“[C]limate risk is investment risk … And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself.” – Larry Fink, BlackRock, Annual Letter to CEOs

I. Introduction

In recent years, there has been a trend in the financial markets towards greener, environmentally friendly investments, and private equity funds (“Funds”) are no exception. Such Funds and their limited partners are increasingly interested in environmental, social and governance (“ESG”) aspects of Fund investments. For instance, in 2019, $20.6 billion was invested by US investors in sustainable Funds, nearly four times more than in 2018.¹ And even in these unprecedented times, investments in sustainable Funds for the first half of 2020 reached $20.9 billion, and total assets in sustainable Funds hit a record high of $1.1 trillion as of the end of June 2020.² The COVID-19 pandemic and its effect on global economies has only intensified the focus on ESG principles, with many policymakers and investors drawing parallels between the unforeseen risks of a pandemic and issues such as climate change and calling attention to the importance of considering environmental, social and governance performance, together with more traditional financial metrics, in evaluating investment risks.³

While ESG investing still largely takes the form of “impact investing”—investments into companies or funds with the intention to generate a measurable, beneficial social or environmental impact along with a financial return—ESG investing is not just about aligning investment strategies with investor values but also the general principle that ESG-negative behaviors impact investment returns. This Legal Update will focus on the impact of ESG principles on the financial markets in the United States and their growing impact on the fund finance industry.

II. Definition of ESG

As noted above, ESG is shorthand...