How the EU's Green Deal and Sustainable Action Plan will affect private markets


The sustainability agenda is inevitably resulting in a wave of new regulation for alternative asset managers as well as the wider business community, a trend which looks set to continue in the coming years.

Despite the challenges of the COVID crisis, the climate emergency remains centre stage for policy makers in the UK and the EU, and the Biden administration has already brought the US back into the fold on climate action. As the UK hosts COP 26 this year, the UK Government is keen to demonstrate leadership on climate issues; the commitment from both the UK and EU to be carbon neutral by 2050 is already a catalyst for legislative action.

The EU's sustainable finance action plan, which is aimed at funding the EU's ambitions in the European Green Deal, will impose important new obligations on many asset managers and financial advisers from March this year. The EU's reforms are potentially game-changing – and not just for EU-regulated firms.  Any firm based in the UK or elsewhere wanting to access EU-based investors or invest in EU companies will be affected.

The UK meanwhile has already begun work on its post-Brexit ESG regime, announcing that it will be first jurisdiction in the world to make reporting under the Taskforce on Climate-related Financial Disclosures mandatory, affecting almost all UK-regulated asset managers (including alternative investment fund managers). We are also expecting the UK to implement its own, perhaps more principles-based, version of the EU's Sustainable Finance Disclosure Regulation, alongside a UK-specific version of the EU's taxonomy which will define the types of activity that are “environmentally sustainable” for the purposes of regulated investment activities claiming to focus on sustainability.

Our webinar series - Sustainability and alternative asset managers: the new normal

As part of our response to these developments, in January we launched a series of webinars on the theme of "Sustainability and alternative asset managers: the new normal".

We hosted our first webinar in the series, "How the EU's Green Deal and Sustainable Finance Action Plan will affect private markets", on 21 January 2021. The webinar featured a keynote speech from Nathan Fabian, Chief Responsible Investment Officer at the UN-backed Principles for Responsible Investment (PRI) and Chairperson of the European Platform on Sustainable Finance, followed by a lively panel discussion, chaired by our Senior Partner, Kathleen Russ.

Joining Nathan and Kathleen on the panel were Vanessa Maydon, Corporate Affairs Director at Cinven and board member of Invest Europe, Mark Fawcett, CIO at NEST, and Simon Witney, Senior Consultant at Travers Smith and BVCA Council member.

Our webinar focussed on the impact of the EU's highly ambitious regulatory agenda, principally on private markets, and the work of the PRI to support those policy objectives.  This is a note of the key points from the webinar, including the keynote presentation, the panel discussion and the Q&A which followed.

Keynote presentation: Setting the scene - the PRIs response to the EU reform agenda on climate change and other socio-economic risks

EU 2030 emissions target: The European Green Deal is at the core of the EU's strategy for achieving its 2030 Climate Target Plan, to reduce greenhouse gas emissions to at least 55% below 1990 levels by 2030, setting the EU on a path towards Net Zero by 2050.

Private finance opportunities: The transition to Net Zero by 2050 is estimated by the EU to require up to €350bn funding, providing extensive scope for private finance initiatives. The EU has established the Sustainable Finance Platform, an advisory group established by the EU under the EU Taxonomy Regulation, to mobilise the power of the financial markets to help achieve that transition and scale up sustainable finance to the levels needed to do so. Mr Fabian, who chairs the EU's Sustainable Finance Platform, told our audience that the EU's current reform agenda is relatively "market-friendly", but he warned that if the market does not play its part, the next version may not be.

The UK government has recently announced that it has joined the IPSF (International Platform on Sustainable Finance), alongside the EU, China, Japan, Singapore, India and others. The objective of the IPSF is similarly to scale up the mobilisation of private capital towards environmentally sustainable investments, but at a global level.

EU/China work towards a common taxonomy: The EU recently announced a collaboration between the IPSF and China on a common taxonomy. Such collaborative initiatives on financial regulation should be a feature of the new sustainable finance era.

Plans v actions: It is no longer enough for market participants to signal good intentions. Concrete action, i.e. a demonstrable positive contribution towards achieving the EU's 2030 emissions target, is now needed given the magnitude and urgency of the environmental challenges we face.

The importance of the Taxonomy: The EU's Taxonomy will set out clear criteria and performance benchmarks for sustainable investment (focusing, initially, on environmental objectives – including, but not limited to, climate change) to help investors and asset owners to make better allocation decisions and transition from a risk-based approach to sustainable investment, towards a performance-based approach.

Transition activities: In the early years, there is likely to be greater acceptance from investors and regulators of lower levels of alignment with climate goals and other environmental objectives across/within a portfolio (e.g. 5-15%) provided there is measurable progress against those goals, but as 2030 approaches, those levels must increase.

The data problem: Data must be provided to measure progress against defined goals, but the PRI recognises that obtaining consistent and accurate data is a challenge (see Q&A).

