1. Sustainable development – responding to the challenges of greener buildings Claudia Watkins and Christopher Woolf

2. Sustainable development – responding to the challenges of greener buildings  “Development which meets the needs of the present without compromising the ability of future generations to meet their own needs”  Security of energy supply  Climate change  Sustainable production and consumption  Increasing tide of policy and legislation  Mandatory and voluntary measures = compliance, commercial and best practice

3. Sustainability EU 6 th Environment Action Programme UN Framework Convention on Climate Change and Kyoto Protocol 1992 Rio Earth Summit CSR UK Climate Change Bill EU Green Paper on Energy Efficiency EU and UK Sustainable Development Strategy

4. Sustainability (cont’d)  Financial implications of climate change better understood  Mandatory measures  EU ETS and Carbon Reduction Commitment  Energy efficiency in Buildings/EPC  Sustainable and Secure Buildings Act 2004  Voluntary or good practice  Green leases  Environmental Management Systems  Sustainability codes

5. Energy Performance of Buildings

6. Introduction Governments are trying to increase awareness of, and transparency in, the energy efficiency of buildings BS:1999453.1

7. Energy performance of buildings  Energy Performance Certificates to be made available to prospective buyers and tenants on construction, sale or lease of building  Display Energy Certificates in large buildings occupied by public authorities providing services to the public  Regular inspection of boilers and air conditioning systems

8. Energy Performance Certificates (EPCs)  Information on potential energy performance of building  Asset rating from A to G  Allows buyers or tenants to compare energy performance of buildings  Accompanied recommendation report  Now required for all commercial and residential buildings, upon trigger events

9. EPCs (cont’d)  Trigger events  Construction of new building  Sale, lease, sub-lease of an existing commercial building – on the earliest of:  seller/landlord providing written information following request;  prospective buyer/tenant viewing; or  contract being entered into  Modifications to the building resulting in more or fewer units, and which affect or extend the fixed services

10. EPCs (cont’d)  Valid for 10 years  May be revoked if a new EPC is issued for the whole building  Fine of £5000 for failure to provide  Landlord may have difficulty in recouping cost of producing EPC  Tenants may press for reduction in rent if building has a poor EPC rating  May need to instruct energy assessors well in advance

11. Display Energy Certificates (DECs)  DEC  Based on actual metered energy use of building in previous 12 months  Advisory report listing recommendations  Must be displayed in a prominent position  Who does it apply to?  Occupiers of all new and existing buildings of more than 1000m² of useful floor space  Occupiers are either public bodies or institutions providing a public service, and are frequently visited by large numbers of the public

12. DECs (cont’d)  DEC produced by occupier of building  Typical tenant’s covenant to comply with statute should pick up the obligation to provide a DEC  DECs are valid for 12 months and must be renewed annually

13. Carbon Reduction Commitment

14. Carbon Reduction Commitment (CRC) – an outline  Climate Change Bill and strict CO 2 emissions reduction target  Carbon Reduction Commitment is a  Mandatory UK-wide cap and trade ETS for large, non- energy intensive businesses and public sector organisations using “core source” energy  2008 is “qualifying year”  Starts 2010, introductory phase up to 2013  Announced 2007, Defra consultation June 2007  Consultation on draft regulations awaited  Regulations should be in place by 2009  Many outstanding issues

15. CRC (cont’d)  Which businesses are covered?  “CRC organisations” – offices, shops, hotels, rail operators, hospitals, universities etc  Who use “core sources”:  Mandatory half-hourly electricity meters  Using >6 000 MWh pa  Likely to be included if total annual electricity bill is £500 000 or more

16. CRC (cont’d)  Definition of “CRC organisation”  Highest UK parent  Other arrangements – “counterparty to the energy supply contract”  The 90% requirement  At least 90% of organisation’s total emissions must be covered by either EU ETS, CCA or CRC  Include smaller emissions sources to reach 90% threshold  Once organisation reaches 90%, may voluntarily opt in all/any other sources

17. CRC (cont’d)  Cap set by government every 5 years  Allowances to be auctioned (fixed price, then closed bid system) in 5 yearly phases from 2013  Businesses to self-certify emissions  Gateway into EU ETS but may not sell from CRC into EU ETS  CRC “performance table” and bonuses or penalties  Scheme to be revenue neutral to Treasury

18. Issues for landlords and tenants  Who is responsible in the following situations?  (A) – owner/occupier or long-term leaseholder (FRI) invoiced directly  → UK parent co of owner of building or tenant  (B) – sole tenant of large property  → UK parent co of owner of property/tenant  (C) – multi-let properties with managing agent/property manager  → UK parent of MA/PM co and tenant

