The Biden administration’s attitude towards climate change and ESG regulation has, in the words of one commentator, made ESG investing “the ultimate megatrend.” But with more attention, investment and competition come more scrutiny.
For one thing, investors and asset owners will have higher standards for impact measurement, transparency, and access to real-time data. A survey just last month revealed that nearly half (46%) of asset owners surveyed want managers to supply information on a portfolio’s greenhouse gas emissions and carbon intensity. What’s more, about a third require thematic metrics that demonstrate how their investments make a measurable social and environmental impact, and nearly 40% plan to demand this information moving forward. On the regulatory front, we can expect a strong push for ESG reporting and disclosure rules, as well as potential ESG-related legislation from new SEC chairman Gary Gensler.
New entrants to the ESG space, such as private equity funds, might especially struggle in this new landscape: a 2020 survey found that while two-thirds of PE firms take ESG into account, only 29% make a full ESG policy publicly available.
No matter the case, all fund managers interested or engaging in ESG need to prepare for a heightened impact measurement and reporting climate. They might do well to glean some lessons learned from those operating in another complex and highly regulated impact space: Opportunity Zones.
Shared trajectory
The trajectory of Opportunity Zones – and the controversies surrounding its early-stage implementation – demonstrate the potential pitfalls of not having strong impact measurement and regulatory clarity.
Take a principal critique of the program (one akin to cries of “impact washing” in the broader ESG investing space): that OZs don’t provide the social impact they purport to, largely because funds are flowing toward real estate projects that primarily benefit developers rather than operating businesses that create jobs and wealth for those living in undercapitalized communities.
While the critique is objectively correct in saying more OZ dollars have gone into real estate projects, critics tended to miss the reasons why that’s the case, and how the tides are turning – not to mention all the positive impact real estate projects can have.
For one thing, many didn’t take into account how the lack of regulatory clarity inhibited these efforts. When the OZ initiative kicked off in 2018, initial guidance dictated that a significant majority of operating business activity needed to be transacted within the zone itself. This may have been intuitive if your operating business was, say, a barbershop, or a laundromat, both of which likely serve primarily local clients. But for companies selling products online or to those who live outside the designated OZ — or who may look to import raw materials from other areas for use in their products — the rules were unclear.
It took subsequent rounds of guidance to clear up these (and several other) issues. Now, operating business investment is flourishing: half of all new fund formations in the second quarter of 2020, for example, were focused on or included operating business investments, according to JTC Americas’ (formerly NES Financial) OZ Data Insights,. That trend that continues to accelerate. Funds are also increasingly smaller in size, which correlates to fund managers becoming more concentrated on targeted, place-based results.
The lesson here is that regulatory clarity – even after initial legislation or regulation is passed, and in lieu of more stringent requirements (such as those proposed in the IMPACT Act for OZs) – can take time to develop. But critics won’t sit on their hands.
In the meantime, the best way to counter claims of “impact washing” and get out ahead of critique is to effectively measure social impact and be transparent about the outcomes.
That doesn’t mean it’s easy, for OZs or otherwise. As a recent article in Fundfire notes, investor questions around ESG are becoming increasingly demanding. How can we implement a carbon-neutral strategy? How can we comply with current regulations and what impact will future legislation have? Can fund managers provide thematic metrics that tangibly demonstrate measurable social and environmental impact? Are there clear internal ESG policies and processes in place?
To answer these questions, more and more managers are looking for practical advice and solutions, including from firms such as JTC Group, which recently acquired NES Financial (a leading impact reporting solutions provider) and INDOS Financial (a leader in ESG governance solutions). They are also adopting technology, from online portals where investors can access information in real time, to data tools that sort through third-party data, to artificial intelligence and natural language processing to collect ESG information.
Some managers may fear that measuring impact themselves will create an added burden, particularly given today’s increasingly demanding investor base. We certainly saw this in the OZ space as the program heated up. One way to ease the load: partnering with a fund and governance solutions provider like JTC. Such partnerships enable managers to easily track and measure impact – employing a framework like the one developed by Howard W. Buffett – as part of a wholly automated technology platform. The key is to strike the right balance between deploying more standardized reporting programs that relieve administrative burden and allow for scale, while implementing more complicated methods when particular situations call for it.
Those who have operated for years now in the OZ space know firsthand the obstacles facing emerging ESG investors and fund managers – be it a lack of regulatory clarity, critiques that the program isn’t having the impact it purports to, or the need for increasingly sophisticated technologies.
Despite these prevailing headwinds, managers should remember that, at the end of the day, you get what you measure. The best solution is simply to measure impact as clearly, transparently and comprehensively as possible.
Reid Thomas is Managing Director for JTC Americas (formerly NES Financial), the U.S. division of JTC Group, responsible for the management and strategic direction of the organization, including the firm’s technology-enabled EB-5, 1031, Private Equity, and Opportunity Zone Fund administration. NES Financial | JTC is a specialty financial administrator that serves sectors characterized by high administrative complexity, increased transaction security need and challenging regulatory compliance requirements.
