The demand for ESG-compliant investments is growing, especially among professional investors. The urgency of climate change and the regulatory requirements are driving the development for responsible investing.
According to Refinitiv Lipper data, a record 649 billion dollars poured into ESG-focused funds worldwide in 2021, up from 542 billion dollars the previous year. Most of the assets held in sustainable mutual funds, mandates and special funds come from institutional investors. Funds and mandates with stocks, bonds, and real estate account for the majority. However, small percentages were also invested in sustainable hedge funds, venture capital funds, direct investments and commodities.
Institutional investors and fund initiators increasingly see that taking ESG criteria into account creates value and mitigates risk. Potential stranded assets, i.e., assets set to lose value in the future, can be identified at an early stage. In addition, a good ESG balance sheet plays an increasingly important role in raising equity and debt capital. The effect: sustainability has a positive impact on a company’s strategic options and its business success.
ESG focus from two angles
The Refinitiv Lipper analysis confirms what we see when looking at our client’s activities: Among the newly launched alternative investment funds on our platform, more than two thirds are classified as Article 8 or Article 9 funds.
Investments in timber, renewable energy projects such as wind or photovoltaic plants, storage technologies, local and long-distance public transport and carbon capture projects are prominent examples. Many alternative investments incorporate an ESG-compliant approach. This is because they frequently offer more direct access to a company or a project in the field of renewable energies. Due to their long maturities, they are also suitable for supporting the United Nations’ Sustainable Development Goals in the long run.
Challenges – Availability and solidity of data
However, ESG data for alternatives is still less transparent than one would wish and leaves a lot of room for improvements, as standards still need to be established. Comparing assets can therefore be challenging. The understanding of regulatory ESG requirements also varies – for example among private equity managers outside the European Union. In this area, mandatory data is not yet comprehensively evaluated to the required and specified extent. In some cases, target companies do not yet conduct dedicated sustainability analyses, or they do not publish them in sustainability or corporate reports.
But awareness is growing: Fund initiators who want to place their funds in the European Union must deal with these regulatory requirements – including the possible costs that they might face by collecting and maintaining the required ESG data.
Regulatory requirements – The proof lies in the content
The Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation also apply to alternative investment funds. If it is the goal of these funds to promote environmental or social features or to aim for sustainable investments, extensive information must generally be collected and disclosed in accordance with the requirements of the SFDR and the Taxonomy Regulation.
At the beginning of January 2023, further reporting obligations according to Level 2 will come into force. From this date on, fund companies and other financial market participants must disclose for their financial products whether and, if so, how they consider negative impacts on certain sustainability factors - in the sense of Principal Adverse Impacts or PAIs - for investment decisions. If PAIs are not taken into account, a detailed justification is required. Comprehensive pre-contractual and periodic disclosure templates must be completed for all Article 8 and Article 9 funds.
These regulatory requirements aim to create transparency and demand that companies act with integrity. Among other things, corresponding marketing activities are targeted: products that are advertised as sustainable but are not, will be discredited by regulators and in the market, and rightly so, for greenwashing.
Many institutional investors and fund initiators recognise that it is not just about compliance and avoiding potential reputational risks. They see the potential that staying true to ESG criteria provides. In order to deal with the increased complexity from structuring and administration to reporting, they will rely on the help of fund service platforms with their own dedicated ESG offices.
Dr Sofia Harrschar is country head Luxembourg at Universal Investment, a knowledge partner of Investment Officer Luxembourg.