A guide to ESG’s standing in private equity

Environmental, social and governance factors are predicted to have a significant influence on the financial investment sector for years to come. In fact, 88% of limited partners use ESG performance indicators when making investment decisions, according to the 2020 Edelman Trust Barometer Special Report.

The growing interest in ESG factors can be attributed to the superior growth and positive returns that asset managers who incorporate ESG considerations into their core strategies are reported to experience. Not only this but consumer pressures will continue to drive support of ESG initiatives as asset managers continue seeking out opportunities to satisfy clients and maintain positive relationships.

In this article, we look deeper into the reasons why ESG should be a strategic priority for private equity firms, and how firm managers can take steps to bring ESG considerations to the forefront of their planning.

What does ESG mean?

ESG is an acronym for Environmental, Social and Governance, but what do each of these refer to individually?

Environmental criteria looks at the potential environmental risks a company might face or contribute to. This includes issues such as energy efficiency, waste management, pollution, and the treatment of animals.

Social criteria focuses on the way a company interacts with other businesses and communities. This encompasses charity efforts, employee working conditions such as health and safety or fair remuneration, and workforce diversity and inclusion.

Governance looks at the internal practices that underpin the environmental and social criteria, often relating to transparent stakeholder decision making, legal compliance, and accurate reporting methods.

Why should private equity firms prioritise strategic ESG goals?

ESG issues have a direct link to the performance of private equity firms. Regulatory developments and consumer pressures initially drove compliance from the financial industry on meeting ESG criteria, but now the perspective is shifting more towards seeing the intrinsic value that prioritising ESG measures can bring.

There is significant research to support the argument that prioritising ESG contributes to improved performance for private equity firms. The EY CEO imperative Study states that 80% of CEOs believe government, business and the public will reward companies for taking meaningful action over the next 5-10 years.

Furthermore, companies that rank well on ESG metrics outperformed the market by as much as 3% in the five years leading up to 2019.

All in all, ESG influences long-term growth, attracts top talent, lowers costs, and improves firm-client relationships by building a sense of trust and improving reputations.

ESG can also be viewed from a risk management perspective, commitment to valid, measurable ESG goals can help firm managers protect their businesses from future risks. Getting a head start on managing ESG considerations will help private equity firms stay ahead of the curve and be prepared for any future compliance obligations that may emerge in the near future.

How can private equity firms meet their ESG goals?

For private equity firms developing a strategic approach to ESG, there are some key considerations to keep in mind.

Make an unbiased assessment of the firm

Evaluate both the practices of the firm and the investment choices it makes using an unbiased, impartial framework like the SASB or TCFD framework. This will help you understand your current position in relation to ESG and allow you to clearly identify areas for improvement.

Push high-impact improvements to the top of the agenda

Once you’ve evaluated the firm’s current position, it’s time to prioritise the areas that will have the most impact. It’s best to start off with a few areas where you can really make a difference, so think about what has the potential to make a real impact.

If your portfolio consists largely of companies within the energy sector, you could take a look at improving your own firm’s sustainability efforts and lowering your energy consumption. Ultimately, the actions you take first will be unique to your firm and portfolio, which is why a clear unbiased assessment is a crucial first step.

Set measurable targets

As you progress with your ESG considerations, your goals, ambitions, and priorities will evolve. For this reason, it’s important to establish clear performance indicators that allow for year-on-year comparisons and create a solid foundation for effective reporting on these matters.

Outline regular reporting requirements

Although there aren’t currently any compulsory reporting requirements, it is expected that this will change when standardised ESG approaches become commonplace.

It’s a good idea to get into the habit of establishing regular reporting standards before they become mandatory.

Private equity has made great progress with regards to ESG and sustainability in recent years, however it is vital that businesses continue to bring ESG considerations into the mainstream and not look at meeting ESG goals as simple ‘box checking’.