RESPONSIBLE INVESTING AND ESG POLICY

Background and Purpose

Mercator Partners’ (“Mercator” or “the Manager”) is an alternative asset manager with an investment focus on the impact of decarbonization and structural disruption across the asset heavy industries such as power production, transportation, and industrial production. Decarbonization represents a multi-decade opportunity encompassing the key themes or sources of disruption, including the energy transition, efficiency and sustainability, as well as resource circularity.

Incumbents in the asset heavy sectors have been the largest contributors to environmental degradation and climate change, largely due to them avoiding pricing their external environmental and societal costs. This is rapidly changing as societal awareness around climate and the environment is increasing and the tolerance for polluting technologies and poor corporate behavior is being eroded.

R&D across materials science, green technologies, electrification, and digitization drive innovation and competitive economics for alternative efficient and sustainable activities and business models. Over the next two decades new and nascent technologies and corporates will scale and succeed, while incumbents must pivot or perish.

Mercator seeks to capitalize on this structural change via a long/short global mandate offering our investors exposure to a decarbonization focused, sustainable, and transparent investment process and portfolio.

Scope & Applicable Asset Classes

All activities in the Mercator Convergence Funds (known as the ‘Fund(s)’). The Fund invests in global public equities.

DEFINITIONS

  • Sustainable Investment(s): An investment that is partially or fully (based on revenue) - eligible or aligned - with the EU Taxonomy¹ for sustainable activities according to its defined environmental objectives.


  • Physical risk²: A direct negative impact on company’s financial value from acute and chronical climate change.


  • Transition risk²: An indirect negative impact on a company’s financial value from its negative contribution to sustainability factors and mediated via societal response through policy, regulations, technology, market forces, and reputational risk.


  • Engagement: Any direct corporate or management interaction (email/phone/in person), or via third party (CDP, UNPRI), in which questions are raised about the company’s relevant non-financial disclosures or lack thereof.


  • Environmental characteristics: Since the inception of the Mercator Convergence Fund in April 2019 the portfolio themes and portfolio exposures have overlapped with the eligible economic activities outlined under the EU Taxonomy’s Environmental Objectives. As an Article 8⁶ aligned Product making Sustainable Investments, the Manager, selected Environmental Characteristics and Sustainability Indicators demonstrating the natural fit of the Product’s portfolio exposures to the high-quality benchmark for sustainable investment set by the Taxonomy. The defined environmental characteristics promoted through the product are

  1. Sustainability Indicator 1 (SI1): A long position’s Eligibility within the EU Taxonomy, whereby “eligibility” means the investment contributes to an environmental objective identified in Article 9 of the Taxonomy Regulation. For the purposes of this Product, “eligibility” also includes sustainable investments contributing to an environmental objective, but for which detailed technical screening criteria have not yet been adopted.

  2. Sustainability Indicator 2 (SI2): A long position’s Alignment with the EU Taxonomy, whereby “alignment” means investments that meet the criteria under Article 3 of the EU Taxonomy regulation.

  3. Sustainability Indicator 3 (SI3): A short position’s transition risk. Transition risk refers to the financial materiality and impact on business models with a negative contribution to climate and nature from societal responses (policy, regulation, technology, market, reputation). One way of proxying transition risk are high levels of Scope 1-3 emissions per unit of revenue (PAI Indicator #2).

SUSTAINABLE INVESTMENT GUIDELINES

Sustainable investment strategies/practices

Mercator Partners’ Equity & Primary Research process lends itself to a quantitative and science based sustainability evaluation where an in depth understanding of corporate data generation (Life Cycle Assessments, LCAs) and sustainability disclosure requirements set out in non-financial reporting frameworks (CSRD/CDP/CDSB/TCFD/GRI/IIRC/SSAB)³ are used in addition to source documents from corporates (sustainability reports, LCAs, technical documentation), industry associations, academia, national labs, and government regulatory & policy institutions.

Sustainability standards for investee companies

Environmental Objectives:

The Fund invests with the goal of building a portfolio that broadly contributes to the decarbonization of asset heavy industry. In drawing inspiration and guidance from the relevant EU directives. The EU Taxonomy Regulation establishes six official environmental objectives. These objectives are descriptive of business activities serving a positive purpose as it pertains to climate and the environment, thus constituting the investment objectives pursued with respect to the Mercator Convergence Fund’s portfolio construction. The objectives include:

  • Climate change mitigation

  • Climate change adaptation

  • Sustainable use and protection of water and marine resources

  • Transition to a circular economy

  • Pollution prevention and control

  • Protection and restoration of biodiversity and ecosystems

Assessment Criteria:

Criteria I⁴ – Meet quantitative thresholds for sustainable activities

Criteria II⁴ - Do no significant harm (DNSH) to other objectives

Mercator applies a proprietary sustainability evaluation algorithm throughout the investment process. From screening, to due diligence, and in the portfolio construction and monitoring, around 90 of the metrics evaluated and tracked relate to Environmental and Social Do No Significant Harm Criteria.

