Over three-quarters of international Limited Partners incorporate climate risk into their investment directives for private markets.
In a significant development, the systemic threat of climate change is increasingly being recognised as a key financial risk by long-term investors. Notable entities such as Temasek and Cambridge University Investment Management have emphasised that addressing climate risks is an integral part of their fiduciary duty.
According to a recent report, while 68 out of the 100 largest Limited Partners (LPs) explicitly require their managers to assess climate-related financial risks, only 62 expect or encourage emissions goals. On the other hand, a higher number of 72 LPs require or expect climate risk assessments.
The report argues that these standards can help managers avoid costly mistakes, strengthen portfolio resilience, and create a competitive advantage. Many LPs, it seems, are focusing on the financial risks of climate change to portfolios, a concept known as "single materiality."
Interestingly, the report reveals a higher uptake of climate disclosures among real asset investors compared to private equity investors. PRI, a leading independent organisation, released a detailed guide on climate risks disclosures for its signatories earlier this year.
The survey also shows a shift in strategy, with LPs prioritising climate risk management over reducing emissions. LPs expect climate risk to be integrated into the investment process and expect active risk management throughout the hold period. About half of survey respondents expect their managers to complete TCFD reports.
The report indicates that LPs expect both quantitative and qualitative risk assessments of climate risks. One respondent for the Australian Retirement Trust stated that they assess an investment manager's maturity on two thematic topics: climate change and modern slavery.
While climate requirements are becoming mainstream, the report by Unwritten shows sharp regional divides. Outside the US, 80-100% of large LPs demand climate risk assessments. However, in the US, just over half of large LPs demand these assessments, reflecting the political backlash against environmental, social, and governance (ESG) considerations.
The New York State Common Retirement Fund treats climate risk as an essential part of good governance, using climate KPIs to demonstrate this. The Abu Dhabi Investment Authority embeds climate assessment in due diligence, portfolio reporting, and planning.
The report analysed the policies of the 100 largest limited partners (LPs), who collectively channel $2.6 trillion into private markets. Interestingly, none of the top 100 LPs mandate membership of net zero alliances.
ESG integration is predominantly achieved through the selection and appointment of new investment managers, and monitoring through the assessment of, and engagement with, existing investment managers. The report by Unwritten, a London-based data provider on climate risk, indicates growing investor demand for improved disclosures and risk management in private markets. The report suggests that climate risk disclosures are more thoroughly adopted by real asset investors compared to private equity investors.
In conclusion, the report underscores the growing recognition of climate risks by global LPs and the need for improved disclosures and risk management in private markets. As the world grapples with the challenges of climate change, the role of these investors in shaping a more sustainable future cannot be overstated.
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