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Private Markets Investing Through an ESG Lens

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Stockholm (HedgeNordic) – In recent years, environmental, social and governance (ESG) issues have moved from somewhere near the bottom of many investors’ priority list up to the top. Olivia Muir, Head of ESG for Real Estate & Private Markets (REPM) at UBS Asset Management (UBS-AM), explains how this complex landscape has evolved, and discusses the benefits and challenges of investing through an ESG lens in private markets.

“We have witnessed the evolution and growth of ESG over recent years, and for many investors, it is now front and center on their agendas and a growing part of the overall picture,” observes Muir. She points out science’s urgency of considering environmental issues. “We must act fast to combat the most devastating effects of climate change,” she insists. The COVID-19 crisis has also emphasized the importance of factoring in ESG issues. “Stakeholders observed first-hand the effects of fragile supply chains, poorly-managed health and safety risks and labor welfare issues, to name just a few other social and governance topics,” says Muir.

“We have witnessed the evolution and growth of ESG over recent years, and for many investors, it is now front and center on their agendas…”

ESG has evolved from a fuzzy concept to a business, investing, and political priority. The most significant shift, however, occurred when ESG started moving money by shifting capital allocation priorities. “ESG is now at the top of many investors’ priority lists for the risks and opportunities that it brings which influence how we manage capital,” concurs Muir. “It affects everything the investment management industry is doing and is only going to grow in breadth, depth and importance in the next few years.”

ESG Challenges in Private Markets

As with the wider asset management industry, private markets have also been experiencing a growing focus on ESG issues in recent years. Although ESG goals are quickly becoming mainstream across the sector, they come with challenges. “The ESG landscape is a complex and fast-evolving field. This is largely due to growing regulation around the world, increasing scrutiny and expectation of transparency of ESG by stakeholders, and a lack of standardization in ESG reporting and scoring, which is especially true in private markets,” claims Olivia Muir, ESG Head of Real Estate & Private Markets at UBS-AM.

For the REPM team, the challenges in implementing ESG practices revolve around three key areas: diversity and scale of activities; rapidly evolving regulatory landscape; and a growing set of ESG frameworks, terms and tools. “Our global business includes real estate, food and agriculture, infrastructure, private equity, and private credit investments, plus evolving sectors such as cold storage, energy storage, global living, life sciences,” starts Muir. “Each a distinct asset class with a unique set of ESG priorities, challenges, targets, and initiatives in terms of cost, resources, etc.,” she elaborates. “Thus, the material ESG topics and challenges facing different areas of our private markets business vary significantly. Each area requires a tailored approach to ESG.”

“The material ESG topics and challenges facing different areas of our private markets business vary significantly. Each area requires a tailored approach to ESG.”

The legal and regulatory landscape governing ESG investments has been driven by global and major regulatory bodies and standard setters, but also by policy responses from individual governments. Therefore, the regulatory landscape is at risk of becoming increasingly fragmented across jurisdictions. This fragmentation adds to the existing challenges associated with the complexity of running global businesses, as well as the rapid pace of change in the ESG universe. “As our business operates globally, we comply with all applicable ESG regulatory requirements which vary in scale and complexity,” confirms Muir. “A constantly expanding set of rules, taxonomies, and standards (which are rarely perfectly aligned) renders meeting these requirements a significant challenge, especially as the regulations have historically catered to ESG in the traditional space such as equities and fixed income, rather than private market assets.”

The associated explosion of ESG frameworks, terms and tools represents another significant challenge in implementing ESG practices in the private markets space. “Most private market stakeholders will be familiar with the ‘alphabet soup’ of ESG terms discussed and reported on by investment professionals,” states Muir. GRESB, GRI, SASB, TCFD, UNPRI, among others, are just some of the ESG tools and frameworks often used to report and assess ESG performance in private markets. “A lack of consistent standards often gives rise to very different snapshots of ESG performance – a portfolio or asset scoring highly in one framework might score only moderately using another framework,” she emphasizes.

“At REPM, the challenge is two-fold as many of our private markets strategies (e.g. our indirect private equity) can’t be assessed using these conventional frameworks,” continues Muir. “While we see a number of tools and standards establish themselves as ‘leaders’ in their respective offerings, the future looks likely to remain fragmented from a regulatory perspective. This may hinder the further standardization of reporting/assessment frameworks.”

Evolution of ESG Emerging Trends

As ESG continues to grow in importance and become critical in the near future, so do a range of topics and issues within the global ESG agenda. The growth of regulation and disclosure frameworks is one of them. “Over the next few years there is going to be a barrage of (even more) regulation coming to the industry globally and this is today, and will continue to be, a top priority for all of us in the investment industry, requiring significant time and resource,” argues Muir. “The industry certainly hopes that the future will bring some alignment of these many regulations and standards,” she continues. “The complex web we find ourselves in today makes disclosure and regulatory compliance an enormous challenge and potential distraction from the hands-on work needed to save the world.”

At the same time, data will remain the greatest challenge in the ESG transformation journey. “Data is already critical and will only become more important really in every aspect of ESG. Regulation will require even more data disclosure and evidence,” explains Muir. “Investors need more data for their own decision processes, regulatory compliance and reporting. Setting targets and assessing progress requires data too, especially transition-relevant data and metrics,” she elaborates. The questions of how to effectively collect, handle, manage and monitor that data and how to get the most value out of it are top-of-mind for many real asset and private market players, according to Muir. “On the whole, it remains a relatively manual process, but huge efforts are underway to automate and modernize many of the systems and processes that are widely used in our industry today.”

“Data is already critical and will only become more important really in every aspect of ESG.”

However, innovation stemming from advanced technologies such as machine learning and blockchain capabilities will be repurposed and tailored to solving critical sustainability challenges in the financial sector, including in private markets, considers Muir. “Verification of GHG emissions, ability to detect climate risks, construction of customized ESG-integrated portfolios are just some of the potential use cases of these technologies.”

Another interesting trend within the ESG universe is the rise of social themes and issues, according to Muir. “Historically deprioritized behind environmental topics, the S component of ESG is rising up ESG agendas,” she emphasizes. “We expect this to continue and to see significant improvement in quantitative and qualitative measurement in this space.”

 

This article features in HedgeNordic’s “ESG & Alternative Investments” publication.

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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