All of the metrics can be grouped in 13 topical categories against which prospective and current positions within the portfolio can be evaluated. For every metric, the algorithm generates a score on the range of 0 (unsatisfactory) and 1 (perfect), whereby the passing threshold is informed by regulatory guidance or through scientific insights indicating what can be understood as “sustainable”. Following the completion of the scoring, all scores are added, normalized, and compared against a score threshold for each respective category, attaining a “Pass” or “Fail”. Any single stock or position that does not satisfy the scoring threshold is not considered a sustainable investment under the Product’s Sustainability Indicators.

Criteria III - Meet minimum safeguards (OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights)

All of the Product’s current and prospective portfolio positions undergo a rigorous screening for compliance with both, OECD and UNGC Guidelines. The guidelines are incorporated into the DNSH section of the Mercator evaluation algorithm previously outlined. While not all companies report on every guideline respectively, Mercator conducts additional research where deemed appropriate to ensure coverage on material metrics across the portfolio.

In the event that a portfolio position is flagged as violating one or multiple metrics outlined below, Mercator conducts additional research to determine the materiality of such a violation in the context of the firm’s business activities as well as the gravity of the violation. Should Mercator come to the conclusion that the respective violation is immaterial, manual overrides of such alerts are conducted. Mercator is willing to disclose details on any such event upon request.

Eligibility (SI1)

For eligibility the evaluated economic activity needs to either be listed under the Taxonomy Environmental Objectives above or deemed to be a closely related/enabling activity a listed activity. For eligibility either one (1) or all (3) Criteria I-III listed above are not satisfied.

Alignment (SI2)

For alignment an economic activity listed among the environmental objectives must meet all Criteria I-III.

SUSTAINABLE INVESTMENT INSIGHT INCORPORATION APPROACH

Mercator seeks to position in companies impacted by structural disruption from decarbonization across the asset heavy/basic industries.

Long exposure (Sustainability Indicators SI1 and SI2)

  • Companies and business models leveraged to the opportunity created for technologies/processes/products/materials contributing substantially and positively to the EU Taxonomy environmental objectives and/or related sustainability factors,

  • Contributing companies with a non- or negative contribution minority stake of legacy businesses with a clear path to eliminating/divesting that transition risk, and

  • Select instances where a company’s activity falls outside of the Taxonomy, or there is an ambiguous interpretation relating to Taxonomy criteria or sustainability factors, but where a science based due diligence process can validate its overall beneficial contribution.

Short exposure (Sustainability Indicator SI3)

Companies with a substantial negative contribution to EU Taxonomy environmental objectives and/or related sustainability factors, exposing them to significant transition risk.

ENGAGEMENT

Through correspondence and interactions with management of portfolio companies, questions around non-financial climate-related and social sustainability issues are raised. Such interactions may occur directly (through email, phone, or in-person interactions) or indirectly through collaboration platforms facilitated by the UN PRI and CDQ. Special areas of focus with respect to non-financial disclosures include:

In any direct corporate or management interaction (email/phone/in person) questions can be raised around a company’s non-financial disclosures are asked such as:

  • Scope 3 Emissions: Scope 3 emissions are indirect, value-chain greenhouse gas emissions, with key categories including “purchased goods and services” and “use of sold products.” Under the EU SFDR and the associated Regulatory Technical Standards⁵ (including the final RTS on principal adverse impacts), EU financial market participants must report Scope 3 emissions for relevant investments as part of their periodic PAI disclosures, with requirements phased in from 2023 and now fully in force as of 2025. As a result, EU investors with holdings in non-EU companies increasingly press those companies to provide Scope 3 data, creating a global spillover effect from the EU sustainable-finance framework⁶. Scope 3 emissions should be informed by a comprehensive Life Cycle Assessment (LCA) report verified by a certified independent third party.

  • Carbon Offsets⁷: Many corporates have initiated programs in which they purchase carbon offsets to reduce their carbon emissions and claim net-zero. It is important to disclose additional information around these initiatives such as:

What type of offsets are they buying (natural, technological)

What was the price paid?

Offset characteristics: clear science, net-carbon removal, verifiability, scalability, cost, permanence, & additionality?

In addition, other topics raised may include, but are not limited to:

  • Climate targets and progress towards such targets

  • Methodologies in generating data

  • Availability of Life Cycle Assessments for products, services and processes

  • Transition plans towards using and/or producing renewable energy sources

  • Labor practices

  • Gender diversity among senior management and workforce

  • Business relations affiliated with senior executives or board members

IMPLEMENTATION, ROLES, AND RESPONSIBILITIES

The Head of Primary research is the owner of the Responsible Investment & ESG Policy, with the CIO carrying responsibility for approval and execution. It is the Mercator investment teams’ responsibility to make sure that sustainability is assessed and executed during investment screening and due diligence, and the performance is continuously monitored throughout the portfolio holding period.

