Environmental, social and governance (ESG) issues have become an essential part of any private equity and venture capital fund raising. For many institutional investors, it is key that they test the ESG credentials of a prospective fund manager, and some investors are even insisting that managers incorporate their policy into the fund documents. The King & Wood Mallesons Private Fund Terms Survey 2016, published at our Annual Investment Funds Seminar in May of this year, revealed that 22% of the funds that KWM acted on in 2015 had formal ESG policies (in some cases managers adopted an investor’s policy, and in others they formulated their own along similar lines) – while 68% of funds had appointed a partner specifically responsible for ESG issues. That figure is expected to rise next year to reflect the fact that ESG is an increasingly important issue for investors in private equity and therefore, the fund managers they invest their money with. The increasing evidence that effective ESG policies and practices at portfolio company level may improve returns will no doubt help to motivate late-adopters.
As reported in a previous edition of Private Equity Comment, fund managers are routinely subject to numerous due diligence requests from