Increasing regulatory scrutiny has made it more challenging for private market managers to classify funds with environmental, social, and governance strategies.
“A number of funds are actually declassifying themselves from being impact funds, because of the significant workload and reporting hurdles to really prove it now,” said Andy Pitts-Tucker, managing director of ESG at the Apex Group, a financial services firm.
Part of the issue is the varying definitions of terms such as ESG, impact, and sustainable investing, which still serve as catch-all phrases for many investors. For instance, managers who are excelling in the environmental aspect but not in the social area may be apprehensive about promoting their strategies as ESG, due to the scrutiny that could invite.
Speaking to Institutional Investor, Pitts-Tucker discussed the green-hushing phenomenon that has recently started to take hold in the asset management industry, with managers preferring to stay under the radar and “down-play” their strategies rather than to expose themselves in areas where they aren’t necessarily hitting global standards.
The Sustainable Finance Disclosure Regulation set forth by European regulators has provided a better understanding of disclosure requirements, setting a precedent for global standards, according to Pitts-Tucker.
“We are seeing disclosure requirements spread more broadly around the globe,” said Pitts-Tucker. “We are seeing the actual requirements become more rigorous and deeper. As of 2023, a sustainable finance disclosure regulation is entering level two reporting… you have to prove with supportive data points that you are doing what you are saying you are doing.”
The SFDR, which go into full effect in January, requires managers operating in Europe to classify their strategies, with categories such as an impact fund — the highest group — or a fund that incorporates ESG.
The Article 8 classification, for instance, covers any fund “which promotes, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices.”
The regulation is intended to make it harder for firms to “green-wash” their products — a phenomenon which has tainted ESG strategies. With “green-hushing,” however, investors may now face the opposite problem, with private markets executives fearful of being accused of exaggerating their products.
“Companies often undersell themselves when it comes to the issue,” said Pitts-Tucker. “There are two reasons why. They don’t want to over promote themselves and get hit with the negative PR implications. But they’re not actually educated yet on how to respond to a lot of these ESG assessments.”
Part of the solution, according to Pitts-Tucker, is for private fund managers to actively engage with portfolio companies, helping them reach ESG targets and investing in the education to support those efforts.
“Private market [managers] have one of the most awesome roles to play. The relationship that both private equity and private debt firms have with their underlying companies is much deeper relationship than [public] equities,” said Pitts-Tucker. “As a result of that, they have much more power to work with those companies to drive change.”
