Against the background of the experience of implementing the SFDR last year, mostly only in relation to existing funds or during an already ongoing fundraising, fund managers are well advised for future fundraisings to already take the topic into account when determining the strategy of new funds. Otherwise, difficult balancing acts can occur both in terms of the scope of disclosure requirements and in terms of investor requirements (which could then in turn affect disclosure requirements).
Consider ESG issues already when determining the fund strategy
When deciding on a strategy, therefore, the fund management’s own interests and objectives are important, as are the wishes and requirements of investors in interplay with the associated transparency requirements. An entry point for private equity and venture capital funds could be the decision whether – and if so, to what extent — “promotion” of environmental and social characteristics should take place. What is important about this question is that since an interpretative letter from the EU Commission last summer, it is probably clear that the Commission wants the broadest possible scope of application of the extensive reporting obligations under Art. 8 SFDR (“light green” funds).
Fund managers should therefore assume, to be on the safe side, that virtually any announcement (beyond the information on sustainability risk management) on how to deal with ESG issues should lead to the applicability of the Art. 8 SFDR disclosure requirements. However, in the case of the regularly used exclusion lists for certain investments (e.g. tobacco, alcohol, gambling), the applicability of the Art. 8 SFDR reporting obligations is not given per se. For this to be the case, such an exclusion list must “promote” environmental and/or social characteristics within the meaning of Art. 8 SFDR. However, fund managers should bear in mind that investors increasingly expect or encourage funds to report in accordance with Art. 8 SFDR. In order to be able to do this in a meaningful way at all, fund managers must of course first define environmental or social characteristics that are to be taken into account when the fund makes its investments.
Anticipate ESG-related side letter and LPA requirements
Furthermore, ESG-related requirements from investors on the design of the LPA and especially on the agreement of side letters are likely to be relevant in fundraisings more frequently. A wide range of investor requirements can be expected here. Investors often expect the fulfilment of sometimes quite vague, sometimes very precise requirements for ESG reports to be completed annually or even more frequently by fund managers. However, due to the still ongoing implementation of own ESG structures in many places, a private equity manager may well be confronted with the wish to set up an excuse right for the investor already now, if an investment violates the investor’s ESG policy, although this is still being drafted. Such anecdotes are regularly the result of ongoing implementation processes, which often complicate negotiations, especially if they are not yet completed on all sides.
Concrete strategies for fundraising
Extensive and often not very detailed requirements from investors are understandable insofar as the topics are often only just being implemented by them and no industry standards have yet developed in many areas. Therefore, from the investors’ point of view, it is essential to have the cooperation of the managers assured as comprehensively as possible, as well as the provision of information that they need for their own reports (also according to the Taxonomy Regulation and SFDR). Venture capital and private equity fund managers are therefore well advised to go into fundraising with concrete ESG strategies and “offers” and to be able to communicate their positions on ESG compliance to investors in a sound manner. Otherwise, managers will have to deal with the various ESG requirements of investors in fundraising without being able to distinguish themselves from overly far-reaching requests by referring to their own strategies, standards and premises.
Create or supplement ESG due diligence questionnaire
It is likely to become increasingly common in the fundraising process for investor due diligence to include the completion of increasingly complex questionnaires on the manager’s handling of ESG issues. Here, too, it is a good idea for fund managers to design their own ESG questionnaires with relevant questions and the corresponding answers and to use these in the fundraising process with the aim of not having to fill in too many more variants from investors. To be able to proceed in this way, appropriate knowledge on the part of the manager is required above all. Even if at present a not insignificant number of investors only ask about and deal with ESG issues pro forma (typical side letter request: “The manager confirms that it has an ESG policy in place”), the number of investors with very precise ideas and comprehensive knowledge is constantly increasing.
During the due diligence process, investors expect to receive concrete answers to their questions regarding the ESG strategy, the standards applied by the management and the objectives of the new fund.
Although it is unlikely that many investors will abandon an investment in the near future simply because of shortcomings in ESG compliance, clear ESG strategies and knowledgeable fundraising staff are a great opportunity, especially for new managers or those who want to tap into new investor groups.
This article was first published in: VentureCapital Magazine 01/2022, p. 28/29