Cleaning up after the crisis

Categories: Sustainability Strategies     

The recent global financial crisis had investors the world over on their knees. In a bid to ensure it doesn’t happen again, at least not for a very long time, there are calls across the board for greater transparency and regulation. What does this mean for the property industry?

Investment

“There is no doubt that since the onset of the global financial crisis there’s been a greater demand for transparency,” says Roberto Fitzgerald, executive director, international & capital markets (ICM) for the Property Council.
Burnt investors are demanding to know exactly where their money is going, and they want transparency of returns and details regarding debt.

But they aren’t the only ones demanding change. Fitzgerald says the push for transparency is coming from the entire sector – managers, owners, investors and regulators.

Managers and owners want to promote transparency to build investor confidence. Regulators must balance the competing objectives of maintaining integrity and facilitating the market. The whole industry has to compete against other asset classes to make sure it is a destination of capital.

According to Tanya Cox, chief operating officer at DEXUS, the call for greater transparency has resulted in increased voluntary reporting. REITs have had to respond to greater scrutiny of their operational performance and structure, and be more responsive to stakeholders and more detailed in their disclosure.

The impetus for change was the carnage left in the wake of the financial crisis. As returns declined, says Cox, investors applied greater scrutiny to their current and prospective investments.

“Companies perceived to have complex business models and investment structures … were firmly in the spotlight,” she says.

As the fog slowly cleared, Cox says there has been a renewed interest in corporate governance, and investors have higher expectations of disclosure.

Erik Mather, managing director of governance research and consultancy company Regnan, agrees. Regnan used to knock on doors to sell governance advice, whereas these days property companies come to them.

It’s really the entire economy that is under increased scrutiny from investors and regulators. The G20 and international regulators are clamping down on banks and credit rating agencies, and the Cooper and Ripoll reviews are shaking up their respective industries. “Given that we are part of the investment market, these all have an impact on the property sector,” Fitzgerald says.

While the pendulum has certainly swung from ‘free market’ towards ‘highly regulated’ over the past 18 months, Fitzgerald says it’s not all one-way traffic. Rather than just more regulation, we are seeing changes to existing regulation that reduce the cost and complications of compliance – the main concern of most property companies.

Along with transparency, the other key objective has been simplicity. “The regulatory changes we’ve seen aren’t all designed to add burden, but to make things easier for investors and managers,” Fitzgerald says.

For example, earlier this year the Australian Securities and Investment Commission (ASIC) changed regulations to make it easier for companies to raise equity.

“There is a push for government to make sure the market is not overly burdened with red tape – there’s a way to go, mind you, but we are making progress,” Fitzgerald says.

According to Mather, the main transparency issue now facing the industry is the lack of remuneration transparency for property executives. “The issue that the industry needs to continue to work on, is … having a strong alignment of rewards, so that our pockets will bulge when the investor’s pockets bulge, and communicating that effectively, [so that it’s transparent.]”

He says it’s important the entire industry takes leadership in these issues, because it affects property as a brand. “The sector historically has not had great transparency – real or perceived.”

Fitzgerald believes the whole industry is pulling in the same direction and can therefore take on much of the responsibility itself. “[It] recognises the importance of leadership as the most effective way for everyone to move forward so that government and investors have confidence in the sector.”

Through the Property Council, the industry came together in 2009 to produce a blueprint for the future of the industry, and it will release a best practise guide to reporting this year.

Says Fitzgerald: “The industry wants to be responsible for its own destiny.”

Tax

The financial crisis was also a catalyst for government to deliver positive changes in terms of tax legislation.

According to Andrew Mihno, deputy executive director, ICM for the Property Council, better tax regulation has been a long time coming. “The GFC highlighted just how financially destabilising it is to rely heavily on inefficient property taxes for revenue.”

As in the investment arena, the industry is facing changes to tax regulation, rather than more new legislation. This is exactly what was needed, says Mihno.

