ESG: What Are Its Effects on Construction Disputes?
Construction has a greater relation to environmental, social and governance concerns than most global industries. With the focus of governments and investors shifting towards greater transparency and responsibility on the part of construction companies, it is likely that ESG disputes will colour the market in coming years.
Kevin Attrill, Managing Director at Ankura, shares his sector insights on ESG and its implications for construction in this feature.
As a foundation for this conversation, could you please explain the premise of ESG and how it has become increasingly relevant to investor concerns in the past few years?
Environmental, social and governance (ESG) captures a broad range of issues, such as climate change, emissions and waste disposal (environment), human rights and community relations (social), business ethics and executive pay (governance). While each of the three disciplines or ‘pillars’ of ESG has its own set of standards and practices, together they indicate an organisation’s dedication to achieving a positive effect on society – or at least not cause harm – in addition to generating a financial return for investors.
ESG investing’s beginnings were largely based on exclusion, i.e. avoiding the asset classes and sectors deemed to have a negative effect on society, thereby denying them access to capital. However, in recent years it has extended to activism, where investors directly intervene to enact positive change.
The cost of failing to appreciate the significance of ESG are high, potentially including fines, criminal prosecution, loss of market capitalisation and access to finance, reputational harm, damage to recruitment capabilities and disruption from activists. Conversely, successful ESG strategies are typically viewed as an indicator of focused and effective management and the long-term prospects of the company as a whole. From my experience of construction disputes, it is not unusual for claims related to non-compliance with ESG rules and regulations to exceed the value of the claims that concern the quality and/or performance of the works constructed.
What ESG concerns are particularly likely to arise during construction projects?
Given the nature of construction and development projects, it is unsurprising that they consistently engage the three pillars of ESG, albeit to varying degrees. The applicable ESG considerations and metrics will change depending on the nature of the project (new build or retrofit), the stage of the project (design, construction or operation and maintenance) and whether it is the producers or the product being considered (the project team or the materials involved). As with the projects themselves, there is therefore no universal approach for ESG in the construction industry.
The environmental impacts of the construction sector are wide-reaching, encompassing climate change and instability, pollution, biodiversity and natural resources alike. These cause uncertainty that, in turn, increases corporate risk and delays investment in construction projects. Though the challenges are broad, they present many opportunities for improvement and durable positive impact. Measures to address the challenges encompass the entirety of the construction ecosystem, from managing waste and carbon emissions across supply chains, designing buildings with more efficient credentials and driving technology towards more sustainable products and methodologies.
The cost of failing to appreciate the significance of ESG are high
Climate change has most commonly led to improved operational efficiency in buildings, with the focus on energy use reductions. However, decarbonisation is a particular concern, as commonly used construction materials such as cement account for a significant percentage of carbon emissions.
Social factors concern a company’s engagement with its workers, customers, supply chain and the community. It covers human rights, diversity and inclusion, health and safety and its impact on the communities in which it operates, particularly those in developing economies where environmental and labour standards may be less robust.
Infrastructure and built assets are generally considered to improve the local community by providing spaces and amenities. However, the public perception of projects during construction must also be considered. Prolonged construction projects may impact local communities, attract negative media attention and have harmful consequences. Given the hazardous nature of activities on a construction site, workplace safety is paramount both during construction and in the use of built assets. Inattention to social factors can cause reputational damage and bring legal and regulatory penalties.
Governance factors concern how a company uses policies and controls to inform business decisions, manage risk, comply with the law and meet moral obligations to stakeholders as well as promote transparency and accountability by management. Governance failures like tax avoidance, bribery and corruption, excessive executive pay, or lobbying cause reputational harm and loss of trust.
The construction industry has above average exposure to governance issues due to the inherent complexity of projects, which exposes companies to contingent liabilities and litigation risks. An area of high vulnerability is the supply chain. A lack of transparency into supply chains often exposes construction companies to hidden and uncontrollable risk that negatively affects ESG such as depletion of natural resources, human rights abuses, corruption, and more. In fact, the greatest exposure to falling out of ESG compliance can occur in the supply chain. Therefore, businesses should not only look at their own ESG credentials but also those of their supply chain.
