What addressing ESG risk in healthcare involves

Health and social care providers that address ESG risk effectively will undoubtedly give themselves a competitive advantage by being able to retain and build value in their operating business and in the real estate assets which underpin those businesses.

Compliance with strict regulation applicable to health and care providers and their investors should only be viewed as a starting point for effectively managing ESG risk. Health and care providers should  devise more comprehensive ESG strategies, with key performance indicators bespoke to their business, and should establish robust systems of data collection and ESG reporting so they are equipped to respond to the reporting requirements their investors and lenders will increasingly seek as they themselves become subject to mandatory ESG related reporting requirements.

Many operators are seeing the need to focus on ESG as a defensive move, but those that embrace it and drive the ESG agenda through innovation are most likely to be the most successful from both a service quality and financial perspective.

The following examples are not intended to be exhaustive, but rather to illustrate what managing ESG risk might look like in practice in the health and care sector.

Environment

Environmental risk is arguably the element of ‘ESG’ that businesses across sectors are most familiar with. This is because the climate crisis has been well publicised and has prompted ever-strengthening international commitments from governments, increasingly reflected in policy and regulation.

In the health and care sector there are clear climate related risks to consider. An example is the impact that rising temperatures could have on residents in care homes.

Where care homes operate in old buildings that are not efficient in cooling the internal temperature, a heatwave presents a real problem for regulating the temperature of people who are already unwell, immobile and often vulnerable. Equally, buildings that do not operate efficiently in terms of heating will not only be more expensive to heat but will increasingly fall foul of existing and proposed regulation to ensure minimum standards for energy efficient buildings.

Whilst hospitals should be looking to make use of on-site or nearby waste management facilities, such as incinerators used to burn surgical waste as a heat exchanger to heat and cool their buildings, there will need to be more creative solutions involving the retrofitting of ground and air source heat pumps for care homes, particularly in the face of energy price rises. We foresee that the siting of new build care homes proximate to heat exchange solutions will, together with local recruitment demographics and transport links, play into land evaluation surveys in future.

Healthcare providers proposing to adapt their buildings to better manage Covid-type risks and overheating might want to take the opportunity to future proof their buildings by increasing their energy efficiency and installing solar PVs or other low carbon heating. With the availability of sustainability-linked loans and bonds at advantageous interest rates, either with specified use of proceeds provision or dependent on the achievement of certain KPIs related to metrics which are clear and increasingly common for the “E” of ESG, retrofitting works could be financed in this way. Last year Primary Healthcare Properties refinanced with Aviva Investors using a sustainability-linked loan with KPIs based on improvements in EPC ratings and, for new developments, higher BREAAM ratings.

There’s a further commercial imperative to pursuing energy efficiency schemes in the context of health and care real estate assets.

Pinsent Masons colleagues recently highlighted the bifurcation that is already happening in the office sub-sector of the commercial real estate market in respect of demand for and the value of office buildings that conform to high environmental standards and those that don’t. The same is true of health and care real estate. As the market evolves further and environmental factors play more significantly into real estate pricing, there is a risk that investors are left with stranded assets that they are either forced to invest substantial capital into improving the energy efficiency of or sell those assets off at a cut-down price – though for others, stranded assets might present an investment opportunity.

We also expect environmental risk management in healthcare to be significantly driven in the UK through the NHS and its procurement policies. NHS England, for example, has set net zero targets (76-page / 2.3MB PDF) which include seeking to be net zero in respect of its ‘Scope 3’ emissions, namely the emissions which come from its supply chain, by 2045.

Under NHS England’s net zero supplier roadmap, which lays out a trajectory of actions for suppliers, from 2030 suppliers will only qualify for NHS contracts if they can show progress on reducing their own emissions.

Social

The concept of social risk in the context of ESG is perhaps something health and care providers will feel they are already addressing by virtue of the nature of their business – delivering high-quality health and social care is itself an activity that falls squarely in the UN’s Sustainable Development ‘goal 3’ of good health and wellbeing.

The reality, however, is that social risk in health and care needs to be viewed through a wider lens. It clearly encompasses other responsible business factors, such as policies and practices affecting employees.

In this context, diversity and inclusion is increasingly important. Health and social care providers will want to review and, if necessary, revise boardroom representation targets, and consider their approach to recruitment to understand and address any inherent bias, for example. Mechanisms for supporting women returning from maternity leave or living with women’s health conditions are also relevant, as are policies around flexible working and parental and carer’s leave.

In health and care, much of the workforce is made up of women. This can present a risk that misleading comfort is drawn from gender pay gap (GPG) data. In this context, health and care providers will not want to measure progress against the economy-wide average, but rather consider whether their GPG stands up to scrutiny against that of other providers in the sector – and take action if it doesn’t.

Further guidance on what is meant by the ‘S’ in ESG is anticipated when the EU releases its social taxonomy, intended to underpin the EU’s Sustainable Finance Disclosure Regulation, which has relevance for investment in real estate assets.

However, whilst the EU’s expert group in charge published its final report in this regard in February this year, the European Commission is now not expected to substantially progress the social taxonomy in its present term, which runs until the end of October 2024. It is reported that the Commission will “continue pursuing other policy initiatives that promote investments with a positive social impact” in the meantime.

Whilst “E” related sustainability linked loans and bonds are becoming common, “S” related ones are less so, linked to the greater difficulty in measuring “S” outputs and the lack of any market accepted metrics for “S”.

There has been “S” related sustainability linked finance in the social housing sector, however. That sector has developed a common sector standard approach to ESG reporting which major lenders and investors have signed up to and which has been a factor in the availability of sustainability linked finance for that sector. This might be a model the healthcare sector could follow. Access to public healthcare is a recognised category of activity which qualifies under the social loan principles drawn up by lending associations.

Governance

As with social risk, some health and care providers may have the impression that because they, and often investors and lenders in the sector, are highly regulated and conform to those regulatory requirements in relation to their primary purpose, including around quality control, record keeping and audit, that they perform well in respect of addressing governance risk. This can be misleading. The concept of governance needs to be considered from a wider perspective to constitute appropriate governance of ESG.

One area of governance that needs to be carefully considered by the private equity houses that own businesses and real estate assets in the health and care sector arises from the ever-stiffening framework of climate-related disclosures.

The Taskforce on Climate-related Financial Disclosures (TCFD) set global standards on climate-related disclosures with a view to increasing transparency over the climate-related risks that businesses, and the financial institutions that invest in them, face, and ultimately encouraging a shift in investor behaviour away from businesses and business activity that cause environmental harm.

Compliance with the TCFD’s recommendations is entirely voluntary, but across the world the standards are increasingly being built on by policy makers and regulators to mandate climate-related disclosures in some sectors.

Private equity houses with assets under management of at least £50 billion are already subject to mandatory reporting requirements in this regard under the FCA’s ESG Sourcebook. The UK government intends to extend TCFD aligned reporting to the whole UK economy by 2025. As well as introducing new reporting obligations, businesses will be obliged to identify and have plans to manage climate risks and opportunities. It is in this context that governance obligations arise.

It would mean, at the relevant levels in the business up to board level, having a system where the climate impact on the business is considered and the risks identified and managed, as well as ensuring there is a process of proper governance around that.

Co-written by Joanne Ellis of Pinsent Masons. The issue of ESG in private equity investment in health and care real estate was the topic of discussion at an event hosted by Pinsent Masons in partnership with CBRE on 15 September in London.