AGEFI Luxembourg - Juin 2022

AGEFI Luxembourg 18 Juin 2022 Fonds / ESG T he last weeks have been tough for the crypto-currencymarket and its investors: Bitcoindropped bymore than 50%sinceNovember 2021 and theworldhaswitnessed the crash of the Luna coin and its blockchainTerra inMay. In the last twelvemonths, despite uncertainty inherent to the cryptoworld, succes- sive venture funds dedicated to cryptos have continuously increased in size. AndreessenHorowitz (a16z), a venture capital house known to be one of the early crypto investors, is topping the charts after raising 4.5 billionUSdollars for two newfunds. Crypto funds aremore about technology than currency Investors may be familiar with cryp- tocurrencies but volatility and uncontrolled changes in prices that have been observed on the cryptomar- ketlookincompatiblewithanormalprivateequityor venturecapitalinvestmentapproach.However,cryp- tocurrencies alone are only the tip of the iceberg: the blockchaintechnology,beingthebackbonebehindall cryptocurrencymechanisms and known to be a real gamechangerforyears,turnsouttohaveapplications outside of the currencies’ world. For example, theWeb3, the successor of the goodold Web 2.0 commonly used by millions, is based on blockchain, andgives rise to the creationof hundreds of start-upcompanies. Therefore, the appetite of ven- ture capitalists appears more clearly, as they would like to reiterateWeb 1.0 and 2.0 success stories. Another example is decentralized finance (DeFi), a new financial technology also based on blockchain removing financial institutions from the equation when it comes to financial instruments and services, such as lending or trading by introducing a new online-based decentralized model with reduced dependance on centralized financial intermediaries. In 2021, blockchain is gained investors’ confidence worldwide.EnormousgrowthinthenumberofNFT transactions and funding for crypto exchangesmade headlines; notably, Coinbase has been publicly listed and FTX raised nearly 1.5 billion US dollars in deal value last year. In Europe, venture capital funds investing in Web3 andDeFi arebackedbymajor institutions suchas the European Investment Fund, showing that the crypto andblockchainworld is not a niche anymore. Blockchain at the heart of newways of investing Following the growth of Web3, NFTs and DeFi, investors are also starting to look around for new ways of investing aside fromdebt and equity deals. When investing in companies developing business around decentralized technologies, why are they not also investing in a decentralized manner through blockchain? Over the past years, tokenization using blockchain technology tocreate fractional digital shares of assets has started to become popular. For example, RealT, a US-based real estate company, offers fractional real estate investment in tokenized assets. Token- owners collect their revenue portion from the total income generated by the asset. The lastmonths have seen the rise of non-traditional investments approaches and among others Decentralized Autonomous Organizations (“DAOs”). DAOs are to some extent similar to part- nerships but ruled by blockchain-based smart contracts rather than by a Limited Partnership Agreement (“LPA”). Instead of shares, tokens with various governance rights canbe issued to the inves- tors through security token offerings (“STOs”). The blockchain source code is the equivalent of the ArticlesofIncorporationortheLPAofthetraditional worlddefining the rules of thegame. The codeof the blockchain also becomes the central organization tracking each investor’s contribution and allocating governance rights proportionally or based on the rules definedwhen setting up the code of theDAO. The main objective of an investment DAO is to raise money from investors without intermediary to finance projects. Many early-stage companies are launching their ownDAOto attract investors in sup- portingtheirgrowthoutsideofthetraditionalventure capital channel.Aurora, a European-based company developingsolutionsaroundblockchainisestablished as a regular corporation and launched aDAO that is usedtoraisemoneybutalsoforgovernancepurposes withvotingcommitteessuchasboardsofdirectorsor meeting of shareholders of the traditionalworld. Despite being very new, DAOs appear to have the potential to become an effective tool for the venture capital industry or even an alternative to it to finance innovative projects thanks to the flexibility of the model and limited administrative burden. HowwouldDAOs impact alternatives and venture capital? Investingindisruptivebusinessesinadisruptiveway using blockchain technologies is tempting and raises the question of howDAOswill impact thewell-esta- blishedworldofinvestmentfundsspecializedinalter- natives andmore particularly inventure capital. As for the example ofAurora,more andmore early- stage companies are being created using