Carbon Equity’s sustainability-related disclosures
What is the Sustainable Finance Disclosure Regulation (SFDR)?
Following the adoption of the 2015 Paris Agreement on climate change and the United Nations 2030 Agenda for Sustainable Development, the European Commission has developed the Regulation (EU) 2019/2088 of 27 November 2019 on sustainability-related disclosures in the financial services sector (“SFDR”). In connection with the SFDR also Taxonomy Regulation (“TR”), EU 2020/852, was developed which defines further criteria and definitions for ESG investments.
The SFDR aims to improve transparency in the field of sustainability. It requires financial market participants and financial advisers to integrate sustainability risks, consider adverse sustainability impacts, the promotion of environmental or social characteristics, and sustainable investments, and to make pre‐contractual and ongoing disclosures in this respect to end investors. In doing so, it aims to:
- Reorient capital flows towards sustainable investment in order to achieve sustainable and inclusive growth;
- Improve the assessment and management of relevant financial risks stemming from climate change, resource depletion, environmental degradation and social issues;
- Foster transparency and long-termism in financial and economic activity.
What is Carbon Equity required to do under the SFDR?
Carbon Equity, as manager of investment funds, has to transparently communicate several sustainability-related disclosures on its website, directly accessible to potential investors. These disclosures on a manager level include:
- Carbon Equity’s consideration of sustainability risks in investments; i.e. how are sustainability risks taken into account in Carbon Equity’s decision to invest or divest in specific underlying funds?
- Carbon Equity’s policy regarding principal adverse impacts of investment decisions on sustainability factors and the due diligence policies with respect to those impacts, i.e. how does Carbon Equity take the possible negative impact of investment decisions on people or planet into account (i.e. sustainability in the broadest sense)?;
- Carbon Equity’s integration of sustainability goals in its remuneration policies; i.e. how does Carbon Equity’s sustainability performance affect the compensation its management or other team members receive?
Carbon Equity is further required to disclose information on a product level (i.e. in respect of the funds it manages), depending on the SFDR classification of its funds. The investment strategies and objectives of the funds managed by Carbon Equity are such that they can be considered of funds being either:
- promoting environmental and/or social characteristics (“Article 8” products); or
- having sustainable investment as its objective (“Article 9” products).
The fund documentation relating to such fund(s), both pre-contractual as well as ongoing in e.g. the annual reports, should reflect the relevant SFDR information on a product-level. Carbon Equity will publish all of the above on its website, in the information about its investment products (data room and prospectuses) and in the annual reports.
How does Carbon Equity enact the SFDR?
Carbon Equity’s mission is to accelerate the decarbonization of our global economy by bringing more capital to the commercialization and scaling of low- and zero-carbon technologies. Carbon Equity does this by aggregating investments of private investors into ‘feeder funds’ and ‘fund of funds’, and investing this capital into impact venture capital and growth equity funds, which in turn invest in climate tech startups and scaleups, e.g. companies that are bringing low- and zero-carbon technologies to the market.
Carbon Equity only invests in funds, and its investment process is focused on selecting the best impact venture capital and growth equity funds. In order to do so, Carbon Equity has developed a positive selection investment strategy. For each fund, Carbon Equity does both a ‘general diligence’ which focuses on the expected financial return and risks, as well as an ‘impact diligence’ which focuses on the expected climate impact as well as risks. The impact diligence is based on a proprietary ‘Climate Impact Scorecard’, which assesses the extent to which a fund has structured its investment mandate, strategy, policies, team monitoring and reporting in a way that will increase the likelihood that the fund will achieve substantial greenhouse gas (GHG) emissions mitigation with its investments, and as such, mitigate climate change. While the primary goal of all of Carbon Equity’s investment products is to mitigate GHG emissions, we expect there to be positive co-benefits on other environmental and social dimensions, including but not limited to climate adaptation, biodiversity, pollution, health of humans and animals and social equity.
A fund must score a minimum of a 3.0 (on a range of 1 to 5, where 1 is defined as “no indication that fund does anything on this point”, 3 is defined as “fund’s impact approach on specific point is sufficient according to Carbon Equity” and a 5 is defined as “best practice seen in the global impact investing market”) on the Climate Impact Scorecard in order for Carbon Equity to be allowed to invest in. If a fund meets that minimum threshold, the insights from the Climate Impact Scorecard, general diligence and ESG analysis, are combined, based on which Carbon Equity decides whether or not to invest in a fund. Further information on the Climate Impact Scorecard and its application can be found here.
How does Carbon Equity integrate sustainability risks in its decision to invest or divest in specific underlying funds? (Article 3 SFDR)
Sustainability Risks are defined as environmental, social, or governance (ESG) events or conditions that, if they occur, could cause an actual or a potential material negative impact on the value of the investment. Carbon Equity assesses sustainability risks in the ‘ESG Analysis’, which is part of the due diligence of each investment and the outcome of which is integrated in the investment decision. This ESG Analysis is done with a proprietary framework, based on the UN PRI ESG DD questionnaire, ILPA ESG assessment framework, the INVEST EUROPE ESG framework and insights from ESG Ventures.
