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Private equity firms can be catalysts to fighting climate change, here is how

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New whitepaper, “Creating Value through Sustainability in Private Markets,” released by the World Economic Forum offers key steps the private equity industry can use to drive change.

This is after the study, which was done in collaboration with Boston Consulting Group (BCG), explored how the private equity industry has a unique opportunity to be a key driver in fighting climate change. With its full ownership model and relative freedom from short-term pressures, the industry is well placed to lead the way in capturing value through sustainable transformation of their investments.

“Many private equity firms are missing out on opportunities to create real financial value through long term, sustainable investments,” says Shrinal Sheth, Lead, Investing, World Economic Forum. “Industry leaders who are interested in driving climate solutions must act quickly to ensure their firms are operating in ways that allow them to successfully create sustainable value.”

However, key barriers like knowledge gaps, internal organization misalignments and an overfocus on divestment are still blocking the private equity industry from fully realizing its potential in driving sustainability shifts.

Transforming “Grey to Green” assets

Instead of divestment-only approaches, the study shows that private equity firms can improve the sustainability performance of currently high-emitting assets by investing in long-term opportunities to make them greener.

In fact, the industry is ideally positioned to play this role, due to its full-ownership model and longer time horizon, relative to public markets.

“Many private equity investors avoid ‘grey’ or high-emitting assets in an attempt to decarbonize their portfolios,” said Greg Fischer, a partner and director at BCG, and a co-author of the whitepaper. “This is a missed opportunity. We cannot divest our way to global Net Zero. Meeting the world’s decarbonization challenge requires investment and engagement. Private equity—with its ability support strategic transformations and a longer horizon than public markets—is ideally positioned to meet this need, transforming high-emitting assets “from grey to green” and making real progress towards our global ambition.”

Three key enablers for this transformation include:

  • Change-over-time emissions reduction frameworks to supplement existing levels-based portfolio emissions targets
  • Carbon pricing to help investors to more directly capture the value of their decarbonization initiatives during the holding period
  • Clear retirement and decarbonization policies for high-emitting assets that explicitly define the intended trajectories, provide incentives for sponsors to undertake bold sustainability transformations and make owners accountable for ensuring that the high-emitting assets they divest are sold not to the highest bidder but to new owners with well-defined decarbonization plans

“The ownership model in private equity allows for meaningful positive change through data and engagement,” said Marcie Frost, CalPERS’ Chief Executive Officer. “As longterm investors, sustainability is critical to value creation, and we believe the convergence and standardization of sustainability data will enable a rapid acceleration in the integration of these factors across portfolio companies in our private equity partnerships.”

“As investors and partners, our job is to improve all aspects of a business to drive growth and improve how they operate over the long haul,” said Kewsong Lee, Carlyle’s Chief Executive Officer. “In a rapidly changing world, that increasingly means helping companies to improve their performance on ESG issues. This is a job we are positioned particularly well for given our ownership stakes, investment horizon, and expertise.”

Five steps for sustainability in private equity

The whitepaper has identified five first steps private equity firms can take to ensure their investments are driving sustainable change.

1. Invest in capabilities and culture: The gap in capabilities is one of the primary barriers to action for LPs and GPs today. Ensuring leadership includes people who have relevant operational and traditional investment experience along with a sustainability mindset can be a vital first step in building institutional capabilities.

2. Focus on a long-term plan: Developing capabilities and driving a cultural change may involve false starts along the way. To stay the course, private-equity leadership needs to take advantage of the greater time horizon flexibility in private markets and optimize for the long-term outcome, not just quick wins by doing things like embracing experimentation and lengthening hold periods.

3. Communicate the plan, along with measurable milestones along the way: Given the lengthy time horizon required to see results at the asset and portfolio levels, communicating the long-term plan and progress towards it to all stakeholders is vital to securing and maintaining buy-in. This should be in by using both standardized metrics customized reporting.

4. Don’t just divest, transform: Private equity’s full-ownership model and flexibility to take a longer-term view relative to public markets should enable the industry to transform sustainability-laggard assets but so far it has not capitalized on this opportunity.

Divestment and sector rotation offer quick wins for a single investor, but they do not remove sustainability-laggard assets from the global mix. Sustainability challenges need to be addressed head-on by deploying capital to transform these grey assets.

5. Collaborate to address key barriers: Addressing measurement challenges and establishing the right incentives cannot be accomplished in isolation. LPs and GPs across the industry must continue to collaborate to set standards and policies.

“Private equity leaders can take these five ‘Monday morning’ priorities as first steps to help their firms fully realize their important role in decarbonizing hard to abate sectors,” says Shrinal Sheth, Lead, Investing, World Economic Forum. “It is time for private equity to take its role in tackling the global crisis of climate change seriously.”

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Financial education gaps are primary barrier to retail investing in capital markets

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New research from the World Economic Forum finds that 40% of non-investors have chosen not to invest because they do not know how or find it too confusing. Furthermore, roughly 70% of people would be more likely to invest, or invest more, with expanded financial education

Done in collaboration with BNY Mellon and Accenture, The Future of Capital Markets: Democratization of Retail Investing also finds that increased participation of retail investors in capital markets is a largely positive trend. Though some concerns about riskier investments remain, retail investors are showing themselves to be prudent investors using markets to build long-term wealth.

