Jul. 1, 2021
Jul. 1, 2021
Five Key Articles on ESG for Hedge Fund Managers
Nearly every day, the media publishes articles on environmental, social and governance (ESG) issues, whether the focus is on corporate disclosures around climate change efforts and the diversity of board members or private funds claiming to invest through an ESG lens. Recent surveys show that investor interest in ESG is also on the upswing. For example, one study found that a majority of hedge fund managers are incorporating ESG factors into their investment processes – driven, at least in part, by investor demand. Thus, it’s no surprise that the government has also increased its focus on ESG. The SEC has taken concrete steps toward regulating ESG-related issues, primarily in terms of disclosures. For example, on April 9, 2021, the Division of Examinations (Examinations) released a risk alert on its review of ESG investing, which the Hedge Fund Law Report is currently covering in a two-part series. Additionally, the SEC’s Spring 2021 short-term “Reg Flex” agenda indicates that the Division of Investment Management is considering recommending that the Commission propose requirements for investment companies and investment advisers related to ESG factors, including ESG claims and related disclosures. To that end, the Hedge Fund Law Report is highlighting five articles from the archives on ESG. These articles address the history of ESG investing in the hedge fund industry; ESG investing policies; ESG considerations in the U.S. and globally; ESG’s transformation of investing in the near future; investors’ use of ESG factors in selecting hedge fund managers; and Examinations’ focus on ESG investing practices in exams. Next week (the week starting July 4, 2021), the HFLR will resume its normal weekly publication.
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ESG Investing in the Hedge Fund Industry: Past, Present and Future; and Designing an ESG Investing Policy
The integration of ESG factors into the investment process has become a primary objective of certain investors for a multitude of reasons. Despite the significant amount of assets being directed into investment strategies that incorporate ESG factors, however, the general industry consensus is that the adoption of formal ESG policies by hedge fund managers remains fairly uncommon. Moreover, there is no one-size-fits-all approach for managers that incorporate ESG factors into their investment processes. That is, in part, because many early adopters of ESG investing in the hedge fund space have done so at the request of their investors. Consequently, managers have had to develop a variety of approaches to meet the diverse needs of investors without uniform requirements. The first article in this two-part series explores the development of ESG investing and its prevalence in the hedge fund space. The second article reviews advice from industry experts on considerations for managers wanting to develop an ESG investment policy, as well as the due diligence demands from investors seeking managers that incorporate ESG factors into the investment process. See “Survey Identifies Drivers and Obstacles for Sustainable Investing” (Apr. 2, 2020); “Preparing for the Impact Revolution: How Fund Managers Can Implement the Philosophy of ‘Doing Well by Doing Good’” (Mar. 21, 2019); and “More Hedge Funds Are Employing Environmental, Social and Governance Investment Criteria” (Nov. 3, 2011).
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ESG Considerations for Fund Managers: U.S., E.U. and Global Developments
Demand for investments that take into account ESG factors continues to grow. ESG investing, however, poses certain challenges for fund managers. A Dechert program took a deep dive into the most pressing issues that fund managers interested in pursuing ESG strategies are likely to face. The program featured partners Julien Bourgeois; Anthony S. Kelly, who was the former Co‑Chief of the Asset Management Unit of the SEC’s Division of Enforcement; Andrew L. Oringer; Mark D. Perlow; and Mikhaelle Schiappacasse. The first article in this two-part series presents the key insights from the program on ESG in the U.S. regulatory landscape, including issues unique to ERISA fiduciaries, private funds, managed accounts and registered funds; SEC examination and enforcement focus; and strategies for ensuring compliance when embracing ESG. The second article addresses E.U and global ESG developments, including E.U. and global leadership; disclosure, taxonomy and low-carbon benchmarks regulations; and other E.U. initiatives. See “The E.U. Sustainable Finance Disclosure Regulation: New Disclosures for U.S. Asset Managers” (May 6, 2021); and our two-part series “Navigating the Evolving Legal and Regulatory ESG Investing Terrain”: Part One (Nov. 19, 2020); and Part Two (Dec. 10, 2020).
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ESG Will Fundamentally Transform Investing in the Coming Decade
Investing that incorporates ESG criteria is likely to upend traditional investment criteria in the coming decade, according to the diverse panel of speakers at a seminar sponsored by research provider IFI Global Ltd. (IFI). Simon Osborn, CEO of IFI, moderated the discussion, which featured Christopher J. Addy, CEO of due diligence provider Castle Hall; William Altman, director of research at ESG fund manager 17 Asset Management; Michael Johnson, group head of fund services at Crestbridge; and Sean Wilke, partner at compliance firm Greyline Partners, LLC. The speakers’ consensus was that, although difficult to define and measure, ESG investing is here to stay and could become the driving force behind investing in the future – especially if ESG principles can be shown to deliver alpha. This article discusses the key takeaways from the presentation. See “Brexit and Sustainable Investing Remain Key Considerations in Luxembourg Funds Space (Part Two of Two)” (Jul. 25, 2019); and “Luxembourg Plays Prominent Role in ESG Investing and Sustainable Finance” (Nov. 21, 2019).
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How Hedge Fund Investors Can Layer ESG Factors into Manager Selection
In 2006, the United Nations Secretary-General launched the Principles for Responsible Investment (PRI) – a set of aspirational standards designed to guide investors towards creating a sustainable global financial system that fosters good governance, transparency, integrity and accountability. Hedge funds are important investment vehicles for many signatories to the PRI initiative. To assist signatories in their hedge fund investments, PRI issued a white paper, seeking to encourage meaningful debate about responsible investment in hedge funds; identify the ESG risks and opportunities presented by different hedge fund strategies and techniques; and provide guidance to investors on how to integrate ESG factors into their fund investment practices. Fund managers that are able to understand the issues at stake and to participate meaningfully in the dialogue can seize upon opportunities to attract capital from ESG-focused investors, according to PRI. This article provides an overview of PRI’s paper, including its assessment of the advantages and risks of various hedge fund investment techniques and strategies for ESG investors, as well as a roadmap for responsible investment in and by hedge funds. See our two-part series on SBAI’s Responsible Investment Policy Framework: “Four Ways to Incorporate Into Investment Strategies” (Apr. 15, 2021); and “Three Key Considerations for Fund Managers” (Apr. 22, 2021).
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SEC’s Targeting of ESG Investing Practices in Recent Examinations and What It Means for Hedge Fund Managers
ESG strategies are increasingly popular with investors and hedge fund managers. Thus, in 2020, the SEC’s Division of Examinations (Examinations) stated that it planned to review ESG investing with “particular interest” as part of its annual Examination Priorities. In fact, Examinations’ scrutiny of ESG investing may have already begun. A number of fund managers reported receiving extensive document requests from Examinations – such as the sample version contained in this article – about their ESG investing practices, including their disclosures, marketing, use of metrics, internal controls and other policies. In light of that scrutiny, fund managers must ensure that they know the risks associated with ESG investing and take steps to mitigate them. To understand the scope of the SEC’s efforts in this area to date and going forward, the Hedge Fund Law Report interviewed hedge fund practitioners advising managers with respect to SEC exams that have covered ESG investing. This article analyzes the SEC’s recent approach to ESG oversight, potential ESG‑related risks for managers facing SEC scrutiny and steps managers can take to mitigate those risks in advance. See “Division of Examination’s 2021 Exam Priorities: New and Emerging Focus Areas (Part One of Two)” (Apr. 15, 2021); and “Focus Areas for Private Fund Managers From OCIE’s 2020 Exam Priorities” (Feb. 27, 2020).
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