The Greening of Private Equity Venture Capital and Hedge Funds

The year 2006 will likely be remembered for the "greening" of the high-stakes upper end of the investment chain—private equity, venture capital, and hedge funds. (See Box 13-3.)

Investing for Sustainability

Box 13-2. Importing Sustainability to China

Although China has huge negative social and environmental impacts through exporting, it has the opportunity to integrate sustainability into its burgeoning finance sector. But the task is as big as everything else about the country, and the banks are at least a decade behind their counterparts throughout the rest of the world in this endeavor. The first steps have been taken, however: in May 2006, Bank of China International Investment Managers launched the Sustainable Growth Equity Fund, the first SRI fund in the country.

Even more significant, Chinese banking regulatory authorities have issued notices to all banks in the country that their lending activity must assess borrowers' compliance with environmental laws. How comprehensively is this mandate being followed? The lack of transparency makes it difficult to tell. Only two banks—China Development Bank and the Export-Import Bank of China—have publicly disclosed their environmental financing standards. In addition, the China Construction Bank has issued a corporate social responsibility report.

The Peoples' Bank of China also recently developed a new credit database that includes borrowers' environmental compliance data, allowing Chinese banks to evaluate how well companies have followed environmental laws before offering loans. And finally, in February 2007 the Shanghai Division of the China Banking Regulatory Commission floated a guidance draft document on corporate social responsibility that addresses banks' "shareholders, employees, financial consumers, communities, and other stakeholders, and social development, and environmental protection," according to the Xinhua news agency. Such guidance would be a first in China.

"By adopting world-class environmental financing standards, Chinese banks can play an important role in advancing sustainability on a global level," said Johan Frijns, coordinator of BankTrack, an NGO consortium. "Otherwise, they threaten to drag down whatever progress that has been made in developing such standards for the international banking sector."

Unfortunately, market forces push down on the environmental and social performance of China's banks. The improving sustainability performance of the rest of the world's banks is leaving the socially and environmentally riskier projects to these newer entrants. China's banks are "bottom feeding on those things international banks are not touching," explains Jules Peck, global policy advisor at the World Wide Fund for Nature-UK, in Ethical Corporation. For example, a European firm seeking to build a dam in Ecuador that is denied funding due to environmental and social risks can seek (and often receive) capital from a Chinese bank.

International banks are not exactly innocent, however. "International banks have complained that the lack of environmental financing standards at Chinese peers is putting them at a competitive disadvantage," said Michelle Chan-Fishel of Friends of the Earth-US. "But banks like HSBC, RBS, Citigroup, Goldman Sachs, and Bank of America all own large shares in Chinese banks. They must take responsibility for ensuring that high environmental standards, which they all claim to have, are also adopted by their strategic business partners."

The issue of international investment support for Chinese companies operating irresponsibly extends beyond China's banks. The oil company PetroChina has come under intense fire from

The effective death of climate change denial helped drive green investment, as the frenzy to find solutions focused on development of "clean" energy—namely, renewable power sources such as solar, wind, and biofuels. The bonanza extended to clean technology (or cleantech), newly recognized as a distinct investment category encompassing a broad range of eco-friendly products and services— from alternative energy generation to waste-water treatment and more resource-efficient industrial processes.32

Market and regulatory forces are also amplifying environmentalists' concerns over

Investing for Sustainability

Box 13-2. continued human rights activists as its parent, the China National Petroleum Corporation, provides significant oil revenues to the Khartoum regime in Sudan that supports the Janjaweed militia who are committing genocide, torture, and rape in Darfur. As with Chinese banks, PetroChina holds hefty investments from international investors.

Activists with the Save Darfur Coalition and Sudan Divestment Task Force targeted mutual fund giant Fidelity Investments and Warren Buffett's Berkshire Hathaway in highprofile campaigns urging them to divest their PetroChina holdings. In May 2007, Fidelity divested 91 percent of its U.S. depositary receipt holdings in PetroChina. It was unclear at the time, however, whether the company also divested its shares on the Hong Kong exchange—if not, it would have divested only 38 percent of its overall PetroChina holdings.

Berkshire Hathaway shareowners filed a resolution for vote at the May 2007 annual meeting calling on the company to divest from PetroChina. The "Oracle of Omaha" (as Buffett is known) contended that using his voice as an investor to promote change at PetroChina through divestment or moral suasion was "fruitless" (despite the fact that Berkshire held the largest stake of PetroChina), and more than 97 percent of shareowners voted against the resolution. However, Buffett later quietly divested more than a quarter of Berkshire's holdings in PetroChina—dumping 445 million shares worth over $1 billion between July and September 2007, according to Investors Against Genocide.

Source: See endnote 27.

Box 13-3. Hedge Funds Marry Ecology with Economics

Hedge funds—unregulated portfolios open only to accredited investors that use "sophisticated" strategies such as shorting (profiting from falling stock prices)—have caught the green bug, with the number of hedge funds in this category proliferating. According to Peter Fusaro, founder of Global Change Associates, there are over 600 environmental and energy hedge funds, 50 hedge funds trading emissions in the United States and Europe, and 13 pure green hedge funds.

