Don’t Drive Dirty Businesses Into the Financial Shadows

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.