a well- known corporate formandonce set up launch their DAOs in parallel. Initial investors can enter into a sharedpurchase agreement in the corporationwith options to receive a pre-determined number of security tokens once the DAO is up and running. The legacy corporate entities remain but the intrin- sic value is in the DAO. These hybrid strategies consisting ofmixing equity and security tokens are becoming progressivelymore common in the ven- ture capital industry. It is also worth mentioning that tokens can be exchanged or traded through online platforms, thereby increasing the liquidity for private assets that are usually seen as an illiquid asset class. In this context, it is likely that companies in the future will have less equity andmore tokens to offer to investors.Maybe the next successful star- tupwill be establishedas aDAOrather thana regu- lar corporation. In addition to being considered at investment level only, the door might also open to use DAOs as investment vehicles. As a matter of fact, an invest- ment fund could be considered as an example of a DAO: investors collectivelyenter a fund that collects capital from them to invest in target companies fol- lowinganinvestmentpolicyforthepurposeofgene- rating a financial return for these investors. Due to the broad definition of what an Alternative Investment Fund (“AIF”) is under the Alternative Investment FundManagersDirective (“AIFMD”), it cannotbeexcludedthatDAOthemselvescouldeven be qualified asAIFs one day. Despite the trendbeingpositive,withDAOsgaining presenceinthecapitalizationtablesofstart-ups’finan- cingrounds,only3%ofthelargestalternativeinvest- ment’sfirmshaveinvestedincrypto-relatedordigital assets as per EY’s 2022Global Private Equity Survey. However, digital assets and therefore DAOs will continue to be an area that many alternative invest- ment firmswill consider going forward to the extent thattheseassetsarebecomingmoreandmoremains- tream.Thesurvey’sresultsalsoshowthatmostfirms remaincautiousastheymonitorhowregulatorstreat digital assets froma legal and regulatory standpoint. Regulatory challenges and risks remain The regulatory framework surrounding cryptos and digitalassetsisbeingbuiltwithongoingeffortsworld- wide. Many challenges remain on how these assets aredealtwithbytraditionalAIFscustodians or simply in terms of legal recognition. In late 2021, theEuropeanSecurities and MarketsAuthority (“ESMA”) added in itsAlternative Investment FundsMana- gementDirective (“AIFMD”)Q&Athat funds investing into crypto assets are to be considered as AIFs as long they are following their investment policy and comply with the AIFMD. Still at European level, the European Commission's forthcoming Markets in CryptoAssets(MiCA)regulation,which aims to create a framework for all digitalassetsnotyetcoveredby European directives or regulations, is expec- ted to see its first appli- cation in 2024. In Luxembourg, the CSSF recently issued whitepa- persandguidanceonvirtualassets providing clarifications on the expected level of due diligence, related internal especially for banks and for funds and their managers falling into the scope of the AIFMD. Unfortunately, there is no explicitmentionofDAOsneitherintheEuropeannor CSSF’spublicationsyet.Currently,onlytwoUSStates (VermontandWyoming)giveDAOsofficialrecogni- tionwith the possibility incorporate and register as a regular company or corporation. Allinall,notwithstandingtheirincreasingpopularity, the road still seems very long for DAOs to become mainstream. Themain issue is the lack of clear regu- latory framework. Although security tokens are governed by regulatory frameworks applicable to securities as these are qualifying as financial instru- ments, many gray zones remain on the legal status of DAOs. AndreessenHorowitz (a16z) as one of the largest investors in the crypto world issued a publi- cationonthechallengerelatedtothelegalframework ofDAOs.Ithighlightsthecriticallegalmattersrelated to DAOs, mainly the absence of country of jurisdic- tion,uncertaintyonthestatusofthelegalpersonality and tax reporting or potential liability for DAOs’ members. Currently, none of these points are yet regulated asmany others in the crypto-assetsworld. Finally, one cannot underestimate the cybersecurity risk andmust bear inmindwhat happened in 2016 with “TheDAO”whichwas the first DAO to act as a venture capital fund and raised more than 150 million US dollars – but 50 million got stolen by a group of hackers. Currently, uncertainty remains, and the DAO envi- ronment is far from perfect. Nonetheless this new form of organizations is one of the most innovative concepts that have been designed with the block- chain. It has clearly the potential of disruptingmany well-establishedbusinesses.Thequestionistherefore not whetherDAOswill have an impact on business, but how to safely navigate this coming revolution while seizing the