As realities about the effects that companies have on the environment and society are coming to light, significant impetus for transformation of business practices in line with human rights and sustainability goals are afoot. Private equity firms, in a bid to improve the business case for their investments to a wider group of stakeholders, are paying considerably more attention to ESG, finds a new report.
The report, conducted by accounting and consulting firm PwC, explores the relationship that private equity (PE) firms have to environmental, social and governance (ESG). The report is based on a survey of 110+ private equity players, with 60% managing assets in excess of $1 billion.
ESG maturity on the rise
The firm’s research finds that responsible investment has become increasingly important to PE firms, with around 70% of respondents having made a public commitment to invest responsibly, compared to 57% of respondents in 2013. Translating commitment into more concrete policies within the operation of the firm, too, has seen increases in recent years: from 55% to 83%. In addition, the firm found that of those without such a policy in place, three quarters are developing them.
Firms are also found to be investing more resources into the management of ESG: 78% said that they have dedicated some resources, compared to 62% in 2013. The resources also tend to be more closely tied to investor activity, rather than marketing or legal, with investor support involvement falling to 33% this year from 64% in 2013, while deal team involvement increased to 66%.
The research also found that more and more key investment team members are expected to have formal Responsible Investment (RI) training, up from 29% in 2013 to 46% this year. Key training programmes remain absent at around half of surveyed companies however,
ESG increases in core relevance
The research further found that PE firms are increasingly vigilant regarding the ESG performance of potential targets. 40% of respondents note that poor ESG performance has led to a material discount in their valuation and/or led them not to invest in a company, while 41% say that they would be prepared to pay a premium for a target company due to its strong ESG performance.
The number of respondents actively screening companies on the ESG performance has increased in recent years, from 52% in 2013 to 60% in 2016. An increased number of respondents (77% vs. 59%) also say that it is mandatory to include ESG issues in their final investment committee papers. Screening companies for risks and opportunities related to ESG during the 100- or 180-day transformational plans drawn up following acquisition, is regularly included at 60% of respondents’ portfolio companies, up from 50% in 2013.
The firm notes however, that while firms are often keen to have clear due diligence on ESG as part of the acquisition process, few regularly include ESG issues in the programme on exit, at 38% in 2013 compared to 36% in 2013.
The report finds that a move towards setting, tracking and meeting ESG targets stems from a wide range of sources. Investors remain a key area of influence, as cited by 17% of respondents; however, since the firm’s previous survey in 2013, risk management has increased from 36% of respondents to 44%. According to the firm’s analysis, the reason for the shift is partly the result of successful pressure from investors in the past, which have aligned their ESG goals – thereby reducing the need for such pressure.
Risk management has become considerably more important, jumping from 36% of respondents as the key factor, to 44%, while leveraging ESG as a means of driving operational efficiency/opportunity has fallen slightly, from 15% to 14%.
In terms of key risks faced by PE firms across their own operation, as well as that of their portfolios, cyber security comes out as the top concern – cited by 85% of respondents. Human rights concerns, related to portfolio companies, comes in second at 79% of respondents. Concrete actions to head off risks in the respective areas remains relatively low however at 27% and 48% respectively.
Climate risks to portfolio companies is an understood concern at the vast majority of companies (79%), while 75% see the carbon foot-print of portfolio companies as a concern. Gender imbalance at the PE firms themselves is seen as a concern by 64%, to which 44% respond that actions are being taken.
Moving towards SDGs
The report finally notes that business practices are changing in light of the reality of environmental and social issues. The UN Sustainable Development Goals (SDGs) are being taken seriously by over a third of responding firms. 35% say that supporting SDG aligns with the firm’s investment thesis and culture, while 36% say that activity in the area creates reputational benefits. Around 30% say that alignment with the goals can create investment return opportunities.
Support for goals includes the allocation of capital to investments that support SDG (19%), the monitoring of portfolio companies in line with SDG (16%) and engaging portfolio companies on responsible investment issues in line with SDG goals (32%).
The report also notes that attitudes about investment as such are changing at just under a third of respondent companies – respondents deem that responsible investment issues are as important, or more important than financial performance of the funds. According to the firm, the “point is an interesting one 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.”