19. Issues for landlords and tenants (cont’d)  Other arrangements being considered:  Pass-through of CRC costs/benefits from landlords to tenants – guidance requested  Channelling of CRC revenue recycling payments into dedicated fund for energy efficiency investment?  If landlord and tenant agree before each phase, CRC responsibility could fall to tenant  Lease provisions will have to deal with this  Lobbying DECC

20. Other outstanding issues  Effect of organisation change  Subsidiaries/ overseas companies  90% coverage rule unclear  Data collection  Market design  Disincentive to take energy efficiency action before 2009/10?  No information on penalties yet  Complex issues for companies who may be in EU ETS and CRC

21. Issues for landlords and tenants (cont’d)  Actions:  Consider if you are likely to fall within this scheme  Look out for DECC consultation on detailed regulations in “late Autumn 2008”  Look out for awareness-raising events  In early 2009, Environment Agency will send registration packs to UK billing addresses with half- hourly meters  You may receive information from energy supplier  Identify “CRC organisation”  Consider how data collection on energy use could be organised

22. Green leases

23. ‘Green’ leases - introduction  What is a ‘green’ lease?  a commercial lease that places obligations on both landlords and tenants to use the property efficiently and in a way that promotes sustainability  there are various shades of ‘green’ that can be applied to commercial leases BS:1999453.1

24. ‘Green’ leases – a closer look  ‘Light green’ leases:  normal obligations in a commercial lease, but no barriers to making the building more energy efficient, eg no prohibition on tenant carrying out alterations to improve heating efficiency  generally, no penalties or rewards on either landlord or tenant for achieving sustainable use

25. ‘Green’ leases – a closer look (cont’d)  ‘Mid green’ leases:  some commitments on both parties, eg a general environmental management plan to share information and monitor energy use in the building  common goals to minimise carbon footprint  failure on either party to perform or maintain obligations not actionable breach of the lease

26. ‘Green’ leases – a closer look (cont’d)  ‘Dark green’ leases:  obligations to reach specific targets, eg on energy and water use, or a target on the landlord to ensure the building achieves a certain energy rating on its EPC  failure by either party will have consequences, eg financial penalties or even forfeiture  landlord could adjust mechanics of the service charge to reflect good practice by tenants  ‘dark green’ leases familiar in some US states, and particularly in Australia

27. ‘Green’ leases – landlord’s incentives  Reducing size of air conditioning systems increases lettable space  Lower service charge and running costs – attractive to tenants  Brand enhancement for ‘green’ landlords  ‘Future proofing’  Landlord’s own corporate social responsibility profile

28. ‘Green’ leases – barriers for landlord  Inability to recover capital expenditure  Uncertainty of covenants which are vague and general – may not be enforceable in court  Typical covenants not yet tested at rent reviews  More time policing or liaising with tenant and monitoring energy use  Difficulty in introducing ‘dark green’ leases where there is no green technology to introduce improvements

29. ‘Green’ leases – barriers for tenant  Tenant with short term view of its occupation may not benefit in terms of lower running costs over a long period  Will ‘green’ lease covenants make lease less attractive on assignment?  Current service charge mechanics discourage energy efficiency  Utility bills small fraction of budget, so landlord charging premium on the basis of lower running costs must show significant energy savings

30. ‘Green’ leases – barriers for tenant (cont’d)  No incentive for landlord to reduce energy usage where leases are on a simple FRI fully recoverable basis  Extra expenditure for tenant and fear that landlord is interfering with tenant’s use of building

31. ‘Green’ leases – incentives for tenant  Potential for reduced energy and fuel costs  ‘Green’ lease as part of overall corporate social responsibility targets

32. Conclusion  Costs and incentives are a big stumbling block  Easier to be ‘green’ in a new building than refurbishing an existing building  Landlords, tenants and advisers are nervous of accepting unfamiliar covenants  Lack of appropriate and widely accepted benchmarks

33. Conclusion

34. Actions  CRC plans going ahead  Climate Change firmly in government sights  Good practice worth developing  Consider how your organisation should respond

35. Questions? These are presentation slides only. The information within these slides does not constitute definitive advice and should not be used as the basis for giving definitive advice without checking the primary sources. Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP's affiliated undertakings.

36. Sustainable development – responding to the challenges of greener buildings Claudia Watkins and Christopher Woolf