“Even amid market volatility, participation in capital markets can empower people to take ownership of their financial future,” said Meagan Andrews, Investing Lead at the World Economic Forum. “We’re just now starting to understand the new wave of retail investors and the power they are wielding in the market. It’s important industry leaders take steps to empower individuals so they can optimize financial decisions for their betterment, whether they currently invest or not.”

Based on a global survey of over 9,000 respondents from 9 countries and expert interviews, the report highlights the importance of enhancing personalized advice for retail investors and improving the reliability of information and investor protections. It also underscores opportunities to improve education, trust and access to increase inclusion in global capital markets.

With the current market volatility, industry players, policy-makers and others need to act now to ensure the benefits of investing are increasingly accessible worldwide.

“Global capital markets are undergoing a fundamental transformation, with more individual and retail investors seeking access than ever before in history,” said Akash Shah, Chief Growth Officer at BNY Mellon. “This research highlights opportunities for the entire financial industry to build the trust and transparency needed to empower and democratize market participation in underserved communities around the world.”

Trends of retail investors
The survey results provided critical insights into the factors and mindsets impacting individuals’ decisions to enter capital markets globally.

Notably, the survey found that individuals primarily look to capital markets to build long-term wealth, especially in emerging markets. Half of those surveyed were investing to save for retirement or to build generational wealth.

Retail investors are skewing younger, with Gen Z and younger Millennials investing at higher rates. Younger investors are much more likely than their peers to have received financial education earlier in life.

Meanwhile, non-investors are less confident they will achieve their long-term financial objectives and, when compared to investors, a higher proportion only learned about investing many years after entering the workforce. Their main reasons for avoiding financial markets were fear of losing money and because of an investing knowledge gap.

Generational wealth also plays a vital role in deciding to invest early. Respondents whose parents invested in the market reported that they began investing earlier in life compared to those with parents who did not invest.

The survey also revealed significant gaps in product awareness. For instance, surveyed investors noted they had a greater understanding of newer products like cryptocurrencies and non-fungible tokens (NFTs) compared to more traditional instruments like stocks and bonds.

Expanding the benefits of retail investing

There are many ways capital markets and global society can work together to grow wealth for more individuals in a responsible manner.

1. Financial literacy and improving investor education

Personal finance education – from setting a budget to learning how to secure one’s retirement – is integral to building wealth responsibly. Industry players should focus on increasing basic financial literacy, promoting responsible investment strategies and improving proactive retirement planning outside of pensions.

Providing information is not enough – content should be fit for purpose, with efforts to make it as understandable as possible. Both policy-makers and private sector actors need to improve their tactics to meet the desires of today’s investors.

2. Personalized, outcome-oriented advice for all

Solutions that financial institutions currently offer are often siloed and don’t always resonate with investors. Those at lower wealth thresholds are often left with few options to get financial advice: 80% of current investors state being able to speak with an adviser is essential to making an investment decision but only 48% are able to turn to a financial adviser or wealth manager for advice.

All investors should have access to the tools and guidance they need to be successful participants in capital markets. This should be inclusive of investors of all income and wealth levels. The industry must expand access to personalized advice and scale services to thrive to meet increasing retail investor demand – this must happen across all wealth brackets.

3. Collaboration and public-private partnerships

Increased collaboration across the industry, including public-private partnerships, will be needed.

Brokerages, wealth managers and exchanges are integral to this effort due to their proximity to retail investors and the speed at which they can enact change. From educational efforts to initiatives to lower the barriers to entry for retail investors, public-private partnerships will be essential.

“Increasing market participation and empowering retail investors has to include collaboration from all stakeholders,” said Kathleen O’Reilly, Global Lead, Accenture Strategy. “Financial institutions especially, from the C-suite to individual wealth managers, must play a critical role in offering relatable education efforts in addition to the investment products that will help investors become smarter and more confident.”

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Global economy: Outlook worsens as global recession looms

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Still reeling from the COVID pandemic and Russia’s invasion of Ukraine, the global economy is facing an increasingly murky and uncertain outlook, according to the latest report released on Tuesday by the International Monetary Fund (IMF).

The World Economic Outlook Update July 2022: Gloomy and More Uncertain, highlights the significant consequences of the stalling of the world’s three main economic powerhouses – the United States, China and the major European economies.

“The outlook has darkened significantly since April,” said Pierre-Olivier Gourinchas, IMF Economic Counsellor and Director of Research.

“The world may soon be teetering on the edge of a global recession, only two years after the last one”.

The baseline forecast for global growth is for it to slow from 6.1 per cent last year, to 3.2 per cent in 2022 – 0.4 per cent lower than forecast in the last Outlook update in April.

Three key economies

With higher-than-expected inflation – especially in the US and the largest European economies – global financial conditions are becoming tighter.

In the US, reduced household purchasing power and tighter monetary policy will drive growth down to 2.3 per cent this year and one percent next year, according to the outlook.

