To maintain a competitive advantage and keep pace with changing carbon and environmental reporting and legislation, many organisations are actively adopting more sustainable operating and investment practices.
According to GlobalData’s Environmental, Social, and Governance (ESG) Strategy Survey 2021, 70% of 1,500 participant executives asked believed that setting ESG targets can positively impact a company’s revenue. The same survey also reported that 80% of companies plan to increase their investments to meet ESG goals in the coming years[1].
ESG typically refers to an approach to finance and investing focused on managing risks from environmental factors, social issues and questions of corporate governance. However, the definition has evolved, broadening to refer to an array of measurements and corporate governance practices.
The EU has taken the regulatory lead in this sector, with legislation implemented or in development that will put pressure on businesses to meet ESG reporting standards as part of their plans to meet net zero requirements. In such instances, ESG is becoming a critical theme that will impact European real estate businesses, especially when it comes to land legacy issues.
“Historically the majority of focus in a property transaction has been on the risk of the built asset. Much less focus was placed on the land that the building is built on. In the majority of cases, the land risk has was simply absorbed internally on the owners company’s balance sheet[2],” says Simon White, ESG Director at MX Underwriting, a leading UK insurance intermediary specialising in bespoke underwriting solutions and complex insurance placement.
“If you buy a property, you, in essence, inherit all of the liabilities associated with that property,” he adds.
White explains that if a site at a future date is found to be unsuitable for use, is contaminated or wasn’t sufficiently cleaned, the owner then becomes liable for the clean-up of any contamination. This could impact an investor’s ESG rating and negatively affect the brand’s image, which far exceeds the expense of cleaning up contamination.
White explains “because of the whole debate around sustainability, asset values and environmental issues, people increasingly want greater confidence that the land, which the building is built on, has the same sort of protections in place as the building itself”.
Historic pollution and property acquisitions
Legacy pollutants are toxic elements found in the environment that have remained long after polluting activity has stopped. Instances of historic pollution such as soil or groundwater contamination and asbestos can raise critical environmental concerns in real estate transactions due to their adverse influence on public health and the ecosystem.
European countries adhere to a ‘polluter pays’ approach, however, when it comes to transactions, often those historic liabilities associated with the polluter are transferred to the new purchaser. Environmental liabilities do not disappear, they just move on. As a result, real estate investors are increasingly seeing environmental legacy pollution issues as an area of concern within a property transaction. In a recent market survey undertaken by MX Underwriting Europe, over 50% of respondents stated that in commercial real estate transactions land legacy issues are absolutely a concern[3].
White believes that third-party stakeholders’ increasing emphasis on understanding ESG risks, is forcing corporations to externalise rather than internalise the risks connected with property acquisitions.
“Most of the time, the purchaser would just accept that they were liable for the site and then absorb all of those [remedial expenses] onto their balance sheet. What is happening now is that investors want to understand the wider risk management picture – we’re not just going to look at your profit loss account, we want to look at your risk management, due diligence, as well as your non-financial exposures,” he says.
If there is no system in place to retain asset values, the land seller and the purchaser may lose money, even if it is not a direct liability risk.
In most cases of environmental pollution, investors will either push for a lower acquisition price or request that the seller clean up the asset before closing the deal.
Alternative risk-mitigation strategies, such as escrow or unlimited indemnity, can frequently result in the buyer and seller being unable to agree on the amount to be held in escrow or the period of the contamination resolution after which the funds can be released. On the other hand, the frequently implemented warranties and indemnities (W&I) insurance coverage in M&A and land legacy transactions does not cover historic environmental contamination.
“If you cannot give confidence to your third-party stakeholders, whether that be the purchaser, lenders or investors, that you have not only understood but also offset your environmental risk, then you will find it increasingly difficult to sell the property without taking financial hits or be able to obtain capital to purchase or develop properties at a financial rate which is favourable to you,” says White.
In such a precarious landscape, the concept of environmental land legacy insurance can help buyers of commercial real estate mitigate the risk of liability resulting from historic land contamination.
How land legacy insurance can help avert risks
Environmental land legacy insurance can be a highly effective strategy to cover the risk of both unknown and known pollution, particularly in acquisitions where it is difficult to gauge the scale or nature of potential contamination.
According to White, environmental land legacy insurance works on a similar principle to structural warranty.
“We will attach a policy to each asset and when the asset is sold, that policy automatically transfers with the asset. Therefore, when doing commercial transactions, site developments, or during the M&A phase, the seller can always transfer the risk with minimum exposure in terms of price chipping and additional work,” he says. “Essentially, if you buy this asset, you automatically have this risk transfer mechanism attached to it and your capital will therefore not be at risk if you buy this site with environmental issues.”
With ESG obligations becoming an important component of investment portfolios, real estate companies must work with specialised insurance intermediaries such as MX Underwriting Europe to safeguard their transactions and reputations from an environmental perspective.
With an in-depth knowledge of global markets and expertise in providing bespoke solutions, the MX Underwriting Europe team and our colleagues in the wider MX division are equipped to guide complex projects that may cross several jurisdictions and affect diverse communities.
The company focuses on designing insurance solutions to strengthen ESG initiatives in the infrastructure, energy, and real estate sectors, which are crucial to meeting global sustainability targets.
To know more about how MX Underwriting Europe can help your business, download the whitepaper below.
[1] GlobalData, ESG Strategy Survey, 2021
[2] Simon White, ESG Director at MX Underwriting, 2023
[3] MX Underwriting Europe, Environmental Legacy Insurance eases real estate transactions, 2022
