How Private Markets are Catching up on ESG

By: David Lazar

Product Manager - CLO & Public Credit
November 16, 2021
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New regulations are driving standardization across the industry and forcing GPs to prioritize ESG initiatives

Private markets have long lagged public in embracing ESG – but that’s changing

Much ink has been spilled belaboring the rise of ESG as a driver of change in investment management. Yet not all segments and regions have been as quick to embrace the ESG mantle. While robust ESG data sets have been available for decades in the public markets, private markets inherently have less publicly reported data. As a result, ESG data sources have been slow to emerge for private companies.

Disparate standards and criteria for both qualitative and quantitative ESG metrics have also contributed to a fragmented market and an inability for investors to compare ESG metrics across investment managers.

New ESG regulatory changes are driving increased standardization

In the last year, regulatory changes in Europe have accelerated ESG adoption by investment managers. While alternative investment ESG funds were mostly limited to European ESG CLOs, the advent of the EU Sustainable Finance Disclosure Regulation (SFDR) has greatly accelerated the incorporation of an ESG focus into investment management in Europe.

Even where ESG adoption has been high, managers often face inconsistent standards, giving rise to accusations of “greenwashing” – where a firm’s commitment to ESG standards is merely for show.

The EU has taken aim at this issue with one of its recent regulations – the EU Sustainable Finance Taxonomy, which is meant to introduce a more consistent standard for reporting on ESG metrics. These reporting requirements apply to any investment manager marketing funds in Europe.

Similarly, the UK has implemented new disclosure rules for any managers receiving investments from UK pension funds. These regulations are already spurring an increased adoption of ESG outcomes in investment screening and standardization in reporting.

What is greenwashing?
Greenwashing, also sometimes known as green sheen, is a deceptive practice where a firm or organization employs an outward-facing stance of taking a serious commitment to ESG without actually upholding ESG standards or practices.

While the US has long been a laggard in the sustainable investment trend, the US Department of Labor in June announced that it will not enforce a previous Trump-era policy that limited financial advisers overseeing retirement accounts to selecting investments purely based on financial considerations – opening up the opportunity for ESG-focused investment options. The Security and Exchange Commission (SEC) quickly followed suit, signaling that it too would enact regulations requiring corporate disclosures of ESG activities and increased consistency via a set of uniform standards. If enacted, this regulation would accelerate the standardization currently relegated to trade associations like the Institutional Limited Partners Association (ILPA) or voluntary compliance with international standards like the UN Principles for Responsible Investment (PRI).

The alternatives ESG landscape varies by asset class

The net sum of these changes is that investment firms can no longer treat ESG as a box-checking exercise. Investment managers are realizing that they must integrate ESG collection and screening into their core investment processes, as these metrics and investment processes are increasingly subject to investor/LP requests and regulatory disclosures.

Yet not all asset classes face the same considerations.

Private Equity firms, by virtue of their ownership, have an outsized impact on the ESG policies and outcomes of their portfolio companies. Private Debt lenders have less direct control but are increasingly engaging with their borrowers on ESG-related topics. ESG criteria have even been incorporated into loan documents, with interest rates paid by borrowers directly tied to key ESG outcomes. Banks have similarly offered more favorable warehouse terms to CLO managers incorporating ESG criteria in their funds.

DOWNLOAD INFOGRAPHIC: 2022 Investor / GP Trends in ESG for Alternative Investments

Many firms are tackling ESG via a “whole firm” approach

Despite the dramatic differences between business lines, investment firms are increasingly focusing on ESG strategies at the firm level. GPs have recognized that their investors are evaluating ESG adoption both at the fund and manager level.

Asset managers have responded by coordinating ESG strategies across business lines, in some cases creating roles focused on ESG. They are increasingly embedding ESG metrics into their operational processes and ensuring consistent data.

Allvue: An industry leader in ESG

Allvue has embraced the trend of accelerated ESG focus in alternative investments. We have developed a robust ESG strategy across the various asset classes we support. For example, private equity customers leveraging our Fund Performance and Portfolio Management solution can assign ESG surveys directly to their Portfolio Companies and leverage a consolidated library of customizable questions.

Similarly, public credit and private debt customers can assign ESG ratings or import from any third-party ESG data source. These ESG scores can then be leveraged during the investment decision-making process and displayed on reports.
In addition to point solutions, Allvue has developed an ESG hub to centralize and consolidate firm wide ESG data for customers that leverage different solution sets. Customers can view their ESG metrics across all their business lines and asset classes.

With a commitment to product enhancements and innovation, Allvue helps firms make better investment decisions, enabling deeper relationships with their investors and prospects so they can spend less time getting information and more time using it.

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