Implementing the EU Sustainable Financial Disclosure Regulation has been a particular challenge for private equity funds. Moreover, this is just the start, with the details of the green investing taxonomy emerging and two more taxonomies in the pipeline.
It would be a stretch to say that Ucits managers have had it easy adapting to SFDR. Yet, when assessing the green credentials of a listed equity or bond, asset managers have numerous data providers and benchmarks to lean on to support their green classification decisions.
In private markets, each decision has to be taken case by case, collecting data for each of their holdings. This is a highly manual process. Not only does it involve substantial back and forth with the companies themselves, auditors, and analysts, but automation is often lacking as back offices lean on Excel.
Nevertheless, it is a challenge most European alternative asset managers appear to be embracing. According to a recent Société Générale Securities Services survey, 71% of the managers of private market funds asked had an ESG component to two-thirds of their fund range. A study by the analysts Bain noted that no less than 80% of the allocation of assets by the top PE institutional investors in Europe featured a commitment to green principles.
European first movers
Agreement is not universal. “When oil majors are looking to sell off stranded production assets, private equity are among the readiest bidders,” noted a recent article in the Financial Times. US and Asian investors are less enthusiastic for green investing than their European counterparts, noted Bain, with respectively 45% and 55% of assets being directed to projects with green intentions. “Yet, in the long run, it is definitely a competitive advantage for Europe to be the front runner on ESG since sustainability concerns are rising globally,” said Riccardo Zorzetto, head of private equity at IQ-EQ.
While this message is of some comfort, there are still many new concepts to understand and integrate into processes. For example, the whole industry is currently digesting a draft green taxonomy published by the European Commission in July. Although just a draft, history suggests this should point quite strongly to the shape of the final text to be implemented next year. Short-term, this gives managers some difficult choices when it comes to what extent they need to start aligning portfolios with this draft or wait for the final text. Then to come are taxonomies on social criteria and managing the transition to net-zero emissions.
Yet there is an alignment of interests in the private equity sector. Managers are keen to become ESG compliant, with businesses willing to do what is needed to tap into funding. This effort is considerable, though. “ESG needs to be integrated across the value chain: from due diligence to ownership of the asset to exit,” stated Zorzetto.
He also believes everyone needs to be realistic about green investing. “When you embed ESG criteria in your investment strategy, you probably need to be ready to be more patient in terms of how fast you will return the capital to investors,” Zorzetto said.