STATE OF THE M ARKET Private Funds Group - AUT VIAM INVENIAM AUT FACIAM
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STATE OF
THE MA RKET
Private
STATE OF THE MARKET 2021
Funds Group
EVERCORE
AUT VIAM INVENIAM AUT FACIAMThe contents of this document are not provided for This document may not reflect information known To the extent this document or any statement con-
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and Markets Act 2000 (Financial Promotions) Order 2005
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or sell any security or other investment in connection which are otherwise applicable to such recipient. Front cover photograph by Jeffrey Grospe
therewith.10
ESG: The new mainstream for alternatives?
BY CORPORATE PARTNER KATE DOWNEY AND ASSOCIATE JAMES O’SHEA AT FRIED FRANK
A
s both sponsors and investors are categorised as ‘ESG-committed’, 42% is levant — CO2 emissions, exploitative labour
will be aware, recent years European versus 51% US. Given that the US practices, diversity of board representation —
have seen an evolution in the still accounts for the vast majority of global and who decides what weighting to apply to
role and importance of ESG capital raised in any year, the strength of the each factor? Who pays for all this data collec-
considerations in the asset European position here is telling. tion, analysis and reporting? These are just
management industry. As we some of the questions facing sponsors as they
enter the new decade, this remains one of In recent years, however, these require- begin to grapple with the integration of ESG
the most rapidly developing and high-profile ments have been moving up the agenda for matters into their funds and strategies. Even
areas of focus throughout the alternatives in- all, regardless of jurisdiction. US and Asian having developed and implemented its own
dustry. ESG increasingly forms a key element managers are now increasingly focused on ESG policy, a GP may well find that the equi-
of discussions between investors and spon- some form of ESG compliance in both the valent policies developed by each of its 50+
sors, reflecting the growing awareness of raising and deployment of capital. Across the investors may place the focus in different,
the long-term implications of issues such as market, a growing number of leading asset but no less valid, areas, requiring thoughtful
climate change and social justice. Whilst the managers and private equity sponsors are dialogue between sponsor and investor as to
predominant focus of the last five to ten years now beginning to direct internal resources how to meet the investor’s requirements. As
has been on environmental factors, several towards building out their ESG-related capa- we move beyond 2020, we can expect one of
key social drivers of late — including the #Me- bilities. the key areas of focus for industry, govern-
Too movement, Black Lives Matter, and the ment, and regulators alike to be the need for
Business Roundtable’s 2019 ‘Statement on the The creation of an ESG policy and repor- a uniform and streamlined set of metrics.
Purpose of a Corporation’ — have also brou- ting framework is not without considerable
ght renewed attention to the ‘S’ in ESG. challenges. ESG covers such a broad range One area which aptly demonstrates the
of potential areas that the greatest practical challenges facing the industry in this regard
The amount of capital raised by GPs with challenge is identifying and defining which is the taxonomy of funds marketing themsel-
a commitment to ESG has risen steadily over elements of ‘E’, ‘S’, and ‘G’ are relevant. Howves as ‘sustainable’ or ‘impact’-focused. This
the past five years. What this means is that can the market properly assess whether an is a potentially significant market; investors
ESG is becoming mainstream across the al- ESG-compliant fund outperforms one that is (including some of the largest US state pen-
ternatives space.1 Many sponsors are now ac- non-compliant when no one is entirely sure sion plans) have begun to make significant
tively incorporating ESG elements into their what ESG or ‘compliance’ means? Whilst allocations to funds that have investment
investment analyses and processes by for- many different industry groups, including strategies focused on sustainability or impac-
mally adopting an ESG policy; in some cases, PRI and SASB, have proposed their own me- tful investing. It is shrewd for asset managers
they are making overt commitments to ESG trics, no over-arching set of standards has to pay attention to this: the impact investing
by joining an association or publicly broad- yet emerged; and in the absence of a co-or- market is estimated to be worth over US$700
casting their views. Approaches differ dra- dinated global effort, it is not entirely clearbillion globally, with for-profit asset mana-
matically as sponsors across asset classes try how one will. Nor do such metrics necessa- gers expected to raise US$20 billion in impact
to work out how to integrate ESG principles rily translate across different asset classes in
funds through the end of 2020.2 Many large
into their often complex and well-established any sensible way. A private equity manager asset managers have launched funds focused
existing business protocols and procedures. taking a majority stake in a US manufactu- on sustainability and/or social and environ-
ring business is likely to have a very different
mental impact over the last few years. Howe-
As a general observation, the European set of parameters to consider than a credit ver, the rise in the number of such funds
market has probably had something of a manager investing in infrastructure debt in being brought to market, combined with
head-start on the US and Asia in this regard. an emerging market. the lack of an agreed-upon, consistent ESG
The larger sources of European capital (i.e. reporting framework, has caused some con-
European state pension plans) have generally What data can be collected as part of rou- cern around the potential for ‘greenwashing’
adopted a more stringent approach to ESG tine due diligence, and against what metrics of financial products.