China’s slowdown has been worse than anticipated amid COVID-19 outbreaks and lockdowns, with negative effects from Russia’s invasion of Ukraine continuing.

Moreover, further lockdowns and a deepening real estate crisis there has pushed growth down to 3.3 per cent this year – the slowest in more than four decades, excluding the pandemic.

And in the Eurozone, growth has been revised down to 2.6 per cent this year and 1.2 percent in 2023, reflecting spillovers from the Ukraine war and tighter monetary policy.

“As a result, global output contracted in the second quarter of this year,” said Mr. Gourinchas.

Inflation

Despite the global slowdown, inflation has been revised up, in part due to rising food and energy prices.

This year it is anticipated to reach 6.6 per cent in advanced economies and 9.5 per cent in emerging market and developing economies – representing upward revisions of 0.9 and 0.8 percentage points respectively. And it is projected to remain elevated for longer.

Broadened inflation in many economies reflects “the impact of cost pressures from disrupted supply chains and historically tight labour markets,” the IMF official stated.

Downward risks

The report outlines some risks ahead, including that the war in Ukraine could end European gas supply from Russia altogether; rising prices could cause widespread food insecurity and social unrest; and geopolitical fragmentation may impede global trade and cooperation.

Inflation could remain stubbornly high if labour markets remain overly tight or inflation expectations are too optimistic and prove more costly than expected.

And renewed COVID-19 outbreaks and lockdowns threaten to further suppress China’s growth.

“In a plausible alternative scenario where some of these risks materialize…inflation will rise and global growth decelerate further to about 2.6 per cent this year and two per cent next year, a pace that growth has fallen below just five times since 1970,” said the IMF economist.

“Under this scenario, both the United States and the Euro area experience near-zero growth next year, with negative knock-on effects for the rest of the world”.

Destabilizing inflation

Current inflation levels represent a clear risk to macroeconomic stability, according to the outlook.

Responding to the situation, central banks in advanced economies are withdrawing monetary support faster than expected, while many in emerging market and developing economies began raising interest rates last year.

“The resulting synchronized monetary tightening across countries is historically unprecedented, and its effects are expected to bite, with global growth slowing next year and inflation decelerating,” said Mr. Gourinchas.

Policy priorities

While acknowledging that tighter monetary policy would have economic costs, the IMF official upheld that delaying it would only exacerbate hardship.

And hampered by difficulties in coordinating creditor agreements, how and whether debt can be restructured, remains unpredictable.

He argued that domestic policies responding to the impacts of high energy and food prices should focus on those most affected, without distorting prices.

“Governments should refrain from hoarding food and energy and instead look to unwind barriers to trade such as food export bans, which drive world prices higher,” advised the IMF official.

Meanwhile, mitigating climate change continues to require prompt multilateral action to limit emissions and raise investment to accelerate a “green transition”.

Policymakers are urged to ensure that measures are temporary and only cover energy shortfalls and climate policies.

Teetering on the edge

From climate transition and pandemic preparedness to food security and debt distress, multilateral cooperation is key, said the IMF economist.

“Amid great challenge and strife, strengthening cooperation remains the best way to improve economic prospects and mitigate the risk of geoeconomic fragmentation,” he underscored.

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Slow Moving Regulatory Decision Making for Cryptocurrency not Economically Favourable

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A new study by the World Economic Forum suggests that the current, indecisive regulatory approach for both crypto and stablecoins poses the greatest risk to financial and monetary stability while also hindering innovation.

Based on interviews with 15 expert economists worldwide, the new white paper, The Macroeconomic Impact of Cryptocurrency and Stablecoins, says that letting both crypto and stablecoins play a regulated role in an economy is the optimal way to promote the advantages of innovation while curtailing potential downsides. The whitepaper also provides important perspectives on the options available to policymakers as they deliberate the path forward for their respective jurisdictions.

“Cryptocurrencies and stablecoins have grown in significance as enablers of economic activity. The time for regulatory ambiguity has passed,” says Matthew Blake, Head of Shaping the Future of Financial and Monetary Systems, World Economic Forum. “Effective regulations are needed to help mitigate the risks associated with digital currencies while realizing the benefits.”

Analysis of macroeconomic net benefit of each regulatory option for cryptocurrencies

Image: World Economic Forum

Analysis of macroeconomic net benefit of each regulatory option for stablecoins

Image: World Economic Forum

The analysis of the macroeconomic impact was carried out using a qualitative review of interview notes from individual interviews.

Next steps for cryptocurrency and stablecoins

Much of the benefits of cryptocurrency and stablecoins will depend on how regulations are designed and enforced. A key component of this regulation will be common definitions surrounding different types of digital currency. The Macroeconomic Impact of Cryptocurrency and Stablecoins lays out important definitions of both crypto assets and stablecoins that will be key for policy-makers to build on as they develop and implement digital currency regulations.

Other steps for regulators to take now are coordinating with other governments, including crypto and stablecoins in monetary financial statistics, and including economic projections in their regulations as they become more available.

In the coming months, the World Economic Forum will release further analysis and recommendations for regulators, business leaders and others in the digital currency ecosystem through its Digital Currency Governance Consortium community.

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