Carbon Equity assesses the sustainability risks of an investment fund it invests in, on two levels:
- sustainability risks related to the fund’s investment activities, e.g. sustainability risks that can impact a portfolio company’s performance. An example of an environmental risk could be a company that pollutes local water with its activities, which could lead to governmental fines and reputational damage;
- sustainability risks related to the fund manager, e.g. sustainability risks that affect the ability of the fund manager to manage the portfolio well. An example of a social risk could be the absence or low quality of Diversity, Equity and Inclusion (DEI) policies, which could lead to the fund missing out on talent and lower quality decision making.
For (1) sustainability risks related to the fund’s investment activities, Carbon Equity assesses the quality with which a fund identifies, assesses and evaluates ESG factors associated with specific investments. The SFDR classification and the PAI statement, to the extent that these are available, of the underlying fund are also assessed.
In the analysis, Carbon Equity looks at the breadth of ESG factors that the fund manager examines for each potential investment, the quality of the process with which ESG factors are identified prior to investment and monitored post-investment, and the quality of ESG analyses that a fund has done for the current or previous portfolio companies.
For (2) sustainability risks related to the fund manager, Carbon Equity assesses the existence, quality and implementation of the fund manager’s ESG policies for its own organisation. Carbon Equity assesses a range of ESG specific aspects, including the funds’ environmental policy, greenhouse gas (GHG) emissions footprint management, supplier policies, employee policies (e.g. pay equity, employee health, anti-discrimination, diversity and inclusion), code of conduct and board independence. Carbon Equity also assesses whether the fund manager screens LPs on potential controversy.
Both types of sustainability risks are assessed prior to making the investment decision. For each potential material risk identified, Carbon Equity defines mitigants, e.g. a factor that can mitigate the risk, and assesses whether this mitigant is sufficient to manage the relevant sustainability risk(s). The conclusions of these analyses are presented to and discussed in the Investment Committee (IC), who is responsible for deciding whether risks are sufficiently managed.
For investments made so far, Carbon Equity believes there is a low to minimal risk of sustainability risks having a material impact on the financial performance of Carbon Equity funds.
How does Carbon Equity consider principal adverse impacts of investment decisions on sustainability factors? (Article 4 SFDR)
Principal adverse impacts (PAI) are defined as negative, material, or potentially material effects on sustainability factors that result from, worsen, or are directly related to investment decisions. Sustainability factors are defined as environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters. In April 2022, the Regulatory Technical Standard (RTS) of the SFDR was adopted by the European Commission, which includes Annex 1, a list of PAI indicators which a fund must take into account to determine that an investment Does Not Significant Harm (DNSH) sustainability factors.
The SFDR prescribes that fund managers must state whether they take PAI indicators into account on an entity level. Carbon Equity does not consider PAI indicators on an entity level, for three reasons. Firstly, most of the funds Carbon Equity selects invest in small and early stage companies, which do not have enough or good enough data available to take PAI indicators into account. Secondly, Carbon Equity invests in funds that are still ‘blind pools’, meaning that Carbon Equity commits to funds before they have made investments in specific companies. Thirdly, Carbon Equity also commits to funds outside of Europe, who do not adhere to the EU SFDR and as such will not use the (full) set of PAI indicators when making investment decisions.
On a product level, Carbon Equity will include PAIs when making investment decisions, albeit on a high and mostly qualitative level. Carbon Equity makes decisions to invest in funds, and assesses the extent to which these funds take PAIs into account when making investment decisions. Specifically, Carbon Equity does an ‘ESG Analysis’ of all funds prior to investing. More information on this ESG Analysis can be found in the pre-contractual disclosures of Carbon Equity products.
While Carbon Equity does not expect PAI indicator data to be available at the time of making the investment decision for its products, Carbon Equity does expect PAI data to become increasingly available during their lifetime. Carbon Equity will use this available PAI data when it becomes available and will then reconsider if it is feasible to take PAI’s into account at entity level for its investment decisions. Carbon Equity will analyse this information, and in case Carbon Equity concludes that PAI’s are sufficiently managed, but there is room for improvement, it will enter into dialogue with fund managers to discuss these observations. In addition, Carbon Equity will use PAI indicators, to the extent that they are available, when deciding to participate in potential co-investments. In the highly unlikely event that Carbon Equity concludes that specific PAI are unacceptably high, Carbon Equity will look for the opportunity to divest from a specific fund.
How does Carbon Equity’s sustainability performance affect the compensation its management or other team members receive? (Article 5 SFDR)
Carbon Equity’s remuneration policies are structured so that there are no incentives to favour the co-workers’ or the company’s own interest to the detriment of Carbon Equity’s customers. Additionally, the remuneration policies are structured in a way that does not encourage excessive risk-taking with respect to sustainability risks nor principal adverse impacts.
As a fund manager, Carbon Equity receives a fixed management fee for all its investment products. Additionally, all its employees receive a fixed remuneration, and no performance bonus is applied based on financial or sustainability performance.