As private equity (PE) firms seek to expand the sustainability of their portfolios in 2022, many limited partners (LPs) are concerned that increasing scrutiny and reporting of environmental, social, and governance (ESG) issues may generate negative publicity that could impact their investments.
PE “funds are very concerned about this and often try to find an ESG angle to their investments now,” says Siew Kam Boon, partner at Dechert LLP Singapore. “There are a lot of advocates and activists out there, so funds are worried about the negative PR that will be generated if it’s known that they’ve invested in companies that could be perceived as harming the environment or failing to take action on ESG issues.”
A survey conducted by Dechert finds that PE investors are under pressure to follow the strong trend towards ESG investing as portfolio company customers, their employees, and LPs demand more sustainable and socially responsible corporate behaviour.
The survey findings indicate that PE investors around the world are now paying greater attention to ESG issues with the vast majority of respondents from all regions expecting LP scrutiny of ESG issues and reporting to increase over the next three years. This is true for 96% of respondents in North America, 80% of those in EMEA, and 65% of Asia-Pacific participants.
In addition to climate change, other ESG issues that are of concern to PE investors are diversity and other worker issues, as well as data privacy, ownership and sovereignty.
Data privacy
Concerns about data privacy coincides with the explosion in the volume of personal data, a steady stream of cybersecurity breaches, and the growing belief that businesses are monetizing data despite consumers not having given their consent or having limited understanding of the issues involved.
Data privacy has become a major concern following the introduction of laws that prohibit the exploitation of personal data without permission. Violation of data privacy is also considered a basic corporate social responsibility under the “S” of ESG.
About 69% of respondents cite data privacy and security among the ESG concerns, while 60% cite employee welfare, and 56% cite climate change.
Asia-Pacific-based LPs are not yet under the same pressure on the ESG front and absolute returns remain the primary driver, according to the Dechert survey.
“One of the traditional attractions for the APAC region used to be its low-cost manufacturing base and less stringent environmental regulations. With the increased focus on ESG and sustainability (including modern slavery laws), private equity firms might consider targets less weighted by these and other ESG issues. Instead, because of APAC’s vast potential for globally significant climate and ecological impact, we expect to see much more private equity investment in renewable energy, high-quality natural capital, and corporations that use technology to reduce carbon emissions in the region,” says Boon.
Meantime, evolving ESG disclosure expectations in private markets are also putting additional pressure on PE investors and fund managers.
ESG metrics
This comes as leading global LPs and GPs (general partners) representing more than US$4 trillion in assets under management announced their commitment to a collaborative ESG data reporting system intended to advance an initial standardized set of ESG metrics and mechanism for comparative reporting.
The “ESG Data Convergence Project”, announced on September 30 2021, is led by the California Public Employees’ Retirement System (CalPERS) and private equity firm Carlyle. Other participating LPs include: AlpInvest Partners, APG, CPP Investments, Employees’ Retirement System of Rhode Island, PGGM, PSP Investments, The Pictet Group, and Wellcome Trust. Participating GPs include: Blackstone, Bridgepoint Group Plc, Carlyle, CVC, EQT AB, Permira, and TowerBrook. The project is open to any GP or LP who wishes to join and agrees to support the principles of the work.
“The industry’s ESG data convergence project is a new initiative by general partners and limited partners to address the lack of consistent and standard ESG metrics for private companies,” says Hillary Flynn, director of ESG private investments at Wellington Management. “This will be a data-driven, collaborative effort to establish essential ESG KPIs and track progress on these issues. Importantly, private companies can start to collect data early to demonstrate a commitment to ESG well before their [initial public offering].”
Also, in June 2022 the new International Sustainability Standards Board (ISSB) will combine standards from the IFRS Foundation, CDP (a not-for-profit charity that runs the global disclosure system for investors, etc.) and the Value Reporting Foundation (including SASB) will offer companies and investors one set of clear disclosure standards.