than, for example, their US counterparts, and should they be analysed? Can ongoing data
have long required that sponsors maintain an be collected from portfolio companies in a Regulatory authorities in the EU and the
ESG policy and report against it on a regular sufficiently routine and manageable way to US have reacted to such concerns in markedly
basis. Preqin data show that of all the private allow a sensible reporting framework to be divergent ways. The EU has proposed what it
capital raised in YTD 2020 by sponsors who developed? Who selects what metrics are re- calls a Taxonomy Regulation, which is inten-
STATE OF THE MARKET 34ded to set out uniform criteria for assessing ment firms) and ‘financial advisers’, and is metrics, it is certainly possible that a version
the sustainability of an economic activity. intended to harmonise such requirements of the framework being assembled in Europe
Noting the concerns around greenwashing, through the common market. The ultimate will become the global standard by default,
this framework is designed to develop over aims are to make it easier for investors to as it is adopted by institutional investors that
time as our understanding of what constitu- compare different financial products from an operate internationally and seek consistency
tes a sustainable activity evolves, rather than ESG perspective, and to move towards con- across their various platforms.
simply labelling certain financial products sistency in the reporting of relevant infor-
as ‘green’. The focus of the Taxonomy Regu- mation. The obligations contemplated by the The differing approaches adopted by re-
lation is exclusively environmental, although regulation include disclosures regarding the gulators to the same basic issues neatly de-
the European Commission is required to plan integration of sustainability considerations monstrate the challenge sponsors and inves-
for the extension of the current taxonomy to into investment decisions, as well as ongoing tors face when they set out to create globally
include social and governance aspects by periodic reporting of sustainability impact relevant metrics for the incorporation of
December 2021. In order to be considered assessments and the extent to which any en- ESG elements into the space. In the EU, the
‘environmentally sustainable’, an econo- vironmental or social aim of a financial pro- industry has also expressed concerns about
mic activity will need to make a ‘substantial duct has been met. Once the detailed rules the practical consequences of implementa-
contribution’ to at least one of six defined for implementing the Disclosure Regulation tion within a short time frame and the lack of
environmental objectives, while doing no have been published on 30 December 2020, guidance or certainty about how compliance
significant harm to any of the others. The six the substantive provisions will apply from 10 with such frameworks will be monitored.
objectives are (i) climate change mitigation, March 2021 onwards, giving firms less than
(ii) climate change adaptation, (iii) sustaina- three months between publication and com- It seems likely that ESG will continue to
ble use and protection of water and marine mencement of their disclosure obligations. be a growing focus for the industry over the
resources, (iv) pollution prevention and con- next ten years. Climate change concerns,
trol, (v) protection and restoration of biodi- Across the Atlantic, the approach has economic volatility driven by the pandemic,
versity and ecosystems, and (vi) transition to been somewhat different. In contrast to the and political focus on diversity and the weal-
a circular economy. Although the climate-re- European view that climate change repre- th gap all have the potential to impact on
lated objectives of the Taxonomy Regulation sents a key source of financial instability alternative investing in the coming decade.
are due to apply from December 2021, the and should therefore be a high priority for The investment opportunities and challenges
regulation will not take effect until the te- securities regulators, the approach of the presented by this most unusual of markets
chnical screening criteria for each of the en- SEC has been more cautious, with regulators all have an ESG overlay, and both sponsors
vironmental objectives are adopted through less willing to legislate for such matters and and investors can expect their performance
the relevant delegated legislation. preferring to let investors make their own and allocations to be scrutinised against this
assessment of what constitutes a material backdrop. A developing industry consensus
As in the EU, the US has also been looking element of their decision to invest. Although can provide some certainty and consistency
at the taxonomy of ‘sustainable’ funds, throu- the SEC’s internal Investor Advisory Com- around ESG obligations and expectations for
gh the potential applicability of the Names mittee (IAC) has publicly declared that the all. Sustained, active industry leadership and
Rule. Adopted in 2001, this requires a fund re- ‘time has come’ for the SEC to address what dialogue between asset managers and inves-
gistered under the Investment Company Act the IAC views as inadequate ESG disclosu- tors will be required to ensure that this ha-
of 1940 to invest at least 80% of its assets in re requirements, the view from senior figu- ppens efficiently and in parallel with govern-
the type of investment suggested by its name. res within the SEC, including Chairman Jay ments’ and regulators’ attempts to engage on
However, the Names Rule does not apply to Clayton, has been that the existing disclosure these topics.
