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Increased scrutiny of ESG disclosures puts a spotlight on private investments
by Stella Clarke
The theme of Environmental, Social and Governance (ESG) has developed into an increasingly important and popular topic across a range of sectors over the last decade. In particular, ESG funds have become an extremely attractive option for investors who want their money to have a positive impact on society. In fact, PWC estimates that ESG funds will outnumber conventional funds by 2025. Yet, as is often the case in the financial services sector, this rapid growth is being closely followed by an increase in regulation and scrutiny by both stakeholders and regulators alike. These regulations open both public and private capital firms, including; venture capital, real estate, private debt and private equity, to a litany of potential risks due to increased disclosures regarding their ESG investments and operations.
Over recent years, public markets have faced a catalogue of greenwashing allegations. The term “greenwashing” in this context refers to allegations of exaggeration or misrepresentation of the ESG credentials of a financial product. Recent examples of public scrutiny include the raid of Deutsche Bank and DWS by German federal police at the end of May and Mellon’s fund management group settlement of $1.5 million dollars with the US Securities and Exchange Commission (SEC) over ESG information on its fund’s investments.
However, ESG data and disclosure in private markets has been traditionally less transparent and standardised. Yet, new EU regulations require more detailed public disclosures about the ways in which asset managers implement sustainability policies in businesses they invest in. The EU’s Sustainable Finance Disclosure Regulation requires bodies that operate or raise capital in Europe to make ESG disclosures to clients or investors and publicly on their websites. What’s more, both the UK and the US appear to following suit. In the UK, the Financial Conduct Authority has begun consultations on new regulations for information provided for ESG funds. Across the Atlantic, the US Securities and Exchange Commission (SEC) has announced it is considering rules for private capital funds regarding ESG claims and disclosures. Moreover, the SEC has established a Climate and ESG Task Force specifically to identify and investigate ESG related disclosures and compliance.
These regulations indicate a new era of public scrutiny for private capital firms, which in turn raise potentially novel risks for private fund managers. If allegations of “greenwashing” are proven, it may give rise to claims by investors who has suffered losses as a result of untrue or misleading statements or omissions made by private investment firms. Aside from litigation, firms may also encounter unfavourable PR which could in turn negatively impact their ability to fundraise from investors. As a result, companies in the private capital industry need to think proactively and pre-emptively about the risks involved when choosing to market a product as sustainable. Lawyers will play a pivotal role in providing advice to this process by, for example, ensuring the maintenance of written records in relation ESG decisions and why they comply with the firms ESG policies.
Overall, both lawyers and their private capital funds clients should prepare for the new challenges that await as scrutiny heightens even further.