Alternatives managers and their clients both acknowledge the threat of climate change, but struggle when it comes to measuring and disclosing their impact on the environment
Alternatives managers and their clients both acknowledge the threat of climate change, but struggle when it comes to measuring and disclosing their impact on the environment
The climate crisis is the number-one concern relevant to ESG investing this year, according to Preqin’s latest investor survey. At least 54% of respondents (Fig. 1) said that plastic and waste management, water management, and natural disasters specifically will be top of mind in 2021, ahead of the impact of COVID-19 and high-profile social issues such as income inequality and political strife.
For alternative investment managers, the feeling is mutual. As much as 63% of surveyed private debt managers felt these same environmental risks were the most relevant issues for ESG in 2021. Private equity managers shared the sentiment (each factor cited by at least 56%), adding that a shift from shareholder to stakeholder capitalism (44%) will also be in focus this year.
Why are these environmental issues ranked so highly? The threat they pose is comparatively more difficult to eliminate, and so must be managed. Risks posed by social and governance issues, on the other hand, such as diversity and inclusion or political turmoil, can be mitigated by avoiding certain companies or regions. Dealing with a decentralized problem is a much greater challenge.
It’s well established that client demand for ESG accountability is motivating GPs’ efforts toward implementing an ESG policy. Many clients – and potential clients – have an explicit ESG policy, or expect to have one within 12 months, across their alternatives portfolios. More than two-thirds of private equity investors affirmed this in the Preqin Investor Outlook survey, with similar feelings shared across real estate, private debt, and infrastructure. Generally, larger managers, a group that is increasingly taking a greater share of committed capital, have acquiesced. Of the $1.6tn in private capital raised since 2010 by the 20 largest managers by capital raised, 58% was raised by managers with a broad ESG commitment.
What we are hearing now, however, is that simply stating a policy is not enough for some investors. California Public Employees' Retirement System (CalPERS), the US’s largest defined-benefit pension fund, spoke at length with Preqin about holding its investments more acutely accountable to ESG standards. When asked about how the organization’s sustainable investment plan has evolved over time, then-Managing Director of Sustainable Investments Beth Richtman responded:
“Over the years the CalPERS Principles have evolved from a guide to proxy voting in public markets, to a broader statement of our views on best practices. We now issue guidance on our engagement with companies, advocate with policy-makers in support of our Investment Beliefs, and engage internal and external managers on our expectations regarding sustainable investment practices.”
Traditionally, a charge leveled at GPs is that they treat ESG investing as a box-ticking exercise, asking clients to trust them on their process. But, as Preqin has observed anecdotally, clients are asking for details of how their assets are being managed under an ESG framework. And in some cases, they need to know ‘the how’ because they in turn are accountable to their stakeholders and/or regulators.
Preqin’s ESG transparency indicators show that many managers aren’t digging deep enough into environmental issues in their portfolios. While the aggregate transparency score¹ across the 4,000+ managers observed is 18.5%, only 11.2% (Fig. 2) of these managers are transparent on carbon emissions. Among that 11.2% of firms, most (17.4%) disclose any policy pertaining to climate change or carbon emissions at the governance level – action-oriented asset-level disclosures were even lower. When pressed on whether they evaluate assets’ ongoing emissions at the company level, conduct environmental impact studies of portfolio companies, or track asset emissions, only, 10.2%, 8.3%, and 8.8%, respectively, answered in the affirmative.
In short, ESG transparency and accountability is not easy at the portfolio and asset level.
When it comes to measuring environmental impact such as carbon emissions, technical knowledge is required, which many businesses lack. The challenges to effectively adopting environmental measures are also broad: the associated costs are often high, the time commitment is large, and obtaining comparable data is often difficult.
The London School of Economics’ Climate Change Laws of the World initiative helps market participants to understand the complexity of navigating environmental issues. The data tracks all UN and UNFCCC parties’ laws and policies related to climate change mitigation, adaptation, and disaster risk management. The initiative found that there are currently 2,118 active climate laws and policies worldwide, with more coming as policy-makers step up in the fight against climate change. While these efforts are valiant, they also highlight the challenges of environmental disclosure created in particular by uneven regulation across jurisdictions.
Consequently, much of policy implementation depends on local regulation and existing frameworks. While these inconsistencies are holding back more robust disclosure in many regions, Europe has taken a more comprehensive approach. The continent’s Sustainable Finance Disclosure Regulation (SFDR) now requires all EU financial market participants to be more transparent about the sustainability of their business practices, including efforts to reduce their carbon footprint.
Local politics will likely drive widespread emissions regulation, but managers can still be relied upon to follow the money. Investors will continue to push for clearer policies and greater transparency within ESG reporting, which will in turn continue to drive managers’ ESG disclosure.
¹Transparency scores were developed by Preqin based on 37 binary indicators, with a score of 100% being fully transparent.
If you’re interested in learning more about ESG Solutions, take a look at our ESG homepage. Alternatively, if you’d like to receive regular updates on our ESG activity, you can sign up here. Finally, if you’re looking to learn more about our ESG methodology, you can download an overview.