We have seen significant growth in the number of private funds being raised that consider sustainability characteristics or seek to have a sustainable objective (i.e., labelled as Article 8 or 9 products under SFDR). While to be able to apply an EU ESG label to your fund, you are only required to “look down” at the portfolio to determine its sustainability credentials; some fund managers have begun to “look up” at the source of funds from investors. The question being asked, is whether a fund is able to meet its sustainable objectives if the capital being invested is coming from harmful ESG sources (such as fossil fuels).

ESG laundering is the process whereby investors use money made from harmful ESG sources to invest in ESG positive investments. In effect, cleaning the money from an ESG perspective.

While fund managers are required to comply with stringent anti-money laundering laws, there is currently no requirement from regulators to ensure money comes from sources which cause no sustainable harm. Even without any legal requirement, fund managers are reconsidering who their investors are, from an ESG perspective. Ignoring this, could lead to potential reputational damage, impinging future fundraising or making portfolio companies hesitant to accept such capital and a risk of existing investors walking away when they find out who they are partnering with. This said, it is a hard proposition for a manager to say “no” to an investor’s cheque solely on ESG grounds, especially in today’s challenging fundraising environment and there being no legal requirement to do so. We do anticipate it attracting more attention though as regulators, politicians, the media and investors, become more ESG conscious and seek to prevent ESG laundering.