A while ago, a colleague in the financial services market told me that I had better get my head around ESG as it will be applicable to all sectors soon. Environment, social and governance. I told her this has been around for a long time. What could be new?

As a construction projects lawyer, I thought I had better get up to date with this and find out what was going on in her financial world and how that would affect the construction industry in which I work and how that would affect our local authority clients. The answer was to be found in NZCS1, NZCS2 and NSCS3 - Aotearoa New Zealand Climate Standards - with No.1 being general requirements for climate-related disclosures. These are requirements under the Financial Markets Conduct Act 2013 for entities subject to that Act to prepare climate statements or group climate statements to comply with the climate-related disclosure. This change has started the ball rolling in New Zealand.

That was last year and while this is a new topic nationally, internationally ESG for construction companies has been on the radar for a while and it's something I have been keeping an eye on. With the recent events in the North Island, this is going to hit the New Zealand construction market sooner than some are suggesting.

So what is coming?

The introduction of ESG into the financial world means that companies' ESG credentials have become an important focus point and I suspect will start to become a focus of procurement processes and decision making in both the public and private sectors for construction related work. However, with this greater focus on ESG credentials for entities overall comes greater scrutiny, new challenges and risks that must be navigated by local authorities and businesses, including stakeholders within the construction industry.

Key ESG concerns for construction projects

The construction sector is quite unique in its effects on the environment, with far reaching environmental impacts on climate change and natural resources, and it's contribution to pollution. In New Zealand, the built environment contributes to 15-20% of the country's total greenhouse gas emissions. Internationally, we understand the statistics are 30% of total greenhouse emissions, using up to 50% of the world's natural resources.

These environmental impacts cause uncertainty within the sector. In turn, this increases risks and delays investment in construction projects.

For the construction industry, concerns around the social pillar of ESG include engagement with local communities, supply chains and staff. Although it is always hoped that the building of new infrastructure will improve the lives of those in the community it serves, it can sometimes have the opposite effect. Projects that are severely delayed can have a negative community impact and attract unwanted media attention. This can cause reputational damage to stakeholders as well as have legal consequences. Is the inclusion of ESG requirements into construction contracts going to impact project delivery time-lines?

The governance pillar of ESG includes the juggle between a company's ability to be transparent and accountable whilst using policies to make decisions, comply with the law and mange risks. The construction industry is vulnerable to governance issues because of the nature and complexity of projects. This is particularly true when it comes to supply chains. A lack of transparency around supply chains can expose developers and contractors to risks that negatively impact their own ESG credentials such as corruption, pollution, fraud, or human trafficking.

Barriers to ESG innovation in the construction industry

With change comes risk, and this is no different when it comes to contracting for ESG risk in construction contracts. On that point, New Zealand standard form construction contracts do not cater for ESG. However, on 26 July 2022, NEC (New Engineering Contract - a UK form of construction contract) introduced the final form of the X29 clause for its suite of contracts which is otherwise known as the climate change clause, with a focus on decarbonisation. The clause requires contractors to comply with the climate change requirements which are set out in the scope documents forming part of the contract. Failure to comply with the clause is a breach and a defect in the works under the contract. It will be interesting to see the frequency of the use of this new clause; but the mere inclusion of such a clause shows how the United Kingdom is moving closer to an ESG model of accountability for contractors.

In New Zealand, traditionally a substantial amount of risk has been placed with contractors. This can potentially become a barrier to innovation given the ever-growing pressures that come with tight margins, supply fluctuations and labour shortages, so is adding another requirement the right thing to do?

Who is going to pay for it?

Traditionally, when it comes to innovation, part of the construction industry's mindset falls back to "who is going to pay for it?" Today, the industry is under ever increasing pressure thanks to disruptive factors such as supply fluctuations, labour shortages and increasing energy and petrol prices. If contractors and developers must also factor in ESG deliverables, where do they draw the line between meeting the demands of sustainability whilst ensuring their pricing remains competitive? The question is - will investors, developers and governments put their hands in their pockets to achieve the high performance, low emission standards they require?

Similarly, funders and insurers are also traditionally risk adverse when it comes to new projects, materials, and new technology. Despite this, they are also establishing their own criteria to ensure their investments and coverage have long term resiliency. In the future, obtaining funding or insurance for a project might hang upon a developer or contractor's historical ESG performance.

The way forward

Perhaps adopting new ways of contracting where risk is shared, such as alliance contracting or something like it, should be considered more by construction industry stakeholders to help achieve desired ESG targets on projects.

With our ever changing environmental status and growing social concerns, this change is now a reality. Watch this space!