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Private Markets Edge Towards ESG Integration

Industry must adapt as “transparency tipping point” approaches, says Preqin.

The traditionally opaque world of private markets is making clear progress towards ESG integration, according to a new report by data provider Preqin.

Private debt has the sector’s second-highest share behind infrastructure (64%) of its assets under management within ESG committed funds, at 59%. Private equity has the highest value of AUM in ESG-committed funds at US$2.3 trillion, but the lowest share of total AUM of any asset class, at 34%. Overall, 42% of total private capital AUM US$4.37 trillion) was being managed by firms committed to ESG investing, as of October 2021.

Preqin tracked manager and investor affiliations to ESG initiatives, recording over 8,000 affiliations to date, covering over US$825 billion in AUM. The type of firms as well as the AUM of the firms varied widely, suggesting a broad penetration into the private market space.

The most prevalent affiliation found was to the UN Principles of Responsible Investment, but the report also discovered that other initiatives were gaining traction. These include the CDP environmental reporting platform, which records performance on climate, water use, and deforestation, and UN schemes such as the Global Compact and the Environment Program Finance Initiative.

The Preqin report also commented that in the private sector, without the breadth and depth of information available in public markets, pragmatism was needed to amass comparable metrics at the portfolio company level.

However, a piece within the report authored by Franklin Templeton’s Anne Simpson, Global Head of Sustainability, and Ben Meng, Executive Vice President of Asia Pacific, argued that private equity firms often benefit from better information transparency than public market investors, and that this granularity helps improve data materiality.

According to Preqin, as the renewable energy transition ramps up amidst cost pressures caused by the Russian invasion of Ukraine, private markets can also benefit from better evidencing their contribution to environmental risk mitigation and adaptation.

Within the report, Richard Nourse, Founder of Schroders Greencoat, laid out the potentially significant benefits of private investment in renewables, yet also acknowledged that each country committed to net zero is seeking to square the new ‘trilemma’ of achieving net zero, maintaining energy security, and transitioning in a way that is affordable for its people and its industry.

Nourse also observed “strong interest” in the ESG characteristics of products classified under the EU Sustainable Finance Disclosures Regulation’s (SFDR) Article 9 (which have sustainability as a direct objective), and 100% aligned with the EU Taxonomy.

Growing demands for transparency

Investor demand is the primary driver for the private markets industry’s path to greater integration of ESG into its investment processes, Preqin’s analysis suggested.

In a recent Preqin survey, 72% of liquidity partners cited investor demand as by far the most common reason why general partners were establishing ESG policies, ahead of regulatory demands, fiduciary duty, or moral imperative. Performance-related issues such as investment risk (19%) and outperformance (14%) were not seen as key drivers.

Jaclyn Bouchard, ESG Manager at Preqin, said: “The power of sustainable private capital puts alternative market players under the spotlight. With this comes growing demand from investors for transparency in ESG practices and policies, and at levels similar to public markets. For a marketplace used to limits in transparency, this shift of expectations is quite remarkable.”

With scrutiny of reporting expected to intensify under legislation such as SFDR and the EU Taxonomy, Preqin said the need for reliable data on ESG integration at the asset, fund, and portfolio level has “never been greater”.

Asserting that the sector was facing a “transparency tipping point”, the report said it was in the interest of private markets to adapt, as without data, investor uncertainty around ESG integration could drive some parts of the market to unravel.

At present, private companies are still disclosing relatively little data on ESG risks, and were described as “significantly trailing” public counterparts in terms of disclosing their climate-related impact, in a joint research by global management consulting firm Bain & Company and CDP.

This is changing as regulation on ESG disclosures increasingly applies equally to public and private firms. New UK rules introduced in April require publicly quoted companies, large private companies and limited liability partnerships (LLPs) to disclose in line with the recommendations off the Task Force on Climate-related Financial Disclosures.

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