As ESG issues rise up managers' agendas, fund administrators are seizing the opportunity to deliver products and services that meet their needs. This article was first published in Private Equity International.
Written by Claire Coe Smith
When Sanne appointed Karlien de Bruin as the firm’s first global head of ESG in 2020, the intention was that she would focus on helping the business reduce its impact on the environment and better report to its clients on what it was doing. What quickly became apparent, as the combination of a pandemic and a sharpened regulatory focus moved ESG up the agenda of the private equity industry, was that her services were going to be needed to help clients tackle their ESG reporting.
“The SFDR regulations coming out of the EU really sped that process up very quickly, with everyone talking about reporting and looking at data,” says de Bruin. “The regulations have really pushed administrators into having to look at this – we can play a really good role in helping GPs to get the data and improve what they are doing. A lot of fund administrators have seized on this as an opportunity.”
SFDR, the EU’s Sustainable Finance Disclosure Regulation, came into force on 10 March with the goal of making the sustainability profile of funds more comparable and easier to understand for investors. PE funds now need to make additional disclosures on their websites, in fundraising documents and in their periodic reports about their ESG policies and adverse sustainability impacts, with much more extensive disclosures around ESG focused products required from the start of 2022.
At the moment, the focus is really around qualitative disclosure but those impacted will soon have to report certain metrics, so there is a real need to address the gaps in data. A lot of the metrics prescribed through the regulation are non-financial and that data is not currently on databases. That needs to be generated, so that’s really where the private equity world is now. GPs are saying we don’t have the data, we need to get it and we need to figure it out”
Because fund administrators already play a key role in reporting to investors and complying with regulation, there has been a clear opening for them to assist clients with ESG at a time when other service providers – including accountants and sustainability consultants – are vying for the same work.
Sitara Fernando, an associate director with Vistra in Singapore, says: “Fund administrators have been developing ESG products and services, with investment focused on partnering with consulting practices and specialists in the sustainability space and product development, including the development of systems for collecting, analysing and reporting on ESG data.
“As a fund administrator, our role is in supporting the GP to align regulatory requirements and LP demands with their strategy, ensuring systems, processes and reporting are in place to meet these emerging requirements and demands. Essentially, regulations are not about the investors, but rather about giving the investors a consistent, regulated way to evaluate investments from a sustainability viewpoint.”
Many believe the long-term goal of ESG reporting will see investors making decisions based as much on financial performance as on environmental and social impact, assessing financial metrics alongside ESG metrics when deploying capital. There is also emerging evidence that the financial performance of private equity funds and integration of ESG considerations are correlated. Such themes support a case for fund administrators – already the guardians of so much financial data for their clients – to take on the collection, analysis and reporting of this new wave of statistics.
Siddharth Swarup, associate director of fund services with Vistra in Singapore, says: “Whether already in play, or still emerging, regulatory requirements are – and will be – fundamentally aimed at GPs integrating ESG and sustainability considerations into their investment decision making process, including measurement against targets and producing reporting to enable investors to evaluate achievement of said targets; this is what GPs are primarily looking for.
“There has been a movement towards greater responsibility, transparency and accountability in investing for a number of years now, and the regulators are putting in place requirements to support this."
On 10 March, the EU’s Sustainable Finance Disclosure Regulation legislation came into effect, introducing high-level disclosure requirements ahead of much more detailed reporting rules that will take effect on 1 January next year.
The EU Taxonomy, which seeks to establish a classification tool that will define the environmental performance of economic activities across industries, also comes online on 1 January 2022, bringing in a further swathe of reporting obligations for some asset managers.
“Taking the two together, those fund managers that market products with environmental or social characteristics or with a sustainable objective will be impacted significantly,” says Simon Witney, a senior consultant at Travers Smith. While the SFDR has already introduced reporting requirements, the focus for many funds is now on data collection ahead of tougher requirements next year.
"For most private equity firms it has not been a big issue so far, because they deal with sustainability risks already, they have had some level of ESG due diligence in place for a while, and they are not new to this,” says Witney. “But if you’re managing a fund that has the higher level of disclosure requirements going forward, or you decide to report a product’s adverse impacts, the work you need to do to comply on an ongoing basis will be significant and will require investment."
What is not yet clear is how the EU will define those funds that require a higher level of disclosure, the so-called Article 8 funds that promote environmental or social characteristics, where the European Commission is yet to publish guidance. “For those firms that are going to be caught by the higher level of reporting, this year is going to see a really big focus on data,” says Witney.
At fund services business Apex, the decision was taken to establish Apex ESG Ratings & Advisory at the end of 2019 with a specific focus on helping private equity funds develop and deploy intelligent ESG data. The business is led by managing director Andy Pitts-Tucker, a former head of marketing and distribution for sustainable investments at Deutsche Asset Management.
"Investment managers need to know the facts; they are data people,” he says. “We decided to create a product that would help investment managers collect data on their underlying investments easily, to then work with them to generate reports and outputs. That is not just about keeping LPs happy with reporting, but also conducting gap analysis and helping companies improve.
"A lot of portfolio companies would have no idea how to improve their sustainability, so we need to ask them the right questions, compile the data and then have those discussions with them in order to drive positive change. We advise on what reports should look like and what policies should look like, but most importantly we make recommendations on how businesses can improve their sustainability and their ESG metrics."
At Sanne, de Bruin is also going beyond just helping funds with identifying metrics, collecting data and supporting disclosure and compliance. “We have decided to go the route of not just the regulatory piece, but if you’re putting in the effort to get all the data, then we can help you use it to manage your portfolio and improve things,” she says. “A real estate fund can look at different properties in the portfolio, delve into their carbon footprints, identify issues and make changes. It might be that one property leaves the lights on, so you can address that and make cost savings as well as improving the ESG performance of the portfolio.
"We are starting to talk to more GPs about that and that’s really where fund administrators can play a key role in assisting them."
While there are many other service providers keen to step up and support private markets with the ESG challenge, fund administrators are now carving out a sizeable piece of the market.
"I have no doubt that ESG data will ultimately be audited to the same extent as financial data,” Pitts-Tucker says. “If your fund administrator can be the single source of data collection and report generation, that takes a headache away. Also, having this wealth of information alongside the financial information, and being integrated into decision-making, will put managers in a great position in a few years’ time to produce some really interesting analysis about financial success and ESG integration. They are going to sit closely together more and more.”
With ESG moving up the agenda for all fund managers, and further regulatory requirements on the horizon, the rush to gather meaningful data and act on its insights is heating up.
Having left the EU on 1 January this year, the UK government opted not to implement the SFDR into UK domestic law, even though the rules will still apply to UK-based funds that market into the EU. Instead, the UK has committed to an outcomes-based equivalent.
Travers Smith’s Simon Witney says: “The UK approach to regulation is instinctively very different to the EU’s, with the government preferring to focus on achieving pre-determined outcomes rather than drafting detailed rules. Specifically, they have said there will be a UK version of the taxonomy, but we don’t know how much it will deviate from the EU version."
There has been no indication on the timing of what has been dubbed ‘UK SFDR’. “I hope the UK will adopt an approach that means that, by complying with the EU SFDR, a fund will be in compliance with the UK rules as well. What we don’t want is two sets of rules with two sets of different requirements,” says Witney.
The UK has, however, already made a clear commitment to TCFD, which introduces more climate-related disclosures for asset managers, where compliance will be required for most by 2023. “The UK has really focused on climate change as its priority and they really want to be ahead of the game there as the first country in the world that will mandate TCFD disclosures across the economy,” Witney says.