Private Equity: Opportunities for Australia funds and investors as climate consultation closes | Hogan Lovells
The consultation comes in the wake of an initial consultation on key considerations for the design and implementation of standardised disclosure requirements that took place between 12 December 2022 and 17 February 2023 (see Hogan Lovells alert Sustainability, disclosure – what Australian funds, sponsors and investors should know as consultation closes).
The second paper Climate-related financial disclosure consultation paper – June 2023 notes that in the initial consultation, “a majority of stakeholders agreed the Government should take a phased approach to coverage over time”.
The paper suggests a three-phased approach, starting with a limited number of relatively large entities that would expand over two years to apply to progressively smaller entities. This would allow smaller entities the lead time to build capability and skills to meet their obligations.
The “Who”?
The proposed requirements would be phased in over three years with full application of the mandatory reporting for all groups of reporting entities from the 2027-8 reporting year onwards.
Entities required to make disclosure will be those that are required to file reports under Chapter 2M of the Corporations Act 2001 (Cth) and that meet particular size thresholds. Entities required to file reports under this provision and registered as a “controlling corporation” under the National Greenhouse and Energy Reporting Act 2007 (Cth) will need to make climate-related disclosures even if they do not satisfy the tests.
The first group due to report from 2024-5 onwards are entities that meet two of the three threshold tests – have more than 500 employees, the value of consolidated gross assets of company and controlled entities of at least AU$1 billion and with consolidated revenue of at least AU$500 million.
The second group due to report from 2026-7 onwards are entities that meet two of the following three tests – have more than 250 employees, the value of consolidated gross assets of company and controlled entities of at least AU$500 million and with consolidated revenue of AU$200 million or more.
The final group due to report from 2027-8 onwards are entities that satisfy two of the three threshold tests – have more than 100 employees, with the value of consolidated gross assets of company and controlled entities of at least AU$25 million and with consolidated revenue of at least AU$50 million.
The “What”?
The paper says that the reporting content requirements “would aim to provide clarity to reporting entities about what types of information must be disclosed and to ensure the requirements improve access to decision-useful for users of financial reporting”.
These requirements would be based on the ISSB’s new global standard for climate-related financial disclosure, IFRS S2 Climate-related Disclosures. The paper highlights the importance of strong international alignment in minimising compliance costs for Australian entities that operate internationally and to ensure that Australia’s regime is viewed with credibility by international capital markets.
In addition, entities will be required to report on their governance processes, controls and procedures used to monitor and manage climate-related financial risks and opportunities.
Private equity (PE) in the spotlight
The prospect of these new requirements come as PE general partners (GPs),face increasing pressure from their investors (Limited Partners, LPs) to prioritise environmental, social and governance (ESG) issues. This shift presents significant opportunities for LPs to invest in funds with investment policies which drive positive environmental and social change.
For many GPs, Europe provides an attractive source of investment from the Australian private capital sector. Alongside financial returns, many Australian LPs are also seeking investments with a positive ESG impact and are therefore actively embracing “sustainable investments”.
Demand for sustainable investments has been driven in the first instance by European LPs, driven by commitments made by European Union (EU) governments and businesses that relate to sustainable goals such as reducing carbon emissions. LPs are also looking to social and ethical standards and practices (the “S” in ESG).
A raft of cutting edge ESG-related disclosure regulations have been introduced by the EU and these have revolutionised sustainable investing. The most important EU regulations applying to PE funds are the Sustainable Finance Disclosure Regulation (EU) 2019/2088 (SFDR) and the Taxonomy Regulation (EU) 2020/852 (TR).
These regulations require fund managers based in the EU or marketing into the EU to disclose the degree to which they are investing in “sustainable investments” and/or “environmentally sustainable investments”.
Both of these terms are subject to pre-defined criteria which, if satisfied, enables a fund to be marketed as “sustainable” within the EU. If Australian GPs want to sell ESG-related funds to European LPs, then they need to comply with SFDR and TR.
The “How”?
Integration of ESG factors introduces new complexities and risks that require careful assessment. As PE investments have a typical investment cycle of three to five years, it is vital a firm’s ESG strategy is embedded from the start of the investment relationship.
How can Australian GPs seize this opportunity, respond to the needs of LPs and mitigate the additional risks and regulatory compliance associated with ESG-related funds?
GPs need to analyse their investment purpose (and how ESG fits in with it) and incorporate this vision into ESG policies and (pre- and post-investment) processes throughout the business.
Best practice includes:
- Development of ESG policies and ensuring that ESG factors are considered and given sufficient weight at all investment committee meetings to satisfy relevant SFDR/compliance obligations.
- Specific ESG due diligence (DD) – this includes pre-investment DD to understand investments’ ESG risks and opportunities and to ensure that they are consistent with the firm’s strategies, policies and procedures (including exclusion criteria). This will also allow for risk and loss mitigation at an early stage.
- Engagement with portfolio companies pre-investment, including signing side letter/agreements setting ESG standards, key performance indicators (KPIs) and targets to enable GPs to comply with ongoing SFDR obligations (including implementing provisions to facilitate the sharing and monitoring of data).
- Ongoing monitoring of progress against ESG standards, KPIs and targets throughout the investment cycle, including provisions to rectify any issues that may have been identified during DD or the ongoing asset management phase.
- Conduct annual reviews to ensure the continued compatibility of the investee company as an SFDR compliant investment.
- Reflect ESG reporting requirements (the SFDR and other) in templates for annual reports and clients.
Next steps
For a number of years Hogan Lovells has been assisting PE firms navigate this ever evolving area in order to facilitate fundraisings throughout the EU and satisfy high investor demand for sustainable funds.
We have a team dedicated to advising on and implementing EU and UK ESG regulatory requirements and offer product advice to assist PE firms in navigating this ESG landscape from advising on potential fund investment policies to asset acquisition and disposal.
Our Sustainable Finance & Investment practice brings together a multidisciplinary global team to support our clients in this mission-critical area.
