Low proportion of GPs with climate change policies unlikely accurate measure of sustainability efforts
Climate-related metrics ‘in transition from ESG to financial’: Yale’s Cort
Regulators including SEC and ESMA examining climate and ESG-related disclosures
(This story was updated on December 14 to correct the number of Article 8 funds in paragraph seven.)
December 13, 2023 (Preqin News) – Nearly 90% of private capital GPs worldwide have no statements or policies on climate change, according to Preqin data. However, an apparent low level of adoption may mask the true extent of managers factoring in climate and other environmental, social, and governance (ESG) issues.
According to data from Preqin’s ESG Solutions, 5,470 GPs – 11% of the total on its database – say they consider climate issues in operations and investments. Given the nature of private markets, names and labels may have less influence in ESG-related decision-making than for some investors in public markets. LPs are more likely to assess ESG risk in their decision-making process, stakeholders say.
‘The typical investors in a private equity fund – large pension funds, insurance companies, endowments, sovereign wealth funds, etc. – can read and understand detailed disclosures, undertake full due diligence on a sponsor, demand bespoke reporting, and read and understand the implications,’ Simon Witney, Senior Consultant at UK law firm Travers Smith told Preqin News.
According to Preqin’s ESG Data in Action, the largest firms are more likely to have ESG policies. It shows that 70% of fund managers with more than $100bn of assets under management (AUM) disclose policies. Only a minority of mid-sized and smaller GPs have disclosed policies: 45% in the $10–100bn range; 26% in the $1–10bn range; and just 14% of fund managers with less than $1bn in AUM disclose ESG policies.
Private capital fund managers with an ESG investment policy raised $1.1bn in 2022, more than double the total raised by managers with no stated policy, according to Preqin data. Fund managers with an ESG policy accounted for two-thirds (66%) of total private capital raised in 2021, compared with 51% in 2018.
For labeling – where a fund adopts terms to indicate it has specific non-financial objectives, such as ‘climate’ and ‘ESG integration’ – a lack of standardization is a potential obstacle to adoption. Firms who simply label their fund as a climate fund do not have to comply with a defined set of criteria, unlike those who label their offering an Article 9 fund under the EU’s Sustainable Finance Disclosure Regulation (SFDR), for example.
Preqin currently tracks 532 alternative asset funds in Europe that comply with Article 8 of the SFDR, and a further 299 Article 9 funds. The proportion of funds from Europe-based managers that had an Article 8 or 9 label jumped in 2021 when the regulation began to come into effect, from 5.3% in 2020 to 11.5% in 2021, currently standing at 11.1% for 2023 year to date.
Some managers have adopted voluntary labels, such as climate, ESG integration, impact, Sharia-compliant, and SDGs (Sustainable Development Goals). These make up many labels applied by private market managers.
Impact funds are the most common by number, with 988 funds, but are in a category of their own given their dual bottom-line commitment of delivering both financial and non-financial returns.
A total of 684 funds have the ‘climate’ label, with North America and Europe home to the most number at 209 and 258 funds, respectively. Private equity has the biggest share (240), followed by natural resources (184), and infrastructure (121).
Capital raised by climate funds has increased from $7.8bn in 2019 to $36.9bn so far in 2023.
Funds and investors want clarity
Keeping up with the different regulations and labels and a lack of clarity or definition as to what some key terms mean is extremely difficult.
‘Every Head of ESG I speak to, whether in a private equity house or a hedge fund, says they’re confused and overwhelmed,’ Victoria Gillespie, Head of ESG at fund administrator Alter Domus in London told Preqin News. ‘They are trying to be all things to all people and deliver on all the regulations. Physically, can one or two people do that? I’m not sure.’
Some measures to help establish consistency in sustainability metrics are being explored. The International Auditing and Assurance Standards Board (IAASB) has launched a consultation on the draft of its proposed International Standard on Sustainability Assurance 5000, which would set out general requirements for sustainability assurance engagements. It has already been welcomed by some of the largest asset allocators, including Norges Bank, the manager responsible for investing in the Norwegian Government Pension Fund Global.
In a written response to the consultation, Norges Bank stated that it agreed with the IAASB’s intention to develop a standard that can be applied to all sustainability topics.
‘Reliability and credibility of information provided in companies’ sustainability reports are crucial for us. As an investor, we currently rely on our portfolio companies’ internal governance processes to enhance the reliability of sustainability reporting,’ it said. ‘While recognizing that it is still not common market practice in most jurisdictions, we believe that assurance of sustainability reporting has a key role to play in improving this reliability over time.’
The language advertising ESG pedigree has also come under scrutiny recently. While much of it has focused on protecting retail investors from so-called greenwashing, it could have some bearing on the way private markets describe their ESG credentials.
The European Securities and Markets Authority (ESMA) launched a process in July to assess sustainability-related disclosures, including ‘to gather further information on greenwashing risks in the investment management sector’. The Securities and Exchange Commission (SEC) has proposed rule amendments governing climate and other ESG-related disclosures, while the UK’s Financial Conduct Authority (FCA) recently confirmed measures designed to increase the transparency of sustainable investment products.
In a blog titled ESG: It’s complicated, Lauren Anderson, an Associate in the Policy and Regulatory team at industry association Irish Funds, wrote in November: ‘We did not expect the financial services industry to solve the climate’s crisis alone, but we did expect better… better regulation, better clarity, better collaboration, and better compliance. To put it simply, a complicated problem has been muddied by complicated solutions.’
‘Momentum is huge’
A comparatively low uptake of labels by private market funds should not necessarily downplay the importance that GPs attach to ESG, with investors and fund managers – increasingly aware of investors’ obligations - factoring sustainability and other metrics into their investment decisions.
‘The momentum is huge,’ Todd Cort, Senior Lecturer in Sustainability at the Yale School of Management in the US, told Preqin News. ‘But we must be careful in how we assess this. While ESG continues to grow in almost all metrics, it is also being integrated into more traditional financial fundamentals. The result is that “labeled ESG” financial products can look bumpy.’
Cort says many ESG practices are now hardwired into operations in a similar way to how firms have adopted workplace health and safety regulations.
‘Long ago, health and safety data would be considered “extra-financial”, but through a combination of liability, regulation and employee/customer sentiment, health and safety is now a core part of financial analysis,’ he said. ‘Climate change is now in this transition from ESG to financial. At no point have ESG factors diminished in reporting and consideration, but as issue areas evolve, they become integrated into financials and drop out of the common vernacular or definition of ESG.’
The increasing demand for environmental and social impact data underscores a trend where greater numbers of LPs are seeking ways to further understand investment sustainability risk.
Jacyln Bouchard, Global Head of ESG Solutions & Corporate Responsibility at Preqin, says demand for ESG data is increasing as it evolves: ‘Over the past few years, there has been a huge need and a demand for ESG and sustainability data metrics across asset classes, and ESG factors are increasingly being embedded into every part of the investment process. Referring to these factors allows investors to make more informed and conscious decisions when screening investments and companies, as well as evaluate the way they do business and ensure their business operations are geared toward the future.’
Ultimately, Gillespie warns, a lack of substance could harm efforts to make sustainability a core component of investment and financial products: ‘People are being too vague and now we’ve got no way of knowing what the terms mean. You can say you are an Article 8 fund because you support the environment and are looking to achieve environmental objectives or SDGs, but it’s meaningless. People are starting to use and look at these terms as if they’re just a marketing thing, which takes away from the intentions of why they were originally introduced.’
Preqin’s Harry Moses contributed to this article.
The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.