Predictions for ESG and investment manager due diligence

By Andrew Borowiec | January 12, 2021

ESG (Environmental, Sustainability, and Governance) is one of the fastest growing asset classes and as such, more focus is being placed on its inclusion in the investment manager due diligence process. Triggered by the SEC Concept Release in 2016 that contained a section on ESG measurement and reporting, we have seen several shifts in the way firms are looking at ESG focused investments.

Our panel of experts, comprising senior lawyers from the US and UK and a senior accounting firm specialist in the area discuss this in our IMDDA on-line workshop “Due Diligence on ESG”. Here are the top trends and what they mean for your ESG portfolio:

1. More detailed investment manager due diligence

Inclusion of ESG specific questions on the due diligence questionnaire

Request for detail and documentation beyond an ESG policy

Inclusion of ESG specific metrics and commitments to ESG frameworks and standards included in PPM, side letters and/or LP agreement

Ongoing investment manager due diligence on ESG

Redress sought in case of non-compliance with ESG objectives

Action: Ensure you have ESG specific elements embedded throughout your investment manager due diligence process.

2. Developments in measurements and standards

SEC moving towards developing a flexible framework for ESG measurement and disclosure

Multi-tier ESG influencers add pressure to movement towards standards development

Private business acting as one of the main drivers towards industry standardization

Action: Get ahead of the curve and start using one of the voluntary frameworks or your own custom system of measurement to evaluate your ESG investments.

3. Move from ESG aspirations to obligations

Policies are shifting from aspirational philosophy to actionable obligations

Policies are being backed up by procedures, measurement and required disclosures

Obligations are making their way into the legal language of the agreements between investors and investment managers

Action: Schedule a review of all existing investments and their investment managers’ ESG policies, risk rate them based on where they fall on the aspiration to obligation scale and work with the manager to implement supplementary ESG measurement and disclosure on highest risk investments (i.e. those with the least tangible ESG policies).

4. Evolving landscape of disputes and damages

Increased number of disputes arising from non-compliance with an investment’s stated ESG objectives

New approach required to redress and damages due to the alternative nature of an ESG failing

Reputational damage rather than financial is the issue

Action: Ensure that all of your agreements state in detail what is to happen in case of an investment manager not being aligned with your organization’s stated ESG objectives. This includes agreement and detailed laying out of: