Reading 2.4

Question 1

From 2016 to 2020, ESG assets under management (AUM) in alternative investments increased by how much?

From 2017 to 2023, alternatives AUM are expected to increase by almost ____%, with _____ growth forecast for every alternative asset class and private equity and hedge funds accounting for over _____ of the 2023 asset base.

Answer 1

more than threefold (from $206 billion to $716 billion).

60%

double digit

two-thirds

Question 2

There are generally four goals for incorporating ESG issues
into institutional portfolios.

Answer 2

1. Increasing risk-adjusted returns (57% of institutional investors believed it increased risk-adjusted returns and Evidence indicates that publicly-listed companies with better ESG scores have less idiosyncratic risk. Evidence is mixed on whether companies with strong ESG ratings earn higher total returns)
2. Reducing reputational risk (70% of institutional investors)
3. Addressing stakeholder concerns (69% of institutional investors incorporate ESG because of stakeholders)
4. Doing the right thing or improving the planet (base of many endowments)

Question 3

There are three key challenges to incorporating ESG principles in investment decisions

Answer 3

1. ESG adoption (asset managers are not meeting institutional investor demand for ESG investing)
2. Lack of standards (little guidance for establishing and implementing ESG policy)

Sustainable Accounting Standards Board (SASB) and ESG ratings from MSCI, Sustainalytics, Bloomberg, RepRisk, and Thomson Reuters are still in their infancy and largely focused on investments in large
public companies, which already have disclosure requirements.

3. Cost (asset managers need to develop their own ESG data sources, analyze that data, and establish operations to ensure consistent application of ESG principles in investment decisionmaking)

Question 4

There are eight environmental issues related to investing in NRs

Answer 4

1. Conserve water (and not polute it)
2. Encourage biodiversity
3. Reduce soil erosion
4. Minimize greenhouse gas emissions
5. Protect endangered species
6. Safe chemical usage
7. Maintain proper permits and licensing
8. Decommissioning (NR investments with a finite life should have a plan for site closure that returns the site as close to its original environmental state)

Question 5

6 Social issues related to investing in NRs

Answer 5

1. Compliance with health and safety standards
2. Meet all labor laws and regulations
3. Provide safety training/ certifications
4. Respect workers’ rights
5. Respect indigenous peoples’ rights
6. Engage respectfully with the community

Question 6

Managers of NR assets should monitor entities (including subcontractors) that work at the site and ensure compliance with all laws and regulations.

4 main areas of focus

Answer 6

1. Cooperate with regulators and non-governmental organizations (NGOs)
2. Achieve industry best practices and/ or sustainability certifications
3. Maintain appropriate anti-corruption procedures
4. Maintain transparency on asset holdings and ESG criteria

Question 7

Commodity returns may be earned in two ways:

Answer 7

directly investing in a physical commodity or using derivative contracts (e.g., futures).

Question 8

Who are commercial investors and non-commercial investors

Answer 8

commercial: commodity producers

non-commercial: users hedge funds, mutual funds, and retail investors

Question 9

The percentage of agricultural commodity contracts and other commodities held by commercial and non-commercial investors

Answer 9

argiculture: about 50/50

other commodities: non-commercial investors hold 70%-90% of
outstanding contracts in other commodities (e.g., oil and gold).

Question 10

ESG investors in commodity futures should consider the
following 5 factors in order to decrease impact on price volatility.

What are the drawbacks of doing so?

Answer 10

1. Do not take delivery of the physical commodity as it may disrupt supply-demand dynamics and distort prices.
2. Only trade the most liquid contracts such that potential for increasing price volatility is low.
3. Demand that hedge funds disclose their strategies and holdings of commodity futures.
4. Avoid funds whose trading is likely to contribute to price volatility.
5. Limit investments in agricultural contracts (especially in smaller, less liquid markets) due to the potential impact of price volatility on poorer countries.

However, enacting these guidelines may reduce pricing efficiency in the commodity markets and reduce profits of ESG-oriented investors in commodity markets.

Question 11

3 possible issues what ESG investors into NR could face

Possible solution to these issues?

Answer 11

1) Sourcing (the source of the NR is not always trasable)

2) Hoarding (investments in certain NR can cause price volatility)

3) Money Laundring (countries with NR often have high corruption, etc)

Possible solution would be to invest directly into the NR plant (mining plant, oil rig, etc)

Question 12

Buildings and construction activity account for ____ of global energy
use and are responsible for ____ of global CO2 emissions.

Answer 12

36% and 39%

Question 13

5 ESG CONSIDERATIONS during REAL ESTATE DEVELOPMENT & ACQUISITION PROCESS

Answer 13

1. Land acquisition and governance (Before an acquisition of real estate, developers should prepare a complete ESG impact assessment of the project)
2. Transparency (policies to avoid bribery and promote open reporting of malpractice by the employees without the fear of retaliation, all contracts and payments are available and transparent)
3. Workers’ rights
4. Environmental stewardship (recycling, environment impact assessment, efficient use of land, walkability, etc)
5. Quality of design, planning, and construction

Question 14

Land acquisition and governance during the REAL ESTATE DEVELOPMENT & ACQUISITION PROCESS - what to consider

Answer 14

Before an acquisition of real estate, developers should prepare a complete ESG impact assessment of the project including:

i. Assessment and consultation with all stakeholders at critical stages of project approval.

ii. Recognition and respect of the rights of indigenous peoples.

iii. Fair and equitable dispute resolution process for workers and the community.

• Acquisition of land should include market value compensation. Involuntary resettlement of people should be avoided; where unavoidable, those displaced should be included in the planning and implementation of their relocation. Relocation should ensure restoration of prior standards of living and economic standing. Investors should ensure that the acquisition process adheres to government and legal requirements to guarantee clear and secure title and avoid future disputes.

Question 15

Transparency during the REAL ESTATE DEVELOPMENT & ACQUISITION PROCESS - what to consider

Answer 15

Practices such as bribery and corruption that may create short-term value for investors can have long-term adverse effects.

For instance, using substandard construction materials may result in property damage and loss of life, and increase project costs.

Policies should exist that ensure that all contracts and payments are available and transparent; and that transactions are carried out independently. Policies can use sealed bids and anonymous applications.

Interactions with governing or regulatory agencies should be conducted in public or available to anyone. Employees and workers should be encouraged to report issues without fear of recrimination.

Question 16

Workers’ rights during the REAL ESTATE DEVELOPMENT & ACQUISITION PROCESS - what to consider

Answer 16

Key workers’ rights: freedom of association; collective bargaining; and
protection from discrimination, harassment, and forced or child labor

• Establish a safe, healthy work environment and ensure that workers are properly trained and have necessary safety equipment.
• Audit subcontractors and suppliers to ensure compliance with labor laws
• Where possible, use local small businesses and underrepresented populations.

Question 17

Environmental stewardship during the REAL ESTATE DEVELOPMENT & ACQUISITION PROCESS - what to consider

Answer 17

Best practices in their real estate developments:
i. Project design in which buildings and infrastructure make efficient use of the land.

ii. Consider walkability, proximity to public transportation, and green spaces as these can enhance a development’s environmental sustainability.

iii. Environmental impact assessment (including water management, energy consumption and GHG emissions, impact on biodiversity, and climate change mitigation).

iv. Use of sustainably-sourced building materials.

v. Site development and construction techniques that minimize soil erosion and materials waste.

vi. Recycling of materials, when possible.

Question 18

Quality of design, planning, and construction during the REAL ESTATE DEVELOPMENT & ACQUISITION PROCESS - what to consider

Answer 18

i. Design and construct buildings to accommodate the impact of predictable future weather, seismic (e.g., earthquake), and climate change events.

ii. Adhere to international building codes and construction standards

iii. Conduct a sustainability analysis of the planned building to assess the optimal design that balances economic, social, and environmental costs and benefits.

iv. Plan for alternative future uses of the building by using adaptable design principles and material choices.

v. Enhance the building occupants’ productivity and health by ensuring adequate levels of natural light, indoor air quality, and common spaces.

Question 19

5 ESG CONSIDERATIONS during USE of REAL ESTATE

Answer 19

1. Transparency and disclosure
2. Environmental stewardship
3. Energy consumption
4. Water
5. Waste management

Question 20

Transparency and disclosure during USE of REAL ESTATE - what to consider

Answer 20

Transparent practices:
i. Robust internal and external compliance programs (including employee training and supplier reporting) to ensure appropriate oversight of transactions and to identify possible corrupt practices (e.g., money laundering).

ii. Transparent framework for collection, use, and secure storage of data on tenants and building operations. Privacy policies should be clearly communicated.

iii. Clear criteria for evaluating building performance against appropriate economic, environmental, and social benchmarks.

iv. Communication protocols for all stakeholders to ensure regular reporting of building performance, management effectiveness, and investment results.

Question 21

Environmental stewardship during USE of REAL ESTATE - what to consider

Answer 21

Buildings use large amounts of energy and water in their operations, emit considerable levels of CO2, and may create considerable waste.

Thus, an ESG policy should include oversight and management of the environmental impact of real estate assets during their use.

Question 22

Energy consumption during USE of REAL ESTATE - To ensure efficient energy use and minimize environmental impact, companies should do the following:

Answer 22

i. Incorporate energy efficiency and tracking in facilities management by adopting recognized global standards (e.g., LEED or ISO 50001).

ii. Use energy-efficient lighting and motion controls to conserve electricity.

iii. Explore the feasibility of becoming energy self-sufficient using renewable energy (e.g., solar panels and wind turbines).

iv. Use “smart” building control systems to track energy usage data and minimize inefficient heating and cooling practices.

v. Incorporate environmental clauses in leases that encourage tenants to adopt energy-efficient practices and share the financial benefits of these practices with them.

vi. Display data on the building’s energy usage and carbon footprint in public spaces to encourage employees and tenants to support efficiency and conservation.

Question 23

Water during USE of REAL ESTATE - best practices

Answer 23

i. Use low-flow plumbing fixtures when permitted by code.

ii. Use metering and sub-metering equipment to track water usage and to identify leaks.

iii. Explore alternative on-site water sources (e.g., capturing rainwater and storm runoff for irrigation or reusing graywater).

iv. Use native plants and low-irrigation landscape plans.

v. Educate building users and tenants on water conservation best practices.

Question 24

LEED stands for …

It is a widely used green building certification program with four rating levels: …

Answer 24

Leadership in Energy and Environmental Design

Certified, Silver, Gold, and Platinum.

Question 25

ISO 50001 is the

Answer 25

global standard for energy management systems

Question 26

Waste management during USE of REAL ESTATE - To mitigate the adverse effects of MSW (minicipal solid waste), companies may do the following.

Answer 26

i. Collect accurate data on the volume and categories of MSW generated by a facility and report this information to tenants on a regular basis.

ii. Provide on-site diversion programs for recyclables, organic waste for composting, and specialty items (e.g., batteries and light bulbs).

iii. Educate tenants on opportunities for recycling, composting, etc.

iv. Adopt practices that avoid production of materials (e.g., replace paper towels with high efficiency hand dryers; order supplies in bulk to reduce packaging; provide reusable dishware and water bottles; and use disposable products that are recyclable).

v. Minimize waste from tenant turnover by encouraging new tenants to reuse improvements and fixtures left by prior occupants.

Question 27

What for is the energy in the building mostly consumed?

Answer 27

The energy is used primarily for climate control (i.e., heating and air conditioning), lighting, heating water, and appliances.

Question 28

TREATMENT OF TENANTS, WORKERS, AND COMMUNITIES UNDER ESG - 4 areas of focus

Answer 28

1) Comprehensive non-discrimination policies (for rentals and sales of real estate)

2) Procurement policies (local sourcing for labor and materials when possible)

3) Health, safety, and well-being of occupants

4) Workers’ rights across the supply chain

Question 29

TREATMENT OF TENANTS, WORKERS, AND COMMUNITIES UNDER ESG:

Comprehensive non-discrimination policies (for rentals and sales of real estate)

Answer 29

i. Extend to buildings that provide public access.

ii. Use transparent, fair contracting documents and procedures.

iii. Provide a process for regularly collecting tenant feedback and addressing grievances.

iv. Develop activities and programs to engage local community members, particularly ethnic and racial minorities, women, children, the elderly, and disabled.

Question 30

TREATMENT OF TENANTS, WORKERS, AND COMMUNITIES UNDER ESG:

Several practices can help to ensure the safety and well-being of occupants during a building’s operating life.

Answer 30

i. All parts of buildings should be accessible to and usable by people with challenges (e.g., mobility, visual, or hearing).

ii. Companies should have clear policies and procedures regarding factors such as fire safety, active shooter training, and weather-related evacuation/shelter.

iii. These policies should be clearly communicated and visible to all building occupants.

iv. Relevant training should be provided where appropriate.

v. Adherence to all health/ safety laws and regulations by tenants and staff should be monitored and reported on regularly.

vi. Potential public health risks created by the building or its occupants should be clearly disclosed.

vii. Access to water and convenient, private sanitation facilities should be guaranteed to all building occupants.

viii. Building managers should ensure adequate indoor air quality by using non-toxic and zero-VOC products in building materials and cleaning supplies.

Question 31

Graywater is

Answer 31

wastewater from buildings that is not contaminated with fecal matter (e.g., water from bathrooms sinks, showers, and washing machines).

Question 32

Once real estate assets are put into use, policies should be established that protect workers’ rights. These policies should entail the following.

Answer 32

i. Cover the owner/manager’s employees and subcontracted workers responsible for maintenance and repair of the building.

ii. Include a diversity and inclusion policy that ensures diversity and gender equality.

iii. Ensure strict adherence to all child labor laws.

iv. Provide proper equipment and training to ensure the safety of workers and occupants.

v. Pay wages that comply with wage laws, including laws against gender pay discrimination, and require subcontractors to do the same.

vi. Communicate and monitor compliance with occupational health and safety issues.

vii. Implement a policy of regular inspection and routine maintenance related to building health and safety.

Question 33

ESG ISSUES IN RECOVERY AND DISPOSAL OF REAL ESTATE

As part of a transparent decision-making process, companies are encouraged to do the following.

Answer 33

1. Review market conditions and long-term demand for the existing building/site (Conduct a comprehensive cost/benefit analysis of potential options, which includes direct and indirect costs and any intangible benefits of sustainable redevelopment)
2. Consider the social and community impact of changing the use of the building (Local historical, cultural, and archeological standards should be respected and incorporated into the renovation or redevelopment assessment)
3. Use standard sustainability assessment tools and methods to evaluate each option’s economic, social, and environmental impact.

Question 34

Real estate assets have long lives (e.g., median age of owner-occupied homes was ___ years in 2016 and average U.S. commercial building was ___ years old in 2021).

Answer 34

37 and 53

Question 35

At the end of a real estate asset’s useful life, a strategic site-use evaluation may be carried out that determines the optimal strategy for the asset which include and is driven by:

Answer 35

Renovation/ refurbishment, redevelopment, or decommissioning

The decision is often driven by investor preferences and economic factors.

Question 36

ESG ISSUES IN REFURBISHMENT AND RETRO-FITTING - best practices

Answer 36

1. Evaluate existing buildings in the context of strategic and long-term requirements to determine the optimal level of renovation (for energy efficiency, a low level renovation may include installation of LED lighting and insulating curtains and a more extensive renovation may include solar panels, wind turbines, or triple-glazed windows)
2. Assess potential levels of refurbishment to determine the optimal combination of costeffectiveness, energy efficiency, and environmental impact.
3. Consider the effect on the building and site of changing environmental conditions and the increased risk related to the current and projected impact of climate change

Question 37

WASTE MANAGEMENT, RESOURCE CONSERVATION, & RECYCLING RELATED TO DEMOLITION OF REAL ESTATE ASSETS

Companies are encouraged to do the following.

Answer 37

1. Conduct a pre-demolition audit that minimizes the amount of waste placed in a landfill and ensures safe handling of hazardous materials.
2. Minimize the impact of demolition/ disposal activities on surrounding communities.
3. Prepare a risk assessment of demolition activities and then develop site-specific procedures to manage these risks.
4. Ensure adequate insurance and emergency procedures to address demolition accidents.
5. Comply with laws for handling and disposing waste materials and obtain necessary permits.
6. Provide for the safe handling of site waste water and ensure safety of groundwater supplies.
7. Process demolition materials for reuse and/ or recycling, ideally, on-site.

Question 38

LAND RECOVERY AND REHABILITATION IN REAL ESTATE

In the rare cases when real estate assets are abandoned at the end of their useful life, land recovery and site rehabilitation activities should be undertaken to ensure that the land is restored to a safe, environmentally sustainable condition.

To achieve this goal, companies should do the following.

Answer 38

1. Review legal and regulatory requirements for preparing environmental impact assessments.
2. Identify considerations to include in an environmental impact assessment ( e.g., wildlife surveys, flora, agricultural, ecological, hydrologic, historical, and archeological).
3. Recruit specialists and commission a comprehensive environmental impact report.
4. Survey site conditions to determine rehabilitation methods needed to return the site to desired environmental standards.
5. Develop an integrated plan of action that incorporates the following, where relevant: interacting with local communities, promoting native species, protecting animal migration routes, managing forestry and water resources, and re-using construction materials.

Question 39

The shift of HFs’ migration towards ESG is driven by

Answer 39

• regulation
• risk management
• client demand
• pursuit of new sources of alpha

Question 40

Preferred Hedge Fund governing body consists of the following:

Answer 40

1. A majority of independent directors.
2. Qualified and experienced directors.
3. Directors who are representative of a potentially diverse and broadening set of investors.
4. Independent directors, who may be needed to represent investors when there are potential conflicts of interest between management and investors.

