Private equity has always been an asset class driven by financial returns, but as markets recognise the value of good ESG policy as the foundation of sustainable longterm performance, LPs are paying closer attention to the ESG credentials of the managers they support.

ON THE PANEL:

Beth Houghton, partner, Palatine Private Equity

Jennifer Signori, senior vice president, Neuberger Berman

Paul Newsome, partner, Unigestion

Moderator: Meghan McAlpine, director of strategy and product marketing, Intralinks

Environmental, social and governance (ESG) has come a long way in the private equity industry over the last decade.

Once consigned to a few pages in the back of private equity firm annual reviews, ESG has moved up the list of priorities for managers and investors. Multiple studies have drawn links between good ESG practice and returns outperformance, and the Covid-19 pandemic has further underscored how business and investment are inextricably linked to the health of societies and the environment.

In a recent Real Deals webinar, held in association with M&A and fundraising technology platform SS&C Intralinks, a panel of experts shared their insights into how ESG has evolved in the private equity asset class and why investors are paying closer and closer attention to ESG credentials when making commitments to new managers. Here are some of the highlights:

Investor ESG expectations have undergone a transformation

Unigestion’s Paul Newsome said that over the last ten years ESG had become increasingly important for LPs.

“If you go back five years or more hardly any of our investors were asking us about ESG, and now when we are filling in due diligence questionnaires almost all of them are asking about our ESG policy and how we integrate it into our process,” Newsome said.

He added that when Unigestion approached GPs in its portfolio about ESG there had also been a noticeable transition. When asking for ESG information ten years ago responses were limited, but now more than 90 per cent came back with thorough responses.

How ESG is shaping the LPA

LPs are asking for increasing amounts of detail in limited partner agreements (LPA) and side letters when it comes to ESG. LP requests will range from exclusion criteria to ESG reporting requirements and commitment to periodic engagement on ESG issues from the GP.

Neuberger Berman’s Jennifer Signori said there has also been an increasing focus from LPs on adverse material social and environmental impacts.

“LPs are going to be focused on the ESG process enhancements and reporting related to the management of adverse social and environmental impacts,” Signori said. “This hasn’t made its way into LPAs and side letters yet, but it is a topic that is coming up more and more.”

ESG: risk mitigation or driver of value creation?

Beth Houghton, who heads impact investment at Palatine Private Equity, said that initially Palatine had looked at ESG from a risk perspective, but as the firm became more deeply involved in the implementation of ESG across all of its portfolio companies, it became clear that ESG was also a value creator.

“We could see the benefits our portfolio was getting from implementing ESG initiatives. Over the last ten years, we have seen ESG move from risk mitigation right through to value creation and it is now embedded in all of our value creation plans," Houghton said. “We have many examples across the portfolio where businesses have saved money and increased investment through ESG initiatives.”

Houghton said ESG value creation levers could be quite simple, such us installing LED lighting across the firm’s restaurant estate, to more complex solutions such as tracking vehicle travel across the portfolio to reduce carbon emissions, fuel consumption costs and time. The firm has also seen benefits from social measures, which have reduced absence and staff churn across its portfolio.

Standardising ESG reporting

Reporting on ESG across the private equity industry still varies, and the question now facing the asset class is whether standardisation of ESG across private equity is realistic.

Unigestion’s Newsome said standardisation would be challenging. “The industry still doesn’t have standardisation in general reporting, let alone ESG. There are standards, like those of the ILPA, and the general frameworks of the UNPRI, but they are not particularly detailed,” Newsome said. “LPs will be pushing in the same direction, but the GP will still have to adhere to different reporting requirements.”

Houghton said that Palatine was a UNPRI signatory and that to date it hadn’t received many additional requests on top of the firm’s existing ESG investor reporting.

“We meet the UNPRI’s requirements every year and we do have a couple of investors that require additional reporting, but we don’t have hundreds of investors asking for different styles of ESG reporting,” Houghton said. “We do push out a lot of information on ESG to our investors. We have an annual ESG report that details ESG in each one of our portfolio companies and we have more than 40 KPIs that we collect across our portfolio and report on. The level of information we are giving to LPs is pretty high.”

Signori said it helped when GPs were proactive about “identifying for themselves what they believe to be relevant in terms of management of ESG and the reporting”. Signori said that in addition to its framework, the UNPRI had also compiled an ESG due diligence Q&A guide, which more and more GPs were including in data rooms during fundraising processes. This often covered most areas LPs were interested in.