What’s behind the private equity rush to ESG?

The PE sector has been quick to adopt the UNPRI and ESG.

PE is moving in a big way towards ESG. A survey published last week in France by Novethic, the Paris-based research company, revealed that nearly a third of 74 private equity managers in France (30%) had already implemented a formal ESG integration policy, while a further 35% plan to do so in the next year. It indicates a surge of interest by buyout firms in sustainability issues. That swell was reflected in a bumper crowd at a recent conference in New York organised jointly by the United Nations Principles for Responsible Investment and Private Equity International. Attendees heard George Roberts, one of the founders of US private equity giant KKR, declare that integrating environmental, social and governance (ESG) factors into private equity is both “good business and the right thing to do”. Roberts – talking persuasively, without notes – suggested that in doing so, private equity houses should swallow short-term costs in favour of long-term value. KKR, he said, would do just that. At the end of 2010, it published its first ESG report titled: “Creating Sustainable Value.” The report said that its Green Portfolio Program, established in partnership with the Environmental Defense Fund (EDF), a US NGO, and covering 16 of its portfolio companies, had identified $160m in cost savings and 345,000 metric tons of C02 avoided at eight of those. No small numbers. Private equity houses have certainly moved quickly to adopt the ESG lexicon. Signatory numbers to the UNPRI have grown rapidly, coalescing around the PRI’s dedicated work-stream to the asset class. Fellow buyout giant Blackstone is reportedly building a responsible investment team, while Carlyle is also working with EDF on the environmental footprint of its portfolio companies. TPG Capital is understood to be holding an ESG conference in Europe later this year.So, why now? Roberts at KKR said the firm wanted to be: “Skating towards where the puck is going, not where it has been.” The ice hockey metaphor might be read in several ways.
Firstly, a number of private equity speakers at the conference noted that environmental and social issues were moving steadily into the policymaking arena, meaning that buyout firms needed to stay ahead of the political curve. KKR and Blackstone are both partly public companies now, meaning their investment books are open to scrutiny, and challenge. Secondly, private equity does not enjoy the best of reputations. Roberts acknowledged as much, saying: “I’ve had my fill of walking into investor meetings to be greeted at the doors by people protesting that they hate private equity. To be honest I could have done without it and we’ve got to change that.” A glance at the UK press in recent weeks showed private equity getting another bashing for the loading up of debt at Southern Cross, a troubled UK care homes group. Thirdly – and perhaps most importantly – clients are demanding it.
In the Novethic survey, private equity firms said investor clients (limited partners) were now increasingly requesting formal policies that take ESG criteria into account prior to investing their assets. Sixty percent of the buyout firms surveyed said they had already received such requests, while others expect to be asked for policies during future fund-raising rounds. In a direct response to Roberts’ ice hockey quote, Anne Simpson, Head of Corporate Governance at CalPERS, the US pension fund giant, said: “We want to hit the puck.” She said the fund, amongst others, was looking at “how to walk and chew” with both the financials and ESG attributions for private equity: “We need the right questions, monitoring tools, rewards
and penalties, she said. David Russell, Co-head of Responsible Investment at the Universities Superannuation Scheme in the UK said the fund now had 12% of its total assets in private equity. He said it asks four major questions of its general partners: due diligence on ESG issues, oversight of ESG processes, reporting on ESG issues, and a final response on the general partner’s response to the UN PRI and other responsible investment initiatives: “We don’t mandate on reporting and we don’t look for the GP (general partner, private equity company) to report on ESG at a portfolio company level. We don’t have the capacity to deal with that kind of scrutiny.” The final way of reading the Roberts puck metaphor is that private equity is just quick to ‘get’ ESG as a better way of overseeing companies. Indeed, the industry argues it was doing much in the way of ESG already, but didn’t label it as such. Bryan Corbett, Principal, Government and Regulatory Affairs at Carlyle, said the firm saw ESG as a way of ‘de-risking’ its portfolio businesses. He acknowledged, however, that the industry was hard-pressed at the moment to put investment numbers on this. Other speakers raised questions about whether trade buyers or public markets put any premium on ESG factors when private equity groups look to ‘exit’ their investments. In the Novethic survey, half ofthe private equity firms polled said they believed that ESG integration could contribute to creating value for invested companies. But, most conceded it was not, with a few rare exceptions, currently used in the valuation of companies. That may change as private equity increasingly broadens its portfolios into developing markets where ESG criteria are seen as necessary tools for doing business. Private equity has always argued that it improves companies for sale with better, more creative management. Critics argue that it is more expert in complex financial engineering, job cuts and asset sales.
Some observers feel a degree of cynicism with the latest ESG drive. As Bob Eccles, Professor of Management Practice at Harvard Business School, noted to the conference: “ESG cannot just be good business and efficiency. If it was why is it only happening now? One of the answers is that it is tough to measure. But I think what we are seeing is a shift of ideology.”
But private equity is anything but sluggish. Roberts told the conference the industry was a “catalyst for rapid change”. As direct owners of companies private equity managers can make quick, effective changes when they want. If the industry moves with commitment it may make a self-fulfilling prophecy of ESG management and measurement, turning it into a race to stay ahead of the sustainability puck.