Question 41

Governance typically covers two main themes:

Answer 41

directors’ backgrounds, roles, and independence;

AND

the transparency of the HF’s leadership team, holdings, restrictions, and risks

Question 42

Open Protocol Hedge Fund Reporting provides a standard and consistent framework involving the following factors:

Answer 42

1. Data and inputs
2. Calculations and methods
3. Timely and regular reporting
4. Protocols and standards, where appropriate

Question 43

HFs should be encouraged to provide transparency regarding …

Answer 43

• liquidity levels
• risk management and monitoring processes
• valuation process (not valuations themselves)
• investment gates,
• lock-ups
• fee structure.

Question 44

HEDGE FUND INVESTMENT TECHNIQUES & INSTRUMENTS, AND ESG

HFs use of advanced instruments and techniques (e.g., derivatives, short-selling, leverage, and high-frequency trading) to optimize their risk-return profiles should be transparent to investors, the following should be disclosed.

Answer 44

1. Short selling (Some institutional investors are prohibited from short-selling. Further, some HFs are taking an active role in governance by shorting the stocks of firms with low ESG scores)
2. Leverage (leverage can also increase a fund’s risk and increase returns).
3. Derivatives (complex instruments the risk profile of which isnt always understood)
4. High-frequency trading
5. Hedge fund strategies
6. Forms of intersection between hedge fund strategy and ESG

Question 45

ESG disclosure requirements for Fund’s use of Leverage

Answer 45

The fund should consider disclosing the following.
i. Conditions under which leverage may be used.
ii. Restrictions and sources of the leverage.
iii. Additional risks due to leverage (e.g., counterparty credit risk).
iv. Details about how leverage is defined and measured by the fund.
v. Match or mismatch of the maturity of the leverage to the assets’ maturity.

Question 46

ESG disclosure requirements for Fund’s use of Derivatives

Answer 46

HFs should consider disclosing the following:

i. Whether derivatives are used by the fund.

ii. If use of derivatives is a central strategy of the fund (as opposed to occasional use).

iii. Regulatory and operating risks to which investors will be exposed.

Question 47

In a 2021 assessment of 300 private equity managers, the percentage rated excellent or good in terms of ESG improved from 27% to ___% between 2014 and 2021, and those rated poor declined from 43% to ___%.

Answer 47

66% and 17%

Question 48

Private equity firms interested in engaging in ESG activities should include what three elements to create and support an ESG culture?

Answer 48

1. Establishing a formal commitment to ESG integration
2. Setting ESG-related objectives and metrics (set specific, tangible, and achievable goals and objectives, which should be clearly communicated to employees.)
3. Engaging and communicating with all stakeholders (limited partners need to be involved early on so they can better understand what is likely to occur and whether its aligns with their objectives)

Question 49

To maintain an organization committed to sustained ESG integration, a number of practices should be initiated and maintained.

Answer 49

i. A formal commitment is needed from the organization’s leadership, who should make resource commitments and guarantees transparent.

ii. One or more persons with experience or expertise in ESG integration should be put in charge of this effort.

iii. Employees should be educated as to why the firm is engaging in ESG integration; how it can help the firm, investors, and other stakeholders; and the likely results of an ESGrelated and engaged strategy and processes.

iv. Achieving ESG objectives needs to be linked to employee and firm performance objectives and results.

Question 50

The investment process can be divided into three areas to evaluate relative to ESG

Answer 50

1) due diligence (ESG screening, industry specific ESG requirements,
2) investment decision and agreement (ESG clauses)
3) ownership.

Question 51

Top ten ESG metrics sought by private equity fund investors are the following:

Answer 51

i. Does the firm have an ESG Policy?
ii. Is there an individual or team that is specifically assigned to administer ESG policy?
iii. Is there a Corporate Code of Ethics?
iv. Presence of litigation
v. People diversity
vi. Net employee composition (e.g., percentage of full-time to part-time workers, etc.)
vii. Environmental policy
viii. Estimation of CO2 footprint
ix. Data and cybersecurity incidents
x. Health and safety events

Question 52

Engagement of portfolio companies (ownership rights in companies) on ESG practices can involve the following

Answer 52

i. The private equity firm can engage with the portfolio company on understanding of ESG related risks and opportunities.

ii. The portfolio company should have ESG policies and processes that are at least as strong as those of the private equity firm.

iii. The portfolio company can share any best practices with the private equity firm and other portfolio companies.

iv. All governance boards should be accountable for ESG-related initiatives.

Question 53

ESG AND THE MONITORING PROCESS

Monitoring the portfolio companies should be consistent, transparent, and incorporate ESG metrics. Investors should do the following.

Answer 53

1. Ensure that ESG issues and risks (and opportunities) remain on the board’s agenda.
2. Provide tools for measuring ESG practices and prepare structured, consistent reporting practices across portfolio companies.
3. Ensure that ESG performance is a part of quarterly/ annual reviews.