PE Players Making the Business Case for Responsible Investment

As sustainability issues force their way higher up the corporate agenda, private equity houses (general partners) are now responding to demand from investors (limited partners) for a bigger focus on environmental, social and governance (ESG) factors.

Four in 10 (41%) of 111 PE general partners surveyed by PwC in its Global PE Responsible Investment Survey would be prepared to pay a premium for a target company with robust ESG metrics.

Two-fifths (40%) said poor ESG performance has seen them demand a material discount or even walk away from a deal.

However, illustrating how much progress there is still to be made only 14% said they had ever received a premium for strong ESG performance at exit, perhaps because so few -38%- regularly include ESG issues in the program for exit.

PE houses also recognize other emerging risks are on the horizon, but the challenge remains to mitigate them. For example, 85% are concerned about cyber security but only 27% are taking action. 64% were concerned about gender imbalance within PE firms - but only half (46%) had taken action on this issue, the survey said.

“Private equity is changing fast,” says Phil Case, Private equity director at PwC. “Still only a relatively youthful industry, it’s reinventing itself from a perception of ‘ ruthless’ to ‘responsible’, and from opaque to transparent. This is the evidence manifesting itself from this year’s survey of 111 General Partners from 22 countries around the world.”

Commitment to invest responsibly

Case notes that the majority of PE houses have now made a public commitment to invest responsibly (70%) and currently have a formal responsible investment policy or will do shortly (96%). With 83% also reporting to their investors on ESG activities, little is truly ‘private’.

“We are observing a fundamental belief in the value that effective management of environmental, social and governance issues can bring – this is the lens through which PE houses view responsible investment.”

The approach to ESG management has moved forward at pace since PwC last surveyed the general partner community industry in 2013.

European firms are more advanced in their approach to responsible investment, although Asian firms have made the biggest improvement, the survey found.

Slowly, but steadily, more PE houses, especially in France, are valuing the benefits of ESG initiatives. One in five now value the impact of their ESG initiatives, an increase of almost double over the last three years.

Private equity firms have embraced ESG management as a core part of the deal process, with 60% now saying they always screen target companies for ESG risks and opportunities.

“Few would expect the PE community to take action on a ‘nice to have’ business case and they’d be right. There is a strong financial business case for responsible investment that’s evident throughout the deal cycle.

“Our results this year show more emphasis on risk management as a driver, less on investor pressure. This is not due to investor interest waning -in fact we believe it continues to grow- especially in the US.

“There is a focus on the value gained by managing ESG issues effectively. Investors may have been the initial driving force, but it is the business reasons for adopting ESG management principles that are maintaining the momentum.

“Whether it’s screening targets for those potential red flag issues that might cause fines and additional costs to rectify, or reputational damage further down the line, or for those ESG opportunities to command a higher premium at exit, effective ESG management provides the right approach to reduce risk exposure and increase investment returns,” says Case.

With the ratification of the Sustainable Development Goals (SDGs) in 2015, there will be increasing pressure on business as governments introduce new regulation and policy to help them achieve these 17 global goals that tackle major world issues.

For the first time, PwC has sought to gauge PE houses’ views on the SDGs in this survey.

“A surprising proportion of PE houses are engaged and taking action to align their ESG activities to the SDGs,” says Malcolm Preston, global sustainability leader at PwC. “44% plan to assess their impact on the SDGs, PwC’s survey found.  At heart, these goals tackle business risks that stem from sustainability issues – whether it’s excessive resource consumption or a reliance on carbon intensive energy and processes or poor working practices.

“Governments will turn to business to help them deliver these goals, and more alignment between business and government on delivering the goals is a win for everyone.

“This engagement with SDGs and the on-going relationship with government are likely to become increasingly important for investors more broadly, including private equity firms.”

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