Getting engaged: An ESG update
Where is the industry now in implementing and achieving change on the ground?
As societies, governments and regulators have increasingly demanded that investors commit capital responsibly and focus on the environmental, social and governance (ESG) factors in the companies they back, private markets firms and their LPs have responded by putting in place frameworks and reporting tools to manage and measure what they are doing.
It’s a process that has been happening for a number of years, and while there remain some frustrations at the speed of progress in some areas, it seems as though the past year to 18 months has witnessed something of an acceleration. As Grace Reyes, CEO of The Investment Diversity Exchange, says: “We’ve seen the movement from putting in place policies, to implementing them and now we’re at the engagement phase.”
This is quite a shift from a few years ago. “A decade ago, some managers wouldn’t even take our money because they thought our ESG practices were too onerous,” says Neo Mooki, Managing Director and Head of Insurance and Private Asset Solutions at Generali. “We don’t see that resistance today. If a fund manager refused money on the grounds of ESG requirements, I’m pretty sure it would set off alarm bells with any other investors looking to invest in that fund.”
Some of this may be the result of changing societal attitudes and regulatory pressure, but there is possibly a more compelling reason: returns. Bain & Co recently conducted a study with EcoVadis into whether ESG creates value. It found higher revenue growth and/or profit margins for companies with strong records on gender diversity, employee satisfaction, use of renewable energy and supply chain sustainability than for those that lagged on these areas. It’s a point picked up by Marc der Kinderen, Managing Partner at 747 Capital. “When we started thinking about ESG around 15 years ago and talked to GPs about it, we were often laughed out of the room,” he says. “Over time, we made the point that they were leaving money on the table. It may not have had an instant impact because they needed the tools to do this, but GPs definitely started waking up when we started telling them that their companies could be worth a lot more if they considered and worked on ESG.”
Yet it’s not just GPs that have become more sophisticated in their approach to ESG. LPs have often been pushing for change and, while initially they may have been asking for more information on this from GPs than they could realistically handle, there appears to be a greater focus on what is material for individual companies and therefore what actions could and should take place. “LP engagement has evolved,” says Sally Rocker, Managing Director, JC Flowers & Co. “The key word today is accountability. Five years ago, LPs might ask us a question, but there would be no follow-up. Now, LPs are seeking specific examples, illustrations and documentation to back up what we’ve claimed. There is far more interaction. LPs want discussions now.”
LP engagement has evolved,” says Sally Rocker, Managing Director, JC Flowers & Co. “The key word today is accountability.
And while increased reporting may have helped LPs get up to speed with what matters in different companies and industries, it is becoming increasingly recognised that just obtaining more information shouldn’t be an end in itself. “It’s not about the data you are reporting,” says Daniel Palme, Head of Private Equity and Financial Institutions at Schneider Electric. “It’s about what you use it for.”
Annachiara Marcandalli, Managing Director and Partner at Cambridge Associates, agrees. “Reporting is not everything,” she says. “In fact, we often see an inverse correlation between the amount of reporting and what happens on the ground. The large asset managers can do the reporting, but these are the ones that tend to be doing the least. Just demanding reporting doesn’t give you the results you want; it’s far more effective for asset owners to engage.”
And it’s here – the engagement phase – that we are likely to see more results across E, S and G. “We see this as a process of ongoing due diligence,” says Mooki. “We do annual ESG due diligence on our portfolio, but we engage at different intensities according to the type of deal, asset class and to whether we are a direct or fund investor. It can’t just be about reporting. Reporting without dialogue and engagement is useless. ESG is evolving and it’s important to stay close and ensure that you remain aligned.”
Indeed, engagement in the form of collaboration and encouragement appear to be the future direction of ESG practice improvement. It’s a development that Peter SH Grubstein, Managing Member of NGEN, sums up. “You have to work with people to get change,” he says. “That requires a recognition that things are not perfect. We can’t let perfect be the enemy of the good.”
