Don’t Drive Dirty Businesses Into the Financial Shadows

(Bloomberg Opinion) -- Asset management firms are increasingly tempted to meet their environmental obligations by withdrawing capital from companies and industries that do the most damage to the planet. But there’s a risk that the assets they offload will drift into the shadows of private ownership, where polluting practices will receive less scrutiny and therefore stand even less chance of being curbed.

Some 1,500 institutional investors with assets of more than $39 trillion have committed to disinvesting from the fossil-fuel industry, DivestInvest said in a report last month. That’s up from fewer than 200 institutions overseeing $52 billion when the lobby group first started totting up such commitments seven years ago.

Europe’s biggest pension fund, state-owned ABP of the Netherlands, which oversees more than $600 billion, said last month it will offload 15 billion euros ($17.4 billion) of investments in carbon-heavy companies by early 2023. Harvard University said in September its $42 billion endowment fund will stop investing in fossil fuels, including the 2% allocated to private-equity funds with exposure to the industry.

But for every seller, there’s a buyer. Hedge funds have made tidy profits by investing in public securities shunned by institutional investors. And the more widespread disinvestment for environmental, social and governance concerns becomes, the greater the temptation for polluters and other delinquents to shun public markets altogether.

“This could push more ‘bad ESG’ into private markets,” London-based think-tank New Financial said in a report last month. “There are already signs that private equity firms are buying up unloved ‘bad ESG’ companies. How can we develop a more balanced framework under which ESG issues are based on a company’s activity and not its ownership status?”

Private equity firms are starting to acknowledge the dilemma. A September initiative led by Carlyle Group Inc., which oversees more than $270 billion, and California Public Employees’ Retirement System, custodian of $470 billion, seeks to collect and distribute standardized ESG data from closely held firms. It initially attracted a dozen firms controlling $4 trillion; more than 100 investors have since inquired about joining the project, Anne Simpson, the director for governance and sustainability at Calpers, told an online investing conference last month.

In a separate but related move, Carlyle has designed credit lines worth $4.1 billion in the U.S. and $2.7 billion in Europe under which its portfolio companies pay less to borrow if they meet diversity and climate change targets. The private equity manager is motivated by more than altruism; it calculates that companies it owns with two or more diverse board members deliver average earnings growth that’s about 12% better than those without a diversity of executives.

And EQT AB, one of Europe’s biggest private equity companies with more than $80 billion, said last month it plans to raise 4 billion euros for a new fund that will invest specifically in companies that aim to lower their carbon footprints and employ more diverse workforces. As much as 20% of the performance fees of EQT’s Future fund will be tied to ESG indicators.

While such inventiveness from the private equity industry is a welcome addition to the arsenal of efforts to ease the climate emergency, a piecemeal approach to ESG disclosures is bound to fall short of what the planet requires. “When large asset managers offload assets, it underscores the need for mandatory disclosure in private equity so that those same assets don’t continue to operate under new owners in the shadows,” former U.S. Vice-President Al Gore said in an interview published by the Financial Times last month.

As regulators around the world start to introduce harmonized rules obliging companies to disclose their climate impact, the standards need to encompass private as well as public enterprises. But asset managers should resist the urge to withdraw capital from recalcitrant firms, instead using their financial muscle to force boards to change their behavior. Engagement, not disinvestment, is the best way to fund the transition to a net-zero economy.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."

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