Incorporating ESG into Private Equity
Gavin Ryan
25 years: Private equity & banking
Private equity is taking into account ESG values in its investment decisions and in how it manages its portfolio companies. In this video, Gavin outlines how ESG is monitored and how the investment process works within private equity.
Private equity is taking into account ESG values in its investment decisions and in how it manages its portfolio companies. In this video, Gavin outlines how ESG is monitored and how the investment process works within private equity.
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Incorporating ESG into Private Equity
13 mins 31 secs
Key learning objectives:
Understand how to measure the impact of ESG
Identify the sources of ESG principles
Outline the success factors in implementing ESG policies
Overview:
The trend of incorporating ESG considerations in investment decisions has existed for many years but has accelerated in the last ten, affecting private equity along with other asset classes. Most PE firms view ESG incorporation as a compliance rather than a value adding exercise; part of the reason for this is the difficulty in directly measuring its financial impact. There are different ESG standards in circulation, making it a continuing challenge for all but the big firms to practically adopt it.
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Is ESG compliance or Value Addition?
A study of ESG in private equity made a few years ago, found that although 70% of GPs included ESG management in their due diligence at investment, only 15% attempted to calculate the value they created through ESG activity in their investments. This suggests that the private equity industry still views ESG as a risk management issue.
ESG proponents argue that value is created by increased sales due to access to new ESG conscious markets, by:
- Cost savings from things like better energy efficiency
- Innovation as companies design new ESG conscious products
- The productivity of increased employee motivation and upgraded supply chains
- Brand enhancement as the company is considered more highly
- Better capital access as capital markets pay more attention to companies’ ESG policies
How to incorporate ESG in practise?
It requires quite some effort to study and get a handle on what is really needed to be done in practise, if you are a private equity fund manager interested in integrating ESG into your strategy. Fortunately, several industry players have taken it upon themselves to facilitate this, both on a not for profit and a for profit basis. The Commonwealth Development Corporation ESG Toolkit was published in 2010. This takes the form of a kind of manual with procedures and templates which a GP can follow. There are some commercial products which attempt to quantify ESG value added by using a system of Key Performance Indicators or KPIs.How does ESG fit into the PE investment process?
The three principal ways are:
- The incorporation of an ESG due diligence screening system and checklist as part of the process conducted by the investment team
- Involving an in-house team specifically dedicated to ESG matters
- Involving an external specialist consultant
Post investment, one of the main questions will be whether the GP will work on ESG upgrading on a company by company basis, or have some kind of integrated system which it will roll out across all the companies.
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