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Pulling back the curtain on private equity’s ESG impact

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Hello from London, where Russia’s invasion of Ukraine has put HSBC in an increasingly uncomfortable position.

As my colleague Stephen Morris and I reported this week, the UK-headquartered bank has repeatedly edited analysts’ reports to soften the language used to describe the war — notably, removing the word “war”.

It’s not clear why this has been happening. A sympathetic reading might infer a desire to protect HSBC’s 200-odd employees in Russia, where the government has criminalised what it calls false information around its so-called “special military operation”. (Unlike some peers and despite pressure from UK lawmakers, HSBC plans to keep operating in Russia).

Others might infer a desire to protect future business with Russian entities — or to align with authorities in China, who have refused to condemn Russia’s attack on Ukraine. Hong Kong and mainland China accounted for nearly half HSBC’s global profit in its last financial year. HSBC declined to comment, pointing instead to an earlier statement that said its thoughts were with “all those impacted by the continuing conflict”.

Whatever the motivation, the edits to the reports triggered serious internal debate and complaints from HSBC employees. They shocked customers too, judging by tweets and article comments from individuals pledging to close their HSBC accounts after reading our story. This included member of parliament Kevin Hollinrake, who urged the public to follow his lead. The episode is a sobering reminder that language matters in all forms of corporate messaging — especially around issues as serious as war.

When it comes to public scrutiny, the private equity industry has often kept a low profile — not least where climate risks are concerned, with disclosures lagging far behind publicly listed companies. But as Patrick highlights below, change may be coming on that front. Also today, we look at the rise of sustainable products in the Islamic finance space, and an intriguing move into the impact investing sector for McKinsey’s former global head. See you on Friday. (Simon Mundy)

ESG standards come to private equity

Private markets, where companies can get away with minimal disclosure about their business, have been criticised as the underworld where polluting assets can go to hide. “It moves from publicly disclosed companies to opaque private enterprises,” Larry Fink said at COP26. “It’s going to create the biggest capital market arbitrage,” he said.

But the shadows are receding. The world’s largest private equity firms and giant pension funds have partnered to establish disclosure standards for environmental and social issues. The number of participants — both PE firms and pensions — has jumped to 140 from just 16 six months ago, said Carlyle, which helped lead the collaboration.

These reporting guides will cover six areas: greenhouse gas emissions, renewable energy, board diversity, work-related injuries, net new hires and employee engagement. Data collection will start on April 30 (emissions reporting will start later in the summer).

The information will be anonymised and aggregated into a benchmark for all participating investors, who will be able to see for the first time the six data categories broken down by business categories, geographies and other elements, said Meg Starr, Carlyle’s global head of impact.

The pension funds involved include the Dutch pension provider PGGM, Canada’s CPP Investments and Calpers — three big entities which are able to exert serious pressure on the private equity firms vying for their money.

“The primary ESG disclosure that we receive today are PDF reports where everyone looks happy,” said Julia Jaskolska at Calpers. The new reporting guides are “a material improvement in rigour over the status quo”, she said.

As the PE firms start to raise their disclosure standards, a new crop of businesses is looking to take advantage. Days before Fink made his pronouncement about private capital, the Ford Foundation and others launched Novata, a business that will help PE firms manage their ESG data.

The Ford Foundation has previously tried to support the drive for sustainability disclosure through grants to the Sustainability Accounting Standards Board, said Margot Brandenburg, senior programme officer for mission investments at the charity, which had assets of nearly $18bn at the end of 2020. But, having seen how hard it has proved to get standardised ESG metrics for public markets, it wants to draw attention to the need for a serious push on transparency in the private realm.

“Private companies are a majority of the economy and can’t continue to be a vacuum,” Brandenburg said. “We need comparable infrastructure.” (Patrick Temple-West)

Islamic bond issuers show growing interest in ESG principles

ESG-linked sukuk — a kind of Islamic bond, compliant with the religion’s prohibition on profits from interest — remains a niche product even as ESG investing and sukuk individually boomed last year. But as the Gulf Cooperation Council shows significant appetite to enter the market, sharia-compliant ESG-linked bonds are set to grow in 2022.

In the first two months of the year, Saudi Arabia issued ESG sukuk totalling $1.5bn. More entities from the kingdom, such as its sovereign wealth fund, are expected to follow, said Adnan Halawi, senior proposition manager for Islamic finance at the London Stock Exchange Group.

“Not only traditional issuers such as Saudi Arabia, Indonesia and Malaysia will continue to issue this kind of sukuk, but more countries will join the club,” Halawi added. Earlier this week, Infracorp, an infrastructure fund, announced the issuance of a $900mn sukuk — the first green sukuk issued by a Bahraini entity.

