European Funds Comment: Sovereign Wealth Funds Respond to Climate Change Risks and Opportunities

19 October 2018
Issue 53

Many of private equity and venture capital’s institutional LPs are already focused on ESG (environmental, social and governance) issues. They frequently negotiate side letters – or even provisions in the Limited Partnership Agreement itself – that impose ongoing obligations on the fund manager to maintain responsible investment practices, and to report regularly to LPs. For their part, fund managers have generally recognised that these practices will reduce risk and enhance returns (especially the value that can be achieved on exit), and that adopting intelligent and proportionate approaches to environmental and social risks and opportunities is therefore in their enlightened self-interest.

But few firms think they have reached the end of the road in their approach to ESG. In particular, the somewhat alarming findings of the Intergovernmental Panel on Climate Change (IPCC), delivered last week, will no doubt spur more investors – and regulators – into action. It is clear that responding to climate change is a global imperative, and many perennial investors into the asset class will deploy their resources to help find solutions and mitigate the considerable risks. That is not just the right thing to do, but is also likely to be a smart long term investment strategy.

Even before last week’s IPCC report, a coalition of important Sovereign Wealth Funds (SWFs) was busy working on its response to the challenges posed by climate change and, in July, French President Emmanuel Macron launched the “One Planet Framework”, which lays out three core principles to respond to the increasing risks and commensurate opportunities of climate change. Since a number of these SWFs – including the Qatar Investment Authority, the Kuwait Investment Authority and the Abu Dhabi Investment Authority – frequently invest in private equity, their requests to GPs in this area may be expected to increase.

The principles – alignment, ownership and integration – are rather broad, and will no doubt be implemented in different ways by the six founding SWFs that have adopted them. But, overall, they demonstrate a shared understanding that climate change will inevitably have an impact on financial markets and will affect SWFs, given their long term investment horizons. As the document says, risks to underlying investees include physical and regulatory risks, whilst opportunities in green technology offer attractive ways to enhance risk-adjusted returns.

This evolution of attitudes among SWFs may deliver collateral advantages for the industry. Private equity fund managers are, of course, all about active ownership. They have the wherewithal and the incentives to seek out attractive green investment opportunities and to steer portfolio companies towards strategies that are entirely consistent with the One Planet Framework’s objectives. GPs now often have in-house experts in environmental matters, and engage external consultants to plug any expertise gaps.

Many SWFs are already active investors in the asset class, but – if the industry can continue to burnish its green credentials – it will provide another good reason for allocations to increase.