Private equity firms are starting to raise their game when it comes to environmental, social and governance issues, but the head of the UN’s Principles for Responsible Investing is calling on their limited partner investors to help speed the pace of change as half of the world’s top 10 private equity firms have yet to sign up to the PRI.
“Private equity has just got such an important role to play because as major investors you can have such a big say. But private equity thinking about responsible investment is really fragmented,” said Fiona Reynolds, CEO of the PRI.
Sponsors are waking up to ESG’s potential impact on fundraising, portfolio returns and exit strategies, as well as opportunities arising from Covid-19 disruption and potentially difficult energy transitions for "brown" companies that could be easier to complete in private markets.
Of the top 10 PE firms, only five are PRI signatories – KKR, TPG, Newberger Berman, CVC and EQT – and Reynolds is calling on the limited partners that commit capital to put more pressure on general partners (the people who actually run PE shops) by voting with their feet.
“I think that LPs need to do more in this space, about really requiring more around sustainability. The LPs have to send strong signals and choose who they work with,” she said.
“It’s the LPs who decide on their managers and it’s the LPs who award mandates. If GPs found that LPs weren't coming to them because they not doing enough around these issues, they would make change.”
There are 7,000 PE firms globally and the PRI has more than 400 signatories from investment managers with more than US$1.6trn of assets under management, which represents about 25% of PE AUM.
The PRI requires PE firms to sign their whole firm up and not just units, which has deterred several major PE firms to-date, along with fears over their ability to control outcomes and potential legal liabilities relating to minority shareholdings.
WINDS OF CHANGE
ESG data and credentials are an increasingly valuable commodity as the asset management industry continues to ask awkward questions about sponsors’ management of climate risk amid the move towards greater regulatory oversight and reporting based on standards set by the Task Force on Climate-related Financial Disclosures.
Sweden’s EQT is one of several PE firms that have put ESG-linked fund financing in place in recent weeks. EQT’s €2.3bn deal links pricing tied to portfolio companies’ ability to hit targets linked to gender equality, renewable energy transition and governance.
The deal, which is similar to a €1.5bn fund financing in January for French private equity firm Eurazeo, will generate a wealth of data that will help EQT to value portfolios and opportunities.
“Non-financial data is going to be as important as financial data as you start assessing the value of companies," said Alexandra Basirov, global head of sustainable finance, FIC at BNP Paribas. "This trend has accelerated faster than expected and it’s no surprise that private equity firms are starting to incorporate ESG factors into valuations."
Some PE firms also see ESG data as a way to improve their sustainability performance. For example, EQT is using digitisation and artificial intelligence to help one of its portfolio companies – pest control firm Anticimex Group – ditch chemicals and move to an electric car fleet with a route-based big data model for fuel efficiency.
A focus on ESG will also help PE firms to improve the industry’s reputation, as Covid-19 has introduced a new social focus across financial markets and sponsors need to tread carefully to avoid accusations of exploitation.
Despite a mixed response from the industry to-date, Reynolds said that the PE group is one of the most active that the PRI is overseeing.
“There’s an active group within the PRI of private equity signatories, but obviously more needs to happen in that space,” she said.