REPORTING

Investor Reporting

The Fund will follow the disclosures and reporting on a voluntary basis relevant for an Article 8 Fund under the SFDR⁶ regulation. Relevant sustainability information and data is also provided to Funds’ investors in fund reports, in line with and subject to the applicable fund agreements and regulatory requirements.

Public Disclosures

Mercator seeks to advance the adoption and practice of responsible investment and ownership principles in the financial industry. To support this goal, Mercator makes its ESG Policy and other key sustainability information publicly available on its website.

This document is confidential and is intended solely for the information of the person to whom it has been delivered by the Investment Manager. This document is not to be reproduced or transmitted, in whole or in part, by any means, to third parties without the written, prior consent of the Investment Manager. In addition, these materials may not be disclosed in whole or in part or summarized or otherwise referred to except as agreed to in writing by the Investment Manager.

This document is not an offer to sell nor a solicitation of an offer to buy securities or interests in any of the Funds. Any such offer shall be made solely pursuant to the offering memorandum of the applicable Fund

REFERENCES

1. European Commission, Directorate-General for Financial Stability, Financial Services and Capital Markets Union, “EU taxonomy for sustainable activities,” available at: https://finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en

2. European Commission, “Communication from the Commission — Guidelines on non-financial reporting: Methodology for reporting non-financial information,” 20 June 2019, available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52019XC0620(01)

3. Non-financial reporting frameworks

  i. CSRD – Corporate Sustainability Reporting, https://finance.ec.europa.eu/capital-markets-union-and-financial-markets/company-reporting-and-auditing/company-reporting/corporate-sustainability-reporting_en

  ii. CDP - Carbon Disclosure Project, https://www.cdp.net/en

  iii. CDSB - Climate Disclosure Standards Board, https://www.cdsb.net/

  iv. TCFD - Task Force on Climate-related Financial Disclosures, https://www.fsb-tcfd.org/

  v. GRI - Global Reporting Initiative, https://www.globalreporting.org/

  vi. IIRC - International Integrated Reporting Council, https://integratedreporting.org/

  vii. SASB - Sustainability Accounting Standards Board, https://www.sasb.org/

4. European Commission, Technical Expert Group on Sustainable Finance, “Taxonomy tools,” 18 June 2019, available at: https://ec.europa.eu/info/files/sustainable-finance-teg-taxonomy-tools_en

5. Commission Delegated Regulation (EU) 2022/1288 of 6 April 2022 EUR-Lex document number: 32022R1288 Official link: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32022R1288

6. European Commission, Directorate-General for Financial Stability, Financial Services and Capital Markets Union, “Sustainable finance package,” 21 April 2021 (last updated 4 June 2021), available at: https://finance.ec.europa.eu/publications/sustainable-finance-package_en

7. “Insights from analyzing a new round of carbon removal projects”, F. Chay, D. Cullenward, J. Hamman, and J. Freeman, 2021

  a. https://carbonplan.org/research/microsoft-2021-insights

APPENDIX

Appendix I: Illustration and explanation of physical, transition risk, and double materiality

Figure 1. From “Guidelines on non-financial reporting: Supplement on reporting climate-related information”, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52019XC0620(01)

Double Materiality for corporations requires information/disclosures to stakeholders on:

1) Sustainability issues that directly influence enterprise value (financial materiality, inward impact).

2) Business practices impacting on the economy, environment, and people (environmental and social materiality, outward impact) → exposure to transition risk and additional financial materiality.

Risk 1 – Physical Risk: Climate change imparts acute or chronical physical risks to a business model or assets, this information should be disclosed and the financial value at risk identified. Two illustrative examples are: 1) An insurance company’s exposure to property in increasingly flood prone regions, or 2) An agriculture business in a region increasingly exposed to severe droughts.

Risk 2 – Transition Risk: Exposes the full extent of a technology’s or an economic activity’s true inherent risk profile (financial materiality).

1. A company’s or financial participant’s economic activity, represented by arrow 1, has a negative impact on climate/ESG and we call this Environmental and Social Materiality, indicated by arrow 2.

2. Societal responses to climate change poor sustainability models are evolving and are becoming more effective via policy, regulation, alternative technologies, market forces, and reputational risk, indicated by arrow 3

3. Transition Risk is the mapping and evaluation of an economic activity’s Environmental and Social Materiality vs. the Societal Responses, which in aggregate then translates into in-direct Financial Materiality for the company or Financial Market Participants, arrow 4.