YvY’s regulatory thesis for sustainable finance
A team of once-public sector bankers and officials is launching a new private equity fund that aims to identify ‘climate winners’ from the transition to a decarbonized economy. It has identified key industries but its central thesis is regulation.
As scepticism swirled around the ability of governments to secure a consensus on climate regulation during COP28, the founders of a new Brazilian environmental, social and governance-focused startup expressed their belief that sustainable finance is a one-way street.
“It is clear to me from [my time in] the corporate environment and the public sector that sustainability is the way to go,” YvY senior partner Roberto Azevêdo tells Euromoney.
Azevêdo is also chairman of the board of the PepsiCo Foundation and a one-time director general of the World Trade Organization.
“I keep saying to people who question the trend that the ship has already sailed," he adds. "Those that think this is avoidable don’t know what they’re talking about. I mean, this thing is for real.”
There is a clear realization on the part of everyone that we’re never going to get there if we just cross our fingers and hope for the best
Azevêdo speaks to Euromoney via video from COP28. At the new firm’s São Paulo headquarters, we meet Gustavo Montezano, another founder of YvY and, until recently, president of BNDES, Brazil’s state-owned development bank.
Montezano ushered in a new focus on ESG under his premiership of BNDES and 14 bankers have followed him from there to his new startup, including Fábio Abrahão, formerly head of infrastructure at the bank.
Montezano is also joined at YvY by his old boss from his days at Pactual, Rodrigo Xavier, as well as former Brazilian minister of economy Paulo Guedes and former minister for the environment Joaquim Leite.
The latter is described by one banker as “a mixed asset” in terms of his track record on ESG, but Montezano insists that he brings “strong green understanding”.
“I’ve been talking to people about their government’s Paris commitments here at COP28, and of course they want to fulfil their commitments, meet their targets,” Azevêdo explains. “And there is a clear realization on the part of everyone that we’re never going to get there if we just cross our fingers and hope for the best.
"So, governments are going to entice companies to reduce their carbon emissions, one way or another. There are several ways you can do that, but it’s mostly about incentives [for improving] or penalizing companies for their carbon emissions.”
The right steps
Montezano says that YvY will invest in companies that they identify as “climate winners”. He argues that Latin America is well placed to drive the coming transition away from carbon-emitting industries, especially in the hard-to-abate sectors.
“South America has huge potential for the transition – we have water, sun, land, natural resources. But if you are not fast enough with the regulation, and if the regulations go in the wrong direction, there is no transition. In order to build the proper regulations, we need a critical mass of thinking people in Brazil to understand and agree what we’re facing and take the right steps.”
For example, green hydrogen offers huge potential, not only for development in Brazil but for export. Many of the hard commodities that will drive electrification come from the region, while programmes on soft commodities – the ability to feed the world’s population in a less carbon-intensive way – are also being developed and implemented in the region.
YvY will have a particular focus on companies with growth potential – either in terms of commodities, technology or services.
“Either the value will be in export or the value chain,” says Montezano. “We want to work with companies that address the supply chain from end-to-end – all aspects of the supply chain, from sourcing inputs to creating products and distribution, will be impacted by decarbonization, and all those pieces need to come together to maximize the gains from all players. That’s the reality of the market today – no one prepares the whole chain from end to end, and that’s our ambition.”
YvY has identified four main investment themes and is talking to global and regional institutional investors to raise sufficient capital to launch. Three are global themes – energy transition, natural resources and agriculture – and the fourth, water and sanitation, is local.
The globals will be dollar-denominated investments, the fourth will be in real. The team is talking to investors about whether to include all four in the same fund, which will involve YvY taking minority equity stakes in companies.
Montezano thinks there should be single fund, with the local theme offering some FX diversification, but that debate is still open.
What’s going to drive the growth in green hydrogen? Regulation. Green fertilizers? Regulation. AI data centres? Regulation
The thematic link between them all is regulation – an investment thesis that global and national regulation will drive structural growth among companies aligned with decarbonization.
“What’s going to drive the growth in green hydrogen? Regulation. Green fertilizers? Regulation. AI data centres? Regulation,” says Montezano. “So, it’s a new type of portfolio. In my career I am used to analysing regulated sectors such as roads or power, but going to global sector regulation is something new. Which is good because you can make a lot of money if you are smart enough – and you are disconnected to the global macroeconomic context, to interest rates,” he adds.
Not only are YvY’s first two themes – energy and natural resources – central to any successful transition, and therefore theoretically exposed to decade-long regulatory-driven structural growth, Montezano argues so are the other two.
“People need to eat” he argues of agriculture, which has been booming in Brazil in recent years. While the fourth, water and sanitation, is seeing similar long-term structural growth due to recent legislation that opened the sector to private capital.
Montezano also argues that regulatory arbitrage might present interesting investment opportunities.
“We are looking at buying into companies that operate in what we call ‘mis-regulated’ industries, or sectors that are not properly regulated, where companies can have a high discount to their cost of equity.
"We are betting that they will become better regulated and the big players can come and invest there. It’s similar to moving from unlisted to listed companies; now we can invest in mis-regulated industries before they move to properly regulated industries.”
He says that the talks with potential investors have centred around the non-correlation with existing investments. He says that the proposition of a fund that has a central thesis of identifying climate winners based on regulatory-driven growth is challenging but attractive.
“These investments not only offer the opportunity for outperformance, they offer uncorrelated performance from the rest of investors’ portfolio, and I would argue, uncorrelated performance to the macroeconomic performance of the next 10 years,” he says, before adding a provocatively optimistic alternative.
“And if in 10 years carbon issues are not a problem anymore, if we have solved the environmental problems, we will be able to give investors their money back.”