As regulators ramp up scrutiny to address greenwashing in markets, having already claimed “high-profiled scalps” in recent months, experts at law firm Gilbert + Tobin believe there is heightened risk of private funds also being found liable for any misleading environmental and social investment commitments.
Earlier this month, Mercer Super was slapped with a $11.3 million penalty by the Federal Court after it admitted it made misleading statements about the sustainable nature and characteristics of some of its superannuation investment options.
The proceedings were first brought forth by the Australian Securities and Investments Commission (ASIC) in February 2023 and marked the first time the corporate regulator had taken an Australian entity to court regarding alleged greenwashing conduct.
Previously, in June, LGSS Pty Limited, trustee of the superannuation fund Active Super, was also found to have contravened the law in connection with various misleading representations of its sustainability credentials, with a pecuniary penalty yet to be determined.
A further case with relation to Vanguard Investments Australia remains before the Federal Court concerning greenwashing.
In a recent note, lawyers at Gilbert + Tobin explained these recent actions raise “the spectre of increased scrutiny on disclosures and commitments by managers of private equity, private credit, infrastructure, real estate and venture capital products in relation to environmental issues”.
“This is not just because institutional investors, like pension funds, that invest in private funds are engaged investors who are attempting to drive positive environmental and social change,” they said.
“There is currently heightened risk of private funds being found liable for greenwashing.”
Particularly, they noted current laws against misleading and deceptive conduct apply to all, including private funds.
Moreover, the investment activities of a private fund could be the root cause of one of the institutional investors in that fund being fined for greenwashing, they suggested.
The lawyers added there is a “heightened prospect” of scrutiny and disputes over a private fund’s own disclosures and side letters, to the extent they contain commitments to avoid particular investments and to make certain undertakings, such as reporting activities or due diligence, for ESG reasons.
Lessons from recent cases
Looking more closely at the Active Super and Mercer Super cases, the legal experts highlighted a number of important considerations for institutional investors – like super funds – in private funds, given this heightened risk.
First, they proposed that institutional investors closely review private funds’ fund documents or side letters to ensure they are in line with their own public commitments.
“If the commitments which an institutional investor extracts from their private funds leave open the possibility of investments that violate the institutional investor’s own commitments, the institutional investor will carry residual greenwashing risk,” they said.
“Given the number of investors that will require a fund manager to adhere to (often slightly varied) ESG restrictions, it is common for the fund manager to try and fit all investors into ’one box’ to create a single ESG standard for the fund manager to have to apply in its investment process.
“However, being strong-armed by a fund manager into a certain ‘box’ could mean that the investor ends up agreeing to standards that are weaker than what their internal responsible investment (RI) policy allows.”
They identified that, outside of Australia, fund managers adopt an “excuse” mechanism to treat investors on a case-by-case basis and exclude certain investors from investments that have the potential to breach those investors’ internal RI policies or side letter commitments.
However, in Australia, the regulations relating to commonly used private fund structures do not allow for excuse rights. Therefore, fund managers adopt a blanket ban approach, they said.
Additionally, noting the standard practice that negative screenings take place only at the time of investment in private markets, institutional investors “do not necessarily push” for screenings at periodic intervals, and this practice could lead to inconsistency with the investor’s own RI policy.
To combat this, funds may need to endeavour “to negotiate assurances that the private fund will indeed conduct period re-screening of the private fund’s investments at an acceptable frequency or for the institutional investor to be able to provide the private fund with any updates to their RI policy from time to time”.
Crucially, the experts flagged that liquidity issues in private markets could mean investors “can do little to limit the exposure” of an investment if it breaches the investor’s internal RI policy.
“Given this dynamic, investors should consider upfront what this scenario would mean in practice and seek to build in protections into their side letters if their own RI policy is breached,” the legal experts said.
“Unless an institutional investor’s RI policy and commitments allow for this sort of leeway and response, the institutional investor may nevertheless carry a residual risk of greenwashing.”