opportunities. Laurent CAPOLAGHI, Partner, Private Equity Leader Pierre-Yves AMÉ, Senior Manager, Private Equity Romain SWERTVAGER, Partner, TMT & Fintech EY Luxembourg What will the future hold for crypto funds? A s Thibaud Clisson, Cli- mate Change Lead, BNP ParibasAsset Manage- ment, explains, the window to limit the global temperature rise to 1.5C is closing fast, but there are investable solutions that can keep it within reach. - Existing climate policies are critically insufficient to reach the goals of the Paris Agreement on climate change and would lead to a temperature rise of 3.2C by 2100 - Annual greenhouse gas (GHG) emis- sions continued to rise between 2010 and 2020, and are now reaching their highest level ever in human history - On the current trajectory, the remai- ning 1.5C carbon budget (500 Gt) is likely to be exceeded before the end of the decade. These are just some of the headline sta- tements from the Intergovernmental Panel on Climate Change’s (IPCC’s) latest report on climate change mitiga- tion. The near 3.000 page document, like preceding reports on climate change science and climate change impacts, gives a clear message on the need for us to take climate action. Acritical situation The IPCC says that tomeet 1.5Cwith no orlimitedovershootoftemperatures,car- bon emissions (CO2) need to peak by 2025, fall by43%by2030 from2019 levels and hit net-zero in the early 2050s. This doesn’t mean we can rest on our laurels until 2025. The quicker we start bending downtheglobalemissionscurve,thebet- ter.While theannual growthratehas slo- wed slightly over the last decade, emis- sions have still risen across all main sec- tors of society. More ambitious policies and structural changes are needed to combat climate change. The report stresses the importance of ‘rapid and deep’ emissions cuts in the energy sector. Energy efficiency gains havenotbeenenoughtooffsettheincrea- sedeconomic activity inall areas that rely on energy. It is also critical to reduce methane emissions from energy and other sectors – the IPCC says that global methane emissions need to fall by 34% by 2030. The IPCC stresses the risk of stranded fossil fuel assets could amount toUSD1-4trillionbetween2015and2050 if global warming is limited to 2C, with coal assets being most at risk, followed by oil and gas in the coming decades. Removing fossil fuel subsidies alone could cut emissions by up to 10% by the end of the decade, the report says. Overall, global coal consumption needs to fall by 95% by 2050 from a 2019 base- line, with reductions in oil and gas use estimated at 60%and 45%, respectively. There are solutions On the plus side, the report says the solu- tions to decarbonise, for example, the energy sector, are readily available and increasingly cost-effective. Solar power and lithium-ion battery production costs have fallen by 85% over the last decade, while wind energy costs have fallen by 55%over the same period. Policymakers are engagingwith the pro- blem. The steady growth in policies and laws targeting GHG emissions, which now cover around 53% of global emis- sions, have prevented5.9 gigatonnes (Gt) per year of CO2 entering the atmosphere over recent years, according to the report. Around20%ofglobalemissionsarecove- red by carbon pricing schemes. Separately, recent research has indicated that if all updated climate pledges made atCOP26aremet,warmingcouldbelimi- ted to 1.9–2C. On demand-side mitigation, measures that reduce the consumption of carbon- intense goods and services could cut glo- bal emissions by 40-70% by 2050, while reducingtheneedforCO2removal,relie- ving thepressureon landand improving humanwell-being. Food-related changes offer the greatest potential for emissions savings, followed by land transport, according to the report. Transforming the transport sector to reduce demand and increase public transport and the use of electric vehicles, will also be key, as will be investing in transport infrastructure. Although most of the pathways modelled in the report involveacertainamountofCO2removal to offset hard-to-abate emissions and cut CO2 levels after a small overshoot, it appears clear that major short-term reductions should lower the need for negative emissions technologies later, highlighting the importance of taking directactionnow.Whilethereportwarns policymakers and the private sector about the need for urgent action to tackle climatechange,italsohighlightsthesolu- tions available for investors to support efforts to reduce emissionsmorequickly. We believe the expense – reducing glo- bal GDP by a few percentage points by 2050 –would be dwarfed by the costs of dithering.Actionnowwould comewith substantial interrelated benefits in areas such as human health and sustainable development. Thibaud CLISSON, Climate Change Lead, BNP Paribas Asset Management Taking real action on climate change is more critical than ever