In other words, there are enough green hedge funds to launch several "funds of funds"—as the name implies, hedge funds that hold a number of hedge funds. The first such meta-fund,the Kenmar Global ECO Fund, which seeks to marry ecology with econom-ics,was launched in July 2007.

There is also enough interest in green hedge funds to get the attention of the world's largest hedge fund management firm. In September 2007, the Man Group announced it had raised almost $400 million in a climate change-related hedge fund. The China Methane Recovery fund will set up subsidiaries to extract methane, a potent greenhouse gas, from Chinese coal mines to generate electricity and also to trade for carbon credits.

Source: See endnote 32.

the viability of traditional energy investments such as coal, according to a July 2007 report from Citi. The report downgraded coal stocks from "buy" to "hold" recommendations due primarily to concerns over impending coal regulations seeking to curb the dirty fuel's contributions to global warming. "Prophesies of a new wave of coal-fired generation [in the United States] have vaporized," writes report author John Hill. "We expect anti-coal politics to intensify, with carbon constraints almost certain to pinch." So carbon regulation is driving investors toward sustainable investing strategies. (See Box 13-4.)33

When it comes to green venture capital and private equity investment—namely, large investments to seed startup or early-stage companies—the statistical picture that emerges depends on who is coming up with the numbers. There is a clear consensus on

Investing for Sustainability

Box 13-4. TXU Buyout Is History's Biggest—and Greenest

The greening of private equity/venture capital took a surreal turn in February 2007. The major private equity firms Kohlberg Kravis Roberts & Co. and Texas Pacific Group had teamed with Goldman Sachs to buy out TXU. The company had been under intense fire from environmentalists for fast-tracking plans (presumably to get them in place before potential federal carbon legislation kicked in) to build 11 coal plants that would annually dump 78 million tons of carbon dioxide into the atmosphere. SRI activists had filed three separate shareowner resolutions calling the plan into question.

The buyers called in two of the main NGOs campaigning against TXU, Environmental Defense and the Natural Resources Defense Council, to broker agreeable terms over two weeks of intense negotiation. "This will not only be the biggest leveraged buyout ever, it is the only buyout in history made contingent on the approval of environmental groups," said Jim Marston, director of the Energy Program in the Texas Office of Environmental Defense, who led the campaign against TXU and lobbied the buyers.

The $45-billion TXU deal, which also included Lehman Brothers, Citi, and Morgan Stanley as equity investors, committed the company to drop applications for 8 of the 11 coal plants, avoiding 56 million tons of annual carbon emis-sions.The plan also committed the company to:

• terminate its previous plans to expand coal operations in other states;

• endorse the United States Climate Action Part-

nership platform, including the call for a mandatory federal cap on carbon emissions;

• reduce the company's carbon emissions to 1990 levels by 2020;

• promote demand-side management programs to reduce energy consumption;

• double the company's expenditures on energy efficiency measures;

• double the company's purchases of wind power;

• honor TXU's agreement to reduce criteria pollutants in Texas by 20 percent (the pledge had been contingent upon approval of all 11 plants); and

• establish a Sustainable Energy Advisory Board on which Marston of Environmental Defense will serve.

Making good on its wind pledge,TXU announced in late July 2007 a partnership between its Luminant subsidiary and Shell WindEnergy to develop the world's largest wind farm—a 3,000-megawatt wind project in the Texas Panhandle—as well as other renewable energy projects. In April 2007, however, the Wall Street Journal reported that the company is also pursuing plans to build the biggest nuclear plant in the United States to make up for the eight canceled coal plants. Some environmentalists now view nuclear power as a climate solution, while others cite continuing concerns about this energy source.

Source: See endnote 33.

one count, however: money is pouring into clean energy and cleantech.

According to a June 2007 U.N. report, global venture capital and private equity investment in sustainable energy totaled $8.6 billion in 2006, increasing 69 percent over $5.1 billion in 2005, with the number of deals increasing by 12 percent. (See Figure 13-1.) The three most active sectors were biofuels ($2.3 billion), solar ($1.4 billion), and wind ($1.3 billion).34

While these investments primarily address the environmental part of the sustainability equation, they sometimes attend to social issues as well. For example, while the majority of the money went into increasing manufacturing capacity (particularly in wind), some went to develop new technologies— such as 20 percent of biofuel investment, some of which supported research for second-generation biofuels, including cellulosic ethanol, that reduce the diversion of cropland

Figure 13-1 .Venture Capital and Private Equity Investment, 2000-06

Investing for Sustainability

Figure 13-1 .Venture Capital and Private Equity Investment, 2000-06

from food to fuel.35

Looking through the lens of cleantech, global venture capital investment increased by 78 percent in 2006 to $2.9 billion, catapulting cleantech into the spotlight as the third largest venture investment category, ahead of telecommunications and medical devices. High demand for global warming solutions such as renewable energy is driving a bull market for clean technology, according to Bob Epstein, co-founder of Environmental Entrepreneurs, who coauthored a study with Cleantech Network on the state of venture capital in cleantech. The report projects that venture capital investments in this sector will exceed $19 billion by 2010—a more than sixfold increase in just four years.36

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