Are smaller managers less transparent due to greenwashing, or are structural factors holding them back?
Are smaller managers less transparent due to greenwashing, or are structural factors holding them back?
As part of Preqin’s Sustainability Solutions effort to make private capital more sustainable and transparent, we have designed a model for measuring and comparing environmental, social, and governance (ESG) factors across the industry. The data provides a highly detailed and comparable breakdown of ESG profiles across LPs, GPs, and funds.
In our final blog entry of the series, we take a closer look at fund size. Can we draw any meaningful conclusions from the size of a fund and its commitment to ESG?
ESG Transparency by Firm Size
Our last blog entry found that ESG transparency declined from the firm to the asset level. As the dataset evolves over time, any disproportional rise in average firm governance scores would suggest the possibility of greenwashing at play. However, a more equal rise in portfolio and asset transparency would run counter to this notion, implying instead that ESG commitment takes time. Firm governance is comparatively low-hanging fruit for most managers, with the more nuanced parts of ESG-committed investing further down in the process.
When we analyze transparency scores by assets under management (AUM), the greenwashing question emerges once again. Preqin collected data on 1,600 private capital GPs, representing more than $6.83tn in total AUM. As Fig. 1 shows, managers’ commitment to ESG fades as AUM declines, implying that greenwashing could be occurring at smaller firms.
A closer look at the data (see Fig. 2) reveals a trend typically associated with greenwashing: a firm implements internal ESG policies, but fails to externalize them down to portfolio companies and other asset holdings. Of course, we rejected that argument in our previous blog entry – ESG implementation represents a culture change that evolves slowly over time – and we will reject it once again. But if not greenwashing, what does the additional overlay of firm size add to this conversation?
We find three key factors why the initial transparency scores at larger firms far outpace their smaller peers: 1) cost, 2) market pressure, and 3) regulatory pressure.
1. Cost
Let’s start with the easy one: ESG implementation is expensive, plain and simple. Culture change of this magnitude, in general, represents significant firm investment. Simply put, larger firms are better equipped to shoulder the financial burden associated with an ESG transition, which includes significant expenditure for staffing, external data sources, and IT infrastructure, as well as the marketing expenses associated with education both internally and for clients.
2. Market Pressure
To date, one of the main drivers of ESG integration globally has been client demand, largely from institutional investors. Another kind of market pressure involves reputational risk or other external pressures. Once a largely theoretical concept, larger firms are pivoting more quickly to develop ESG policies, especially those that focus on the E and S. BlackRock’s annual shareholder letter from CEO Larry Fink highlights some of the market pressures associated with climate change. Similarly, several notable social justice movements over the past few years (including #MeToo and #BLM) have required firms’ attention. Furthermore, the ongoing coronavirus pandemic has put the spotlight on labor relations and employee healthcare.
3. Regulatory Pressure
Finally, larger firms by AUM are quicker to adopt ESG based simply on regulatory requirements. As is typically the case across all regions and jurisdictions, regulatory changes are almost always implemented from the top down. That is, larger firms bear the initial burden of implementing government- or exchange-driven mandates. While part of the reason is cost – larger firms have the resources to withstand regulatory changes – the other reason why mandates initially target large firms is that they represent the widest segment of the market, meaning that changes there will have the most immediate impact on the general population.
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.