Room for improvement
A new survey reveals that the Dutch private equity sector has yet to fully integrate sustainability, as Nina Röhrbein reports
A research paper by the Dutch Association of Investors for Sustainable Development
(VBDO) on private equity (PE) houses in the Netherlands – ‘Private Equity: The Future or the Vulture?’ – has concluded that sustainability has not yet been adopted by the sector as a vital aspect of its core business. Only nine of 16 surveyed PE houses have a demonstrable policy.
This is the more astonishing considering that the influence of the investor in PE is much bigger than in public equity.
“Responsible investment began with public equity but while it has moved onto corporate bonds and to a certain extent sovereign bonds, it is still lagging in alternative investments,” says Kees Gootjes, project manager responsible investment at VBDO. “PE is 10 years behind the public sector in terms of incorporating environmental, social and governance (ESG). The public equity sector, for example, has long moved beyond exclusions. But ESG is surprisingly easy to integrate in PE as investors generally have a controlling interest in the company and the smaller size of the company means adaptation happens much faster. PE investors also have a long-term interest in the company – in the Netherlands, for example, PE is on average held for five to seven years compared to an average holding period of less than a year for public equities.”
But ESG has undeniably risen up the agenda in recent years.
Asset manager RobecoSAM started implementing ESG in its PE investments in 2004.
“Back then we were one of the early movers,” says Andrew Musters, global head of private equity at RobecoSAM. “Nowadays the vast majority of private equity firms look at ESG in various forms from a relatively light perspective to a more detailed one.”
Both limited partners (LPs) and general partners (GPs) have played a role in spreading ESG in PE. “From the LP perspective, ESG has gone up the agenda, not least as a result of the growth of the UN Principles for Responsible Investment (PRI),” says David Russell, co-head of responsible investment at USS. “GPs have responded to this. That said, our experience is that many of the GPs we invest in were already looking at these issues, although they were not calling it responsible investment, or disclosing what they were doing. This is not to say that there are not issues remaining, or that more needs to be done.”
“ESG has always been important to us but today we manage these issues much more systematically and visibly than we did before,” says Jörg Rockenhäuser, head of Germany and board member at PE house Permira, which was judged to be a leader in ESG by VBDO and which formed its own in-house ESG team in 2010. “As the industry is maturing there is an equal desire to get this right on all sides. We have never had as many questions on our ESG policies as during our latest fundraising cycle, so the LP community is more focused on this than ever before.”
However, many investors have developed their own disclosure requirements and methodology. “GPs are willing to work with investors on increasing their ESG scores but they do not want to fill in 10 different questionnaires from 10 different investors, which is why initiatives are slowly being introduced to create more standardisation,” says Musters.
The ESG Disclosure Framework for Private Equity – designed to help rationalise the types of questions that LPs are increasingly asking GPs on ESG – has recently joined other guidelines, such as the pilot reporting framework on private equity by the UN Principles for Responsible Investment (PRI) and the PRI guide for limited partners.
An experienced professional should not have a problem interpreting the existing guidelines, says Niall Mills, head of infrastructure asset management, Europe at First State Investments.
“There are, of course, many specialist advisers too, so there is no excuse for not understanding best practice,” he says. “On top of this, the international standards ISO 25999, 9001, 18001, 15001 all provide a framework and to very exacting standards. The world’s leading companies have multiple ISO accreditations and it shows in their performance.”
According to data by RobecoSAM dating back to 2004, larger PE houses on average tend to score higher on ESG, which Musters attributes to the extra resources larger funds can deploy. Funds that are focused on majority investing have higher average scores than those focusing on minority investing, while generalist funds typically score higher than sector-focused funds.
“It is also more challenging to implement ESG in secondaries,” he says. “It is easier to include ESG clauses in the contract or side letter with a primary fund when signing up,” he says. “The data also shows that PE has always been relatively good at the governance component. If PE houses acquire a company, for example, they tend to clean up the board structure. A few years ago PE also started to focus on the environmental side, mainly driven by the fact that it is increasingly expensive to pollute as a company and natural resources are becoming scarcer, which impacts the bottom line. Attention on the social side – such as labour relationships – is a more recent occurrence. PE funds in their own operations are becoming more transparent, mostly as a result of pressure from investors.”
“Environmental liabilities or risks are understandably a key focus of PE funds,” says Russell. “We encourage the funds in which we invest to manage environmental and social issues, as efficiencies in all areas add to bottom line returns. In terms of governance, the chain between the investor and the company is much shorter in the PE model, so in theory government risks are reduced. However, the level of risk involved depends on the nature of the investment, and the level of control taken by the fund. With many buy-out funds, the PE firm will take full control, and therefore many of the issues associated with poor governance become moot.”
Growth capital and low to mid-market buyout specialist WHEB Partners looks at quantifiable data showing any shipped products and the knock-on impact on factors such as carbon, land, energy, air and natural resources. The information is independently audited and can show a reduction in greenhouse gases and air emissions, reduced landfill waste, wetland recovery, reduced salt contamination, energy and fuel savings, as well as natural resource preservation. WHEB has also been working on improving the governance of some of the small businesses it has invested in through new shareholder agreements, clarifying some of the rights and decision-making powers of the board. On the social side, it has recently begun to gather data such as staff training undertaken and disciplinary records.
“After signing up to the UN PRI only last year, transparency is the first issue we tackled and now we are moving on to implementing policies, which we will then track performance against,” says Megan Bingham-Walker, principal at WHEB Partners.
Since selling its private equity arm AlpInvest in 2011, fiduciary manager PGGM has been building up in-house capacity to invest directly in PE through funds. It also established its own responsible investing in PE policy to set out a clear expectation of what it wants to achieve.
“Some companies are high, some medium and some are low risk,” says Ruulke Bagijn, CIO private markets at PGGM. “For high ESG risk companies, we set the bar higher than for those with lower ESG risk. Then we benchmark the important ESG issues against best practice as we see it in the sector. Any shortcomings are discussed with the external manager with whom we agree an action plan. After we have invested, we monitor the relevant ESG factors. We try to achieve alignment in commercial terms by having performance fees and a substantial GP commitment. When it comes to ESG matters that are important to our clients we also want to set clear expectations of how GPs should act.”
Internal processes establish a plan at the outset of an investment at PE firm Actis. It monitors its performance against various demonstrable indicators of the plan every six months and notes any changes. But Actis has no one-size-fits-all approach to its investments, with the exception of the energy space where it has a proprietary energy impact model with multi-dimensions.
“The holy grail of this world is to have a series of measurable outcomes that everyone can compare and contrast,” says Paul Fletcher, senior partner at Actis. “But there is not any one set of standardised metrics that suits all investments.”
“We would like to see the sector start to report in a very structured way,” says Bagijn. “Case studies and policies are great but ultimately we need to move beyond a box-ticking approach to structural ESG reporting by GPs.”