Recent changes include reviews of GST architecture, the margin scheme, the managed investment trust regime and changes resulting from the Henry tax review.

Mihno says the problem for tax has not been a transparency issue, but rather a targeting issue. “[The regulation needs to] more accurately target the behaviours it wants to discourage, [rather than] those it wants to encourage,” he says.

But he doesn’t believe the property industry is under particular scrutiny from the ATO; he says the scrutiny is an ongoing reality for the industry due to the massive transactions. “They are simply keeping a closer eye on everyone, post-GFC.”

Mihno says the property industry wants to work with the ATO to minimise compliance costs and disruption. Most sophisticated property players diligently comply with tax laws and don’t want to risk having an adverse finding against them. “[They] don’t want to see cowboys out there – [it gives] the industry a bad name,” says Mihno.

Mihno believes the better regulation will only have a positive impact. While there is always going to be some cost of compliance, the ATO is mindful of providing the greatest integrity gain for the smallest cost.

Sustainability

Unlike in other areas, sustainability regulation is advancing as the threat of climate change weighs more heavily on our shoulders, rather than as a direct result of the GFC.

With the National Greenhouse Energy Reporting Scheme (NGERS) now in force and the proposed Mandatory Disclosure of Energy Efficiency due next year, new regulation is coming thick and fast.

According to Paul Waterhouse, executive director, national policy for the Property Council, there is always more sustainability regulation on the way. “Everybody wants to be seen to be solving climate change,” he says.

Simone Menz, partner, property for Mallesons Stephen Jaques, agrees more regulation is inevitable. But she says most property players feel the current regulation isn’t necessary. “The market … is well ahead of regulation particularly [in] development of new buildings ...”

Waterhouse says while there is a role for regulation, incentives are a better solution. “Regulation deals with a minimum standard and in the assumption that it’s going to solve everything. But providing incentives will achieve higher levels of sustainability than regulation alone.”

This means schemes such as accelerated depreciation, energy efficiency certificates, public funding programs and green building tune-up initiatives.

While much of the new regulation aims to increase transparency, it’s not necessarily driving sustainability. The upcoming Mandatory Disclosure scheme will require owners to provide energy efficiency information about their buildings before they can sell or lease space.

Waterhouse says it assumes investors and tenants will make different decisions based on this information. But this is unlikely given energy is a relatively small component of a business’s overall costs.

Menz, too, is sceptical of the new regulation. She says in most cases, buyers will have carried out due diligence and made their own assessment of the building’s energy efficiency. Equally, from a tenant’s perspective, most are still not prepared to pay a higher rental for green buildings. “Whether Mandatory Disclosure will influence tenant decision-making behaviour in terms of the types of premises that they take remains to be seen.

“You can provide lots of transparency on how green things are … but if that’s not driving people, it’s not going to lead to a reduction in greenhouse gas emissions,” he says.

Complying with Mandatory Disclosure regulations will be time-consuming and result in opportunity cost. Waterhouse says with the added congestion generated by the new regulation, owners could be waiting some time for ratings.

When you look at what is now in place in terms of sustainability reporting requirements, perhaps we’ve gone too far.

Says Waterhouse: “We’ve got property owners who will be required to report under the National Greenhouse Energy Reporting System (NGERS), the Energy Efficiency Opportunities Act, the Mandatory Disclosure scheme, state and territory reporting regimes, the carbon disclosure project, [and] their own corporate responsibility reports. [It’s] the same information provided in different ways to different bodies.”

“There is a direct impact on the bottom line for property investors,” Menz says. This is coming on the back of pain from the credit crunch and asset valuations.

Additionally, increased regulation is counter-productive. It takes up valuable time of the people who would otherwise be working on making buildings more sustainable. This is exasperating for property companies, Waterhouse says.

Some companies spent thousands of dollars on legal advice to interpret the NGERS reporting scheme. “Surely this money would be better spent actually improving the sustainability of their buildings?” Waterhouse asks.