Keeping tabs on ESG

A number of tools to help fund managers meet the increasing demands of ESG investment launched at the end of 2016, the first being a questionnaire released in November by industry body Invest Europe.

Drawn up in collaboration with private equity fund managers and institutional investors in Europe, it covers areas such as environmental impact, health and safety processes, human rights and labor standards across a company’s operations and supply chain.

It is designed to help fund managers identify issues requiring more detailed technical assessment, and opportunities to enhance value and mitigate risks following – or before – investment in a portfolio company.

“Not all portfolio companies are on the same page when it comes to ESG factors,” says Marta Jankovic, senior sustainability and governance specialist, head of ESG integration alternatives at APG Asset Management, and chairwoman of Invest Europe’s responsible investment roundtable. “The more we can help fund managers and investors identify the potential issues and opportunities in the investment process, the more we can promote high ESG standards across the board.”

The launch of the questionnaire was followed in December by European bank ClearlySo’s online impact assessment portal for private equity and venture capital firms.
ClearlySo’s ATLAS program helps firms work out the social and environmental impact of their investments, or potential investments, and suggests areas that could be improved. It takes into account guidance from various sources including the Principles for Responsible Investment (PRI). Results are mapped to the UN Sustainable Development Goals.
“We request data from the private equity firm, and then we do the rest. Clients pay an annual membership, and access the portal online,” John Lloyd, ClearlySo’s chief marketing manager tells pfm.

Target companies are assessed for potential human, economic and environmental impacts, and the program gives a final, overall score. This can also be broken down into area-specific ratings. Firms can then download the impact report and share with interested parties.

There is also a knowledge bank available on the website, which keeps clients up to date with the latest developments in the impact investing.

The launch of these tools came a year after the UN-backed PRI initiative finalized a standardized due diligence questionnaire for investors, which enables them to evaluate fund managers on their commitment to these issues. The questionnaire, drawn up by a working group of PRI signatories including LPs, funds of funds and general partners, is aimed at building consensus on matters already touched on in other resources.

Legal moves

Law firms have also bolstered their efforts on the ESG front over the past year, setting up dedicated teams to assist their private equity clients in their responsible investment practices.

Global law firm Goodwin Procter launched an impact and responsible investing practice in the US in November, and its team will advise on related legal matters including ESG and sustainability certification, benefit corporation formation and certification, immigration law compliance, foreign corrupt practices act compliance, tax exempt status and the employee retirement income security act.

“Impact and responsible investing is among the fastest-growing, most prolific forms of global financial innovation,” says David Hashmall, chairman of Goodwin.

There is a strong incentive for fund managers to use the ESG assessment services available to them. Investor demand for ESG opportunities remained strong in 2016, and in August the California Public Employees’ Retirement System’s board of administration adopted a new ESG five-year strategic plan, naming six initiatives to support the public pension fund’s efforts in sustainable investing.

While investors have traditionally been the main reason behind decisions to invest responsibly, other factors including risk management are becoming increasingly important, according to a recent survey by PwC.

It found risk management, such as being aware of the danger of encountering human rights issues, is now the most influential factor driving a firm’s decision to make a responsible investment. Almost half, 44 percent, of the fund managers surveyed agreed, up from 36 percent in 2013.

Environmental and social issues, and accompanying advice and legislation are also impacting investment decisions. The UN Sustainable Development Goals are being used as a template for investment culture by 35 percent of the fund managers surveyed, with more or less the same proportion agreeing that activity in these areas creates reputational benefits.

Attitudes about investments are also changing, with just under a third of respondents saying responsible investment issues are as important, or more important, than the financial performance of the funds.

“[The point] is interesting and a real sign of change in approach by the industry. Traditional business models are profit-centric, but new business models, considering the needs of wider stakeholders in the mix, are now on the increase,” PwC said in its report.

Taking responsibility

The PwC survey of 111 global private equity managers highlighted the importance of responsible investing:
•96 percent of respondents said they have, or will soon have, a responsible investment policy;

•41 percent said poor ESG performance has seen them demand a material discount, or walk away from a deal;

•40 percent would be prepared to pay a premium for a target company with a strong environmental, social and governance performance.

But while ESG is becoming increasingly important at entry, there is still some catching up to do at exit:

•14 percent have received a premium for strong ESG performance at exit;
•38 percent include ESG in the program for exit.

And although they have made progress in identifying key ESG factors, action to tackle them has been less forthcoming:

•85 percent of managers are concerned about cybersecurity, but only 46 percent have taken action;
•64 percent worry about gender imbalance within private equity firms, but only 46 percent have tried to mitigate it.