Meaningful ESG-related innovations and improvements can be most effective when developed in the early phases of project planning and design, so it is likely that this stage will take longer and require new capabilities and technologies. At Ankura, we observe that the implementation of new and untested technologies on renewable energy projects such as wind and solar plants is proving to be a fertile ground for disputes as ESG regulations and standards continue to evolve.
What can companies involved in construction do to demonstrate their ESG credentials and avoid potentially costly disputes?
Construction faces particular difficulty in demonstrating its ESG credentials. ESG metrics are constantly evolving and differ across regions and countries, with transparency varying greatly by firm. Identifying which standards to follow, what to measure and which metrics to compile is not a straightforward task. Currently it remains largely up to individual construction companies to identify both their ESG baseline and the mix of areas that they will measure and report. Nonetheless, companies should explain the basis and importance of the metrics and topics reported.
The construction industry has above average exposure to governance issues due to the inherent complexity of projects, which exposes companies to contingent liabilities and litigation risks.
At project level, several organisations provide measurable achievement and independent ratings for the design and construction of buildings that allow those involved to demonstrate their ESG credentials. Such certification organisations include BREEAM, WELL, LEED and WiredScore.
Certification programs offer clear metrics that construction companies can use to measure performance and simplify the process. Monitoring systems can measure the outcomes of, for example, air quality and energy usage. Weak ESG credentials might result in the development being considered a distressed asset.
How do you expect ESG developments to influence the construction sector and the emergence of disputes in the next 10 years?
As one of the world’s largest polluters, the global construction industry has become a particular focus for change in respect of its ESG impact. In late 2021, COP26 brought greater focus to climate issues – as did the increasing incidence of extreme weather events. Public awareness of sustainability and ESG factors is increasing, as is the potential for ESG related disputes to occur more frequently.
Areas where ESG’s influence can expect to be felt in the construction sector going forward include:
- Higher standards – the trend from governments is firmly towards setting higher ESG standards for construction industry compliance trough legislation and regulation.
- Disclosure – reporting and monitoring requirements will increase requiring companies to provide more ESG data. This will lead to a greater level of administration and generate increased scrutiny and costs.
- Procurement – ESG considerations are already part of procurement decisions in both the public and private sectors and this trend can be expected to increase.
- Supply chain – contractors’ responsibilities for their supply chains will become more prominent as legislation is expected to enhance protections in this area.
- Technology – smart cities and buildings, connecting communities to the built environment, operational efficiency and cost optimisation will be an increasing focus. Benefits will include the ability to monitor energy and water use, enabling a more sustainable environment.
- Health and safety – construction regularly ranks as one of the most dangerous occupations. Continued focus and increased regulation can be expected.
- Increased costs – adjusting the construction industry to comply with increasing ESG regulation will attract additional construction costs.
- Standard form construction contracts – will increasingly include ESG provisions of greater scope and effect. For example, the NEC4 secondary Option X29 was published earlier this year with the aim of reducing the impact of construction works on climate change. Similar provisions will increasingly be incorporated into supply chain contracts.
In the next 10 years it is clear that ESG-related disputes will increase and come in a variety of forms due to the broad spectrum of ESG issues. Construction companies that can demonstrate that they perform well against ESG metrics will be in a better position to avoid or mitigate the impact of these disputes.
Kevin Attrill, Managing Director
460 Alexandra Road, #22-05 mTower, Singapore 119963
Tel: +44 07918 194297
Kevin Attrill is a Managing Director at Ankura and a Chartered Quantity Surveyor with over 25 years’ experience in major construction and engineering projects across the public and private sectors. Based in Singapore, he provides advice to employers, specialists and contractors on a wide range of quantum issues.
Ankura is a global consulting firm providing services in construction disputes and advisory, data and technology, forensics accounting, and financial investigations as well as turnaround and restructuring.