LPs demand more from managers on ESG

LPs ARE UPPING THE ANTE

Investors are coming under increasing pressure to rate their portfolios against environmental, social and governance criteria – and that is set to have a knock-on effect on GPs. “We are being asked to do it and expected to do it for all our assets so this is coming your way,” said David Russell, co-head of responsible investment at USS investment management, one of the largest UK pension funds. Or as Anders Stromblad, head of alternative investments at AP Fonden, the second Swedish national pension fund, put it: “Reporting and data collection from GPs to LPs will increase over time. Prepare yourself for that. That will happen.”

ESG IS A GP's RESPONSIBILITY

Russell was also keen to stress that LPs firmly place the responsibility for ESG at a GP’s door. USS, one of the largest UK pension funds, is invested in more than 2,000 portfolio companies via its private equity investments, he said: “There’s no way for us to monitor 2,000 companies. Our expectation is that the GPs is managing the material risks. It’s not our job. It’s what we pay funds for.”

NEW METRICS ARE NEEDED

One of the more innovative ideas came from Ignacio Sarria, managing director at US private equity fund New Mountain Capital. As part of its ESG programme, New Mountain created a “social dashboard” showing the number of jobs at a portfolio company when NMC acquired the business and how many jobs at each year’s end. These reports are then sent to LPs. He suggested that private equity should do this industry-wide to demonstrate the number of jobs created by the buyout industry – a key ESG metric – “and nail once-and-for-all the notion that private equity is killing jobs,” he said.

CLIMATE RISK IS TOP OF THE AGENDA…

New guidelines from the Financial Stability Board calling for private equity firms to disclose the risks portfolio companies face from climate change are a potential game-changer: “For the first time we are being asked to consider the impact on the company not the impact of the company,” said James Stacey, partner at environmental consultancy ERM, which carries out climate risk assessments for general partners. The FSB’s Task Force on Climate-related Financial Disclosures has said the financial risk that climate change poses to companies should be disclosed as part of annual financial filings.

…BUT SUSTAINABLE DEVELOPMENT GOALS ARE BECOMING MORE IMPORTANT

Robeco Private Equity, a Dutch asset manager with €2 billion in private equity under management, is one of a “small but increasing number of GPs” using the Sustainable Development Goals released by the United Nations in 2015 as part of their investment criteria, Silva Dezelan, its director of sustainability, told the conference. The 17 goals include zero hunger, affordable and clean energy, gender equality and quality education. Individual investments can be screened against individual goals, Dezelan said. For example, adopting the economic growth goal could be used to track jobs created, or the gender diversity goal could be used to encourage greater female participation in the workplace. “SDGs are a paradigm shift for responsible investing,” said Mikkel Kallesoe, senior sustainability advisor at Dutch development bank FMO.

CYBERSECURITY IS AN ESG ISSUE

Cyber-risks are an increasingly important part of technology due diligence, Matt Hawley, director of cybersecurity at PwC, told a break-out session at the forum. The reputational risk from a cyberattack makes the issue a key part of ESG concerns. The question to ask, Hawley says, is how well the board understands what its cyber-risk is. Key indicators, according to Hawley, include whether the company has engaged a third party to gauge risk, whether it has achieved ISO 27001 certification and whether it has a chief information security officer – a CISO – on the payroll.

SUPPLY CHAIN MANAGEMENT IS KEY

Managing the supply chain remains one of the most challenging aspects of responsible investment: gow exactly do you ensure that one of your suppliers doesn’t employ underage workers? Delegates were told that a key starting point is the OECD Guidelines for Multinational Enterprises, which set out the key principles for managing businesses across different jurisdictions, and establishes the principle that GPs need to ensure portfolio companies manage due diligence in their own supply chain. Useful groups include Sedex, a global not-for-profit membership organization which is home to the world’s largest collaborative platform for sharing responsible sourcing data on supply chains, and the Fair Wear Foundation which verifies workplace conditions at overseas garment suppliers.