Overall, global sukuk issuance surged to a record $250bn in 2021 — up from $180bn a year ago, according to the Institute of International Finance (IIF). But only $5bn, 2 per cent of the total, was linked to ESG factors. “There is more room to grow,” said Emre Tiftik, head of sustainability research at the IIF.

“Investors who may never have heard of sukuk are now being drawn into this discussion,” said Scott Levy, founder of the UK-based Bedford Row Capital and adviser to sukuk-specialist Al Waseelah. Levy said he believed there were synergies between ESG investing values, and those promoted by Islamic finance — which embraces responsible consumption and production.

Some ESG investors might be sceptical about investing in economies where oil is a major income source. However, Levy argued that it was important for global capital to help the energy transition of oil-dependent countries — along with strong independent assessment and due diligence. (Tamami Shimizuishi, Nikkei)

LeapFrog Investments gets a big name to supercharge growth

Dominic Barton
Leapfrog’s new chair: former McKinsey head Dominic Barton © Bloomberg

When LeapFrog Investments launched in a small New York office provided for free by the consulting giant McKinsey, its field of impact investment — focusing on positive social and environmental effects rather than just financial returns — looked to many like a marginal curiosity. Fifteen years on, things have developed, as reflected by LeapFrog’s announcement today of its new chair: McKinsey’s former global head Dominic Barton.

Since 2007, LeapFrog has raised $2bn to invest in “purpose-driven” private companies which have 272mn customers spread across 35 countries, and employ more than 140,000 people. Assets in the impact investment sector as a whole reached about $715bn at the end of 2019, according to the latest data available from the Global Impact Investing Network, an industry body.

Barton, who was born in Uganda and finished a stint as Canada’s ambassador to China in December, will work alongside chief executive Andy Kuper to attract a wider range of institutional investors and accelerate fundraising for LeapFrog.

He has been involved in the development of responsible investment strategies as a former chair of the International Integrated Reporting Council (IIRC) and a co-founder of Focusing Capital on the Long Term, a New York-based not for profit think-tank.

But Barton’s tenure as McKinsey’s boss between 2009 and 2018 was marked by a number of damaging scandals. The consultancy last year agreed to pay almost $574mn to settle claims brought by US states alleging that McKinsey’s advice to pharmaceutical companies, including Purdue Pharma, contributed to America’s deadly opioid crisis.

McKinsey did not admit wrongdoing or liability as part of the settlement and Barton has said that he had “simply no knowledge of the work undertaken for Purdue by my former colleagues”.

Meanwhile, Kuper said impact investment assets were now approaching $1tn. Increasing allocations by long-term investors such as insurance companies, sovereign wealth funds and development finance institutions would fuel future growth.

Temasek, the Singapore state-backed investment company, agreed last year to make a $500mn allocation which will be used as cornerstone investments to establish new LeapFrog funds. Temasek has also acquired a minority equity stake in LeapFrog, which has just completed the deployment of its third fund.

The International Finance Corporation, a sister organisation of the World Bank, has said that impact investment assets could eventually reach $26tn.

Even that could be an underestimate of the potential growth, according to Kuper, who said that the coronavirus pandemic had shown that there were large numbers of small but highly dynamic companies in Africa and emerging Asia that could transform the quality of life for low-income people if they had the right investment partners.

“Impact investing is still a developing market and there is a very long way to run before it reaches maturity. It will lead to the development of tens of thousands of growth companies that investors will not be able to find in high-income economies,” he said. (Chris Flood)

Chart of the day

Bar chart of 'Why did your fund create an ESG strategy?' (responses in %) showing Funds say attracting capital is the top motivation for creating ESG strategies

Why do fund managers bother drawing up an ESG strategy? Sector professionals canvassed by HSBC gave an interesting set of responses. Attracting capital and requests for proposals (in which funds pitch for business) was by far the biggest motivation, with peer pressure also playing a major role. Concerns about risk mitigation featured less prominently, and only 8 per cent of respondents focused on the potential for the approach to drive higher returns.

Moral Money Forum: Does divestment work?

As pressure to combat climate change mounts, investors are under pressure to divest from dirty fossil fuel assets. But does divestment work or is engagement the better strategy? From guns to tobacco, investors, campaigners and academics have long been divided on whether investors can exert more leverage by dumping a company’s stock or by holding on and pushing its board and management to clean up their act. Our next Moral Money Forum report will take a deep dive into this debate, and we’d love to hear your thoughts as we begin our reporting. Please let us know where you stand, and why, via this survey.

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