fund names that describe a fund’s investment regime is sufficient. In particular, there is a
objective, strategy, or policies. Therefore, to perceived reluctance to move away from an This article is provided for informational and educational
purposes only. It does not constitute investment advice
the extent that ESG is seen as an investment approach based on verifiable, historical data and should not be construed as an offer to sell or a solici-
strategy rather than a type of investment, the to the inevitably forward-looking, speculati- tation to buy securities. The views and opinions expressed
80% requirement set out in the Names Rule ve basis that underpins calculations of ESG are those of the authors as of the date of this article, and
would not apply to a fund whose name im- risks and potential impacts on performance such views may be subject to change after such date. Any
forward-looking statements are as of the date of this arti-
plies a sustainable investment focus. Althou- from environmental factors. As with any dis- cle and are subject to uncertainties.
gh the SEC has sought comment on whether closure presented through forward-looking
the existing Names Rule is fit for purpose as statements or other projections, ESG disclo- 1. Preqin — September 2020. YTD 2020, 127 funds raised
regards ESG funds, it is not yet clear whether sures made on this basis have the potential to by ESG-committed GPs secured an aggregate of $177bn in
private capital
the SEC will significantly alter course and expose the sponsor making such a statement 2. Source: Global Impact Investing Network
seek to impose a more prescriptive disclosure to increased liability. Source: Global Impact Investing Network.
or taxonomy regime as is being put in place
in Europe. The European Commission’s initiative re-
presents a concerted, targeted effort by EU
In the EU, the European Commission has regulatory authorities not only to require that
also initiated a legislative process aimed at sponsors consider and report on the impact
clarifying the duty of asset managers and of sustainability in investment decisions, but
institutional investors to take sustainability also to put in place a framework for assessing
into account in their investment decisions, what could ultimately be viewed as ESG ‘per-
primarily through enhanced disclosure. formance’. The direction of travel in the EU is
The Disclosure Regulation (Regulation (EU) clear. Meanwhile, the IAC has voiced its con-
2019/2088) governs the transparency and dis- cern that, given the wide-ranging internatio-
closure requirements for ‘financial market nal focus on this issue, the US risks being left
participants’ (including AIFMs, UCITS ma- at a competitive disadvantage. In the absence
nagement companies, and MiFID invest- of clear reporting guidelines and universal
STATE OF THE MARKET 35Kate Downey is a Corporate Partner in
Fried Frank’s London office, and head of the
Firm’s European Private Equity Funds Prac-
tice. Ms Downey advises fund sponsors and
financial institutions across a broad range of
asset classes, including private equity, ven-
ture and growth, infrastructure, credit, and
real estate. She counsels fund managers on
carried interest, co-investment, and other
incentive arrangements, including levera-
ged co-investment arrangements. Additio-
nally, she has experience in a broad range
of international private equity transactions,
including secondary portfolio acquisitions
and synthetic secondaries, fund and mana-
gement company restructurings, and other
general corporate matters. Ms Downey is
consistently recognised as a leading private
funds practitioner by Chambers UK where
she is currently ranked in the Investment
Funds: Private Equity (UK-wide) category James O’Shea is an Associate in Fried
(Band 1) and in Investment Funds: Private Frank’s Asset Management Practice in the
Equity: Credit Funds (UK-wide) (‘Spotlight Ta- London office. Mr O’Shea advises fund spon-
ble’). She is also recognised by Chambers Eu- sors, investors and financial institutions
rope, Legal 500 UK, Legal 500 US, IFLR 1000, across a broad range of asset classes, inclu-
Best Lawyers (ranked in UK 2020 edition for ding private equity, debt, infrastructure, real
Investment Funds), The Lawyer (ranked in estate, venture and growth, credit, and real
2019 Hot 100), Who’s Who Legal (Formation - estate, with a particular emphasis on structu-
EMEA: Global Elite Thought Leader) and PLC ring complex and multi-jurisdictional funds.
Which Lawyer?. He also advises in relation to carried inte-
rest and co-investment incentive schemes
Ms Downey co-chairs the European Com- and secondary transactions in the private
mittee of Women in Fund Finance, a group funds space. Mr O’Shea is recognised as a key
focused on recognition and promotion of lawyer by Legal 500 UK in the Private Funds
women leaders within the alternative invest- category and by IFLR 1000 as a Rising Star for
ment fund finance industry. Investment Funds.
She is admitted to practice in England and He is admitted to practice in England and
Wales. Wales.
STATE OF THE MARKET 36STATE OF THE MARKET 2021
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