By creating jobs and utilising resources, companies exert a direct and indirect influence on our society in many ways. The overall social responsibility of companies is reflected in management according to corporate social responsibility (CSR) criteria. Measures include not only fair business practices, an employee-oriented human resources policy or the promotion of cultural and social projects, but also ecological aspects. With the growing awareness of the consequences of global warming, the focus is increasingly shifting to the protection of climate and environment. Companies should operate in a resource-conserving and climate-neutral manner, particularly in order to reduce their own carbon footprint. ESG (Environment Social Governance) criteria serve to align companies with sustainability factors and the consideration of environmental, social and employee concerns, respect for human rights and the fight against corruption and bribery.
The issue of responsibility has now also reached investors. In its 2020 market report, the Forum Nachhaltige Geldanlagen / FNG (Forum Sustainable Investment) determined that the volume of funds invested in sustainable investment strategies in Germany had almost doubled in 2019 compared to the previous year. This trend continued in 2020 and will continue to strengthen.
One of the reasons behind this strong trend is the regulation on sustainability-related disclosure requirements for private equity and venture capital fund managers put into force by the European Commission. With Regulation (EU) 2019/2088 on sustainability-related disclosure requirements in the financial services sector, which is to be applied in principle from 10 March 2021, sustainability risks in investment decision-making processes become the subject of a binding set of regulation for the first time. In this context, a sustainability risk is "an environmental, social or governance event or condition, the occurrence of which could have an actual or potential material adverse effect on the value of the investment." It is clear from this formulation that compliance with ESG (Environment Social Governance) criteria is not only about sustainability factors such as environmental, social and employee concerns as well as lawful and fair business practices, but also about maintaining the value of an investment in a company. With the so-called Taxonomy Regulation, which is to be applied from 2022, the EU Commission will also present concrete criteria for measuring the environmental sustainability of economic activities.
Until now, investors have only been required to make a contribution to sustainability criteria in the context of impact investing. Impact investors only provide capital to companies that offer scalable social or environmental added value in addition to a financial return. In the drafting of contracts, such provisions have been known for some time. Impact investors also place social and environmental sustainability issues on an equal footing with traditional compliance issues such as anti-corruption, money laundering prevention, and data protection compliance in their pre-investment due diligence. The current regulations of the EU Commission and the increasing demand from investors mean that ESG or sustainability criteria will be of decisive importance in the future, not only for impact investors, but for all private equity and venture capital funds. Discussions are currently underway on how the commitment to sustainable management can be promoted by implementing sustainability clauses in the contractual documentation of private equity and venture capital investments.
As part of a voluntary commitment, "sustainability clauses" are included in the contracts underlying a financial investment. This begins at the term sheet level, in which the future portfolio company's commitment to ESG criteria is stipulated in advance. With the incorporation of the detailed sustainability clause into the shareholders' agreement of the portfolio companies, the commitment becomes legally binding and can be demanded and controlled by the investors or the advisory board or supervisory board of the investment. From a legal point of view, "sustainability clauses" have direct effect only between the shareholders and for the portfolio company itself. The company's managing directors or board members are responsible for implementing the sustainability criteria in the company's business operations. Here, there is wide scope for creating incentives or sanctions to motivate management to implement the intended measures. These range from a mere reporting obligation through the remuneration of the management bodies up to the personal liability of the managing directors or board members.
With the introduction of sustainability clauses, financial investors are sending out an important signal in the global fight against global warming and proving that financial investments can serve not only as a driving force for innovative business models, but also for changes in society as a whole. The focus of the "sustainability clauses" is mostly on climate-neutral business and the reduction of one's own carbon footprint. However, current legislative projects at European level make it clear that this only covers part of the requirements for sustainable action in the areas of environment, social affairs and corporate governance. In the future, sustainability aspects will increasingly be decisive for investment decisions at all levels: Investors will evaluate a fund on the basis of sustainability criteria just as the fund evaluates the investment in a portfolio company. Appropriate sustainability clauses will thus become standard in all investment documentation, at the fund level as well as at the level of the investments in portfolio companies of the fund.
A study by the financial information and analysis company Morningstar in 2020 showed that aligning investments with ESG criteria does not conflict with high returns. According to this study, in a sample of 745 sustainable funds based in Europe, the long-term performance of funds geared towards ESG criteria was better over three, five and ten years than that of funds not guided by ESG criteria.
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