling cannot be definitely owned,and can be sanctioned in two ways: by the certificating organisation, but also by the market.
On the one hand, regular annual monitoring audits of the funds can be realised by the organisation that has attributed the ISR label to control if the rules of management are still compliant to the requirements of the label.
If the auditor raises irregularities, corrective measures will have to be applied and the certifier organisation will proceed to monitoring added specific audits.
If the breaches continue, the fund will have the possibility to decide to arbitrate the building to expel it from the fund. Ultimately, the ISR Label may be withdrawn.
On the other hand, the investor will also be very careful concerning the respect of the ESG standards guaranteed by the labelling, which will influence its choice and thus impact the attractivity of the fund.
Indeed, the ISR Label translates a very strong movement among the investors around the integration of extra financial standards. This will induce for the real estate asset managers tough constraints on information towards assuring that their ISR impact will be understood by the investors. An increased transparency of the real estate assets will be essential to ensure the success of the fund beneficiating from the ISR Label.
4) Towards an overhaul of the ISR label
Since its introduction in the legal framework, it is difficult to dispute the success of the ISR label among financial players. Indeed, 500 billion in assets under management are currently managed under this label. But this quantitative success of the ISR label has raised many doubts about its intrinsic qualities, and many have questioned the reliability of the promises it makes to investors, particularly that of combining financial returns with sustainable investment.
It is in this context that the General Inspectorate of Public Finances (IGF) submitted a report to the Minister of the Economy in December 2020 entitled “Assessment and Prospects for the Socially Responsible Investment (ISR) Label”.
Its recommendations are of three kinds:
- to strategically refocus the ISR system: it is important for the label to keep its promise to investors, such as allowing the financing of a sustainable economic model. It will also be necessary to affirm the ISR label as a label intended above all for individual investors, who do not have the same capacities and information as institutional investors. This will involve simplifying the message conveyed. It will also be necessary to place the ISR label within the European perspective, by improving its articulation with similar labels specific to other countries of the Union.
- to define new requirements: the IGF recommends clarifying the reference framework used, which should be done through the distribution of an audit guide. One of the key measures of this overhaul, which is expected to take place in 2022, would be to raise the requirements of the label, notably in favour of greater selectivity. In particular, the label will exclude areas that expose investors to the most polluting fossil fuels or sectors that are contrary to ESG values, such as the sale of tobacco or unconventional weapons. Lastly, the label should evolve towards greater transparency, shareholder engagement and impact, and the range of labelled assets should be expanded.
- to reform the governance and organisation of the label: while this reform should strengthen the role played by the State within the label, it should result in its refocusing as the owner and guarantor of such label. It will also entrust a label committee with the threefold responsibility of proposing changes to the standards, promoting and awarding the label. This label committee should also be narrowed down to four to six people in order to reconcile the effectiveness of the work and the involvement of stakeholders. The credibility of the system will depend in particular on the formalization of the committee’s operations. It will also be necessary to improve the management of the label by providing it with increased resources financed by its own resources. These resources should be housed within a structure responsible for assisting the label committee, whose members will be selected following a call for applications.
It is in this context that on June 7, the Ministry of the Economy, Finance and Recovery launched a call for expressions of interest (AMI) for market organizations and associations that might be interested in hosting the future team in charge of the ISR label secretariat. The deadline for applications is Friday, June 25, 2021. This AMI represents the Ministry’s consideration of the proposals made by the Inspectorate General of Finance and underlines its willingness to move forward quickly on an issue whose importance has only been accentuated by the pandemic crisis.