ESG policies becoming critical in private capital markets

Investment funds in the private capital markets sector increasingly need to be seen to be quickly moving towards, or having already implemented, a rigorous environmental, social and governance (ESG) policy, or they could risk falling outside of many institutional investor’s consideration.

Environmental, social, governance (ESG) considerations are becoming a significant part of the investor side business development and relations component of the insurance-linked securities (ILS) fund manager operations.

In addition, ESG is becoming a critical component of insurance and reinsurance market operations as well, with shareholders increasingly focused on understanding what their investments are doing in the ESG space.

As a result, ESG policies are becoming important for companies themselves, but also for specific ILS, catastrophe bond and reinsurance investment fund strategies, as they can lay out clearly a manager’s approach to integrating ESG considerations into their asset management activities, and most importantly their risk selection.

Importantly though, the ILS community understands that the industry needs to walk-the-ESG-walk, as well as be able to talk-up its ESG credentials, so investment processes that align with an ESG policy are likely to become defacto for many ILS fund manager strategies.

Highlighting just how important an ESG policy is for a private capital market investment fund, research by alternative investment data specialists Preqin found that roughly 42% of the private capital assets under management it tracks is managed by funds that have an ESG policy in place.

Regulations are starting to become more prescriptive about the approach investment managers in private capital markets need to take, while both investors and managers are increasingly demanding data to help them make more ESG policy aligned decisions and to show how ESG is integrated into strategy formation, deal sourcing or origination, and portfolio management and execution.

All of which are critical in insurance-linked securities (ILS) and ILS fund managers are implementing policies to outline how they are integrating ESG considerations into their deal origination, analysis and capital deployment activities.

“Investors are a key push factor in ESG uptake in private markets, as managers look to deliver against Limited Partner (LP) preferences for ESG adoption,” Preqin explained.

This has been the main driver for the ILS market’s adoption of ESG policies and practices, alongside the reverse of this, in maximising the integration of ESG for its marketing properties as well.

Preqin previously found that a quarter of 350 alternative investment Limited Partners (LP’s) surveyed had turned down an allocation due to ESG considerations, with a further 39% saying they were prepared to do so, where ESG considerations are deemed insufficient, or misaligned.

While Preqin’s data shows that 37% of investors in alternatives have an active ESG policy in place, the positive benefits to managers that embrace ESG are clear, as more than that, at 42%, of private capital AUM is managed by firms that say they are committed to ESG investing.

Preqin has tracked $4.37tn of private capital assets under management (AUM) where the investment manager says they arecommitted to ESG investing, which is around 42% of total private capital AUM ($10.3tn).

Of note to ILS managers, Preqin explains that, “Investors are asking General Partners (GPs) to report their ESG commitments, and driving demand for higher quality, more granular data to demonstrate how their portfolios are delivering on their own commitments towards delivering ESG outcomes.”

Jaclyn Bouchard, Executive Vice President, Head of ESG Solutions and Corporate Responsibility, at Preqin, commented, “As ESG continues to embed into private capital markets, tracking managers’ commitments is essential to inform investors who to select to achieve more sustainable portfolios. As GPs consider ESG risks and opportunities in their investment decision-making, and LPs feel pressure from regulations and client expectations, private markets are at a transparency tipping point. High-quality and reliable ESG data is essential to move from vision to reality. From our perspective, the more transparent the industry is on ESG reporting, the better our data and analysis can be for the whole private markets lifecycle – it is a symbiotic relationship.”

While Preqin’s analysis focuses on the typical private capital market asset classes, such as private equity or venture, private debt, real estate, infrastructure and natural resources, as well as emerging segments like cleantech, sustainable food and agriculture, the overall findings are very relevant for ILS and reinsurance linked investment markets.

The focus on ESG is growing at both investors and managers, with LP’s increasingly wanting to understand their GP’s approach to embedding ESG within the firm, as well as within the strategy and investment thesis.

The ILS market has been proactive in this respect, with many ILS fund managers already having ESG policies, while numerous catastrophe bond funds are now aligned with European sustainable investment guidelines and standards.

These steps are likely to continue, as in the currently volatile capital market and investing environment, having an ESG aligned policy for a diversifying fund or asset class like ILS, could prove extremely attractive to end-investors.

ESG investing and the opportunities it presents are a growing focus for the insurance-linked securities (ILS) market. Read more of our insights on this topic here.