The PRI's response to regulatory change: On reporting frameworks and standards, regulators are now moving faster than the PRI.  The PRI for its part is reviewing its Reporting Framework in line with regulatory developments (e.g. the TCFD). The PRI also published a guide to TCFD last year and continues to maintain a range of other resources for investment firms, including guidance on directors' ESG duties under UK and Delaware law (the former authored by Simon Witney) and its Due Diligence Questionnaire for responsible investment, which has been adopted by ILPA (Institutional Limited Partners Association).

Human rights issues: The PRI is also elevating human rights considerations to the same level as climate issues, recognising that the S in ESG is a particular challenge for many investors, and anticipating the regulatory moves in this area. The European Commission recently announced that it was committed to introducing legislation in the first half of 2021 (the "EP Draft Directive") to make human rights due diligence mandatory for all EU companies, recognising that voluntary action has not brought about the necessary behavioural change at corporate level. The Directive would require EU companies to implement human rights due diligence processes akin to those recommended by the 2011 United Nations Guiding Principles on Business and Human Rights.  Under the EP Draft Directive, these processes should also extend to environmental and governance risks in addition to human rights. Correspondingly, it is anticipated that the EU Taxonomy Regulation will be extended in future to cover social issues.

Panel discussion

Q: What is the value of being a PRI signatory, for a firm and for its investors?

The PRI was established in 2006 and its activities are guided by the PRI’s Blueprint for Responsible Investment. There are over 3,000 investor signatories across the industry in emerging markets as well as major jurisdictions, with collective assets under management of US$103.4tn (March 2020), making it the world's largest voluntary investor sustainability initiative. The PRI's "big tent" approach gives it legitimacy and authority as the leading advocate for responsible investment, and as the voice of investors on these issues. During the past year, despite (or perhaps because of) the COVID crisis, investor engagement with the RI agenda, and take-up of sustainability strategies has increased significantly. Last year, 94% of PRI signatories investing in private markets incorporated ESG factors (PRI Annual Report 2020) in their investment appraisal and active ownership.

Meaningful data: Our panellists observed that PRI membership brings significant benefits for firms and investors and as such is more than a box-ticking exercise. The PRI is driving the collection and publication of meaningful data - needed to determine asset allocation, price assets, monitor progress against KPIs/targets and provide a framework for accountability and investor engagement. And the resources provided by the PRI, including its reporting framework, have been helpful in establishing consistent approaches across the asset management industry.

Performance index: In response to one panel member's observation that performance on sustainability issues is still mixed across both public and private markets, questioning whether the PRI's annual assessment of firms' performance is sufficiently rigorous, Nathan Fabian agreed that expectations have changed in the 15 years since the PRI Reporting Framework was first created. As noted above, the Framework has been reviewed and a new version, reflecting the tougher regulatory environment, was published recently.

Value creation: Investors are asking more searching questions about sustainability credentials during fundraising processes.  There is increasing acceptance among asset managers and investors in private funds that thoughtful integration of material ESG factors in decision-making creates value and mitigates risk, as well as being an ethical responsibility.  Being a PRI signatory clearly signals a commitment to consider and report on ESG issues – and that is helpful, even if it is only the beginning of the conversation for some investors.

Q: What is the likely impact of the EU Taxonomy and other emerging regulations on private markets?

Significant impact: Our panellists agreed that the sustainable finance reform agenda, including the Taxonomy, SFDR and other disclosure regulations, will have a significant impact on sustainable investing over the next decade. We are also tracking a number of other important emerging reforms, such as the EU's proposal on corporate governance, mandatory due diligence obligations and changes to the UK's Modern Slavery Act, to name a few.

Strategic implications: These instruments go to the heart of investment strategy, and sustainability regulation is clearly an issue that cuts across the whole business. Many believe that being a leader in this area – going beyond minimum compliance and pushing themselves to be super-compliant – could be a competitive advantage. Decisions taken now on the approach to adoption of these regulations therefore should include investor relations executives, general counsel and other members of senior management as they may have important implications for future fundraising, investment strategy and deal processes – as well as the potential for additional costs.

A plea for clear regulation: The panel also made a plea for regulations to be as clear as possible; a one-size-fits-all approach is unhelpful and convoluted compliance obligations can be a cost to business and may in fact divert investment professionals from the pursuit of real impact and delivering positive outcomes.

Q: What are firms doing already? Is PE lagging public markets or ahead of them?

Adoption of ESG metrics: Our panellists agreed that, on the whole, PE firms are doing more on ESG than they may be credited for. There is already widespread adoption of ESG metrics in investment appraisal and stewardship in private markets, and recognition that demand from investors for strong financial returns coupled with value-aligned investment strategy will only increase as demographics begin to favour the socially-responsible millennial investor. The trend is likely to be fuelled by macro-economic trends as growth in global demand for food, water and energy will drive the need for innovation to manage that demand. As well as greater transparency and accountability, investors are seeking a consistent framework for the measurement of impact against common indicators, and measures to address greenwashing or "impact washing", which is why the EU Taxonomy is such an important feature of the new regulatory landscape.

