• Editorial Team

4 Reasons Why Private Equity Firms Should Focus on ESG Now

The current crisis is shining a new spotlight on the importance of incorporating Environmental, Social and Governance (ESG) factors in the context of risk management and business resiliency. Here are four reasons why private equity firms (PE) should not lose focus on ESG during Covid-19.


1) ESG is a key differentiator for attracting and retaining capital.

2) Consideration for ESG practices strengthens your risk management.

3) Investor ESG focuses are changing, not diminishing.

4) Amidst the market slowdown, PE firms must avoid falling behind on ESG.

1) ESG is a key differentiator for attracting and retaining capital. During Covid-19 and beyond, raising and preserving capital is even more critical than before. Within the last couple of years, many private equity firms had begun realizing that incorporating ESG goals into their strategies could help them stand out to attract and retain capital from pension funds and other limited partners for whom ESG is a “must have”. Thus far, ESG funds invested in public companies have outperformed their counterparts and have shown to be more resilient during this crisis [1]. Furthermore, the desire by many investors to “build back better” and advance social and environmental goals following the crisis will likely open the way for impact investing or investing in new solutions, an area of opportunity for private equity that will continue to grow post-crisis. For instance, the 'Global Impact Investing Network' estimates the size of the global impact investing market was $502 billion in 2019 and continues to grow rapidly [2].

2) Consideration for ESG practices strengthens your risk management. The Covid-19 pandemic has illustrated the materiality of ESG-related risk factors, namely social factors and the importance of strong governance. Failure to sufficiently address issues such as employee and customer health and safety can potentially have financial and reputational/brand degradation consequences. Furthermore, the pandemic provides companies with an opportunity to step back and rethink their long-term risk management strategies, potentially with greater consideration of ESG-related risk factors. Using ESG factors to evaluate management quality has become even more imperative during this time, with thoughtful CEOs and boards standing out versus ones that are not responding with proper stakeholder management in mind.

3) Investor ESG focuses are changing, not diminishing. Contrary to the belief that ESG should take a back seat during the Covid-19 crisis, investor responses show that ESG is still a key focus with particular emphasis on social and governance factors, namely employee health and safety, executive pay and minimizing job loses (See figure 1).


Figure 1: Likely Rebalance of Investor ESG Engagement Priorities During the Crisis

Longer term once the dust settles, investors will not forget about other important risk factors common before COVID-19 such as climate change. In fact, many investors view the pandemic as an opportunity for companies to learn lessons that can be applied to future crises in order to build resiliency. Furthermore, general partners (GPs) are often criticized for having a short-term outlook and therefore not compatible with an ESG investing style. Since ESG factors are long-term by nature, formally integrating ESG into all aspects of the investment process can help focus strategies on the longer term.

4) Amidst the market slowdown, PE firms must avoid falling behind on ESG. ESG is a fast-moving space and failure to act now can put PE firms behind. This period offers an opportunity to make a start towards creating a strong ESG program, or strengthening an existing one, by crafting a clear responsible investment (ESG) policy that is meaningful and has buy-in from senior leaders. To do this right, the process takes time. In addition, new EU ESG disclosure standards for funds will require most private equity firms – including non-EU funds that are marketing in Europe – to disclose on the integration of sustainability risks, the consideration of adverse sustainability impacts in their processes, and the provision of sustainability‐related information from March 2021[3]. Another reason to get started now!

How we can help you

Creating an ESG policy is a central starting point upon which you can build your ESG program. Having an ESG policy allows you to respond more quickly to due diligence questionnaires from asset owners and their advisors. Additionally, a clear ESG policy can help you avoid internal confusion and clarify your stance on ESG.


Our expert guidance can also help GPs develop key performance indicators (KPIs) which track and report on the most relevant information to your firm and portfolio companies. Not only is this important from an ESG perspective, but those firms looking to capitalize on investors’ growing interest in impact investing will increasingly need clear, quantifiable KPIs to track and assess performance.


With our support, you will find that creating and implementing an ESG framework and creating ESG-related KPIs does not have to be time consuming or taxing. We can help you focus on what matters and align your policy with your investment process. With our support, we can develop your ESG policy and reporting to set you amongst the leaders and by doing this now, it will set you on the road to success with your ESG program.

Notes

[1] Morningstar, Sustainable Equity Funds Are Outperforming in Bear Market, March 2020

[2] Global Impact Investing Network, Sizing the Impact Investing Market, April 2019.

[3] European Union Regulation on Sustainability-Related Disclosures in the Financial Services Sector, November 2019.

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