Reputational issues: PE firms are mindful of the need to use their governance and stewardship responsibilities to influence corporate behaviour in a positive way. There are reputational risks for firms if they get this wrong of which firms are only too aware, and investors will ask difficult questions if a portfolio company is seen to be falling short.

Impact investing: Private markets are also arguably responding more quickly to the trend for impact investing – an investment strategy which focusses on investments which demonstrate a positive impact (for example, achievement of Sustainable Development Goals) rather than just the management of ESG risks or the absence of a negative impact. There is also an expectation that the private equity ownership model better enables asset managers to use their governance and stewardship arrangements to follow ESG principles throughout the life of the investment in order to effect measurable change.

Strategy first: As noted above, the importance of an embedding sustainability into strategic planning was a key theme. Our panel agreed that, despite the weight of regulation in this area, the priority should be the development and implementation of a credible ESG strategy and only then checking that the strategy is aligned with regulatory requirements.


What are good practices/pragmatic examples that PRI has seen pension funds doing across equities (and other asset classes) in line with sustainability goals?

A: (Nathan Fabian) - A number of pension and insurance asset owners within the PRI have publicly committed to a Net Zero portfolio by 2050 and have recently released 2025 targets of a 20% reduction in emissions. They plan to achieve this in part through altering their strategic asset allocation to favour sustainable businesses, and in part through working with existing investee companies to achieve reductions.

Is there a marked difference in the US, UK and EU approaches to ESG?

A: (Simon Witney) - The US approach, which has recently been not to require or even to permit most ESG issues to be taken into account in investment decisions, is likely to change under Biden (he has already re-signed the Paris Agreement). We recognise that the EU has a particular challenge in harmonising rules across all 27 territories so has a strong rules-based approach but should be applauded for demonstrating strong leadership on ESG/sustainable finance issues. The US/UK post-Brexit approach is likely to be more principles/outcomes-based. The position is complicated by the equivalence debate, which has a long way to go, but on sustainability, the UK is expected to follow the EU's lead in some respects (and has said will adopt UK versions of the EU SFDR and Taxonomy), but the UK will also want to diverge in some areas, not least to demonstrate the "value of Brexit".

How to overcome concerns over the obtaining and sharing of data?

A: (Simon Witney) - Data is a particular problem in private markets, and it can be difficult to obtain reliable data from some investments, particularly in, for example, emerging markets. The reporting requirements favour firms investing in larger businesses with resources and structures in place to obtain/report reliable data but acknowledges that the PE ownership structure facilitates better/closer governance and can therefore be used to the advantage of the asset owner in obtaining data.

(Vanessa Maydon) - Advised that firms should establish a clear reporting methodology from the outset of an investment, using KPIs and defined core/standard metrics, supplemented with metrics on matters which are material to the business in question.

Closing reflections from the panel

Simon Witney: As articulated by the Director General of the BVCA in recent months, it is clear that delivering strong returns is no longer enough for the private equity industry.  Private equity needs to demonstrate its positive impact and social value to society alongside outstanding financial value for investors.

Mark Fawcett: Encouraged by the messages from the webinar. Believes sustainable capitalism is essential.

Vanessa Maydon: Don't start with regulation, start with strategy and then align with regulation. The PE community is doing a lot of work on sustainability and it is a real differentiator.

Nathan Fabian: This is the last chance for capital markets to respond to the climate challenge. Policy makers are trying to show the way by providing a market-friendly regulatory framework: it is now time for the private markets to respond.

Future webinars

Our next webinar in this series will look more closely at stakeholder capitalism and the role of corporate governance in private markets.  Simon Witney will speak about his new book – "Corporate Governance and Responsible Investment in Private Equity" – and we will assemble a panel to debate how company law can contribute to the creation of long-term sustainable value in large companies – whether public or private.  

If you would like to take part in this and future sessions, please register your interest here.

Our response to the sustainability question

We are committed to supporting our clients in their transition to a more sustainable future and in meeting the challenges presented by a commitment to Net-Zero targets. On our Sustainable Business Hub, we present a range of resources, including news, views and guidance, designed to help our clients to anticipate regulatory change, proactively manage risk, and achieve sustainable business objectives. Right across our practice, we are making sure that sustainability expertise is integrated into all of the advice that we provide – recognising that responsible business is the "new normal" for our clients.   

Our Sustainability Initiative is led by Senior Partner, Kathleen Russ, Environment and Operational Risk Partner Doug Bryden, Corporate Partner George Weavil and Senior Consultant, Simon Witney. Please do get in touch with any of them, or your usual contact at the firm, if you would like to discuss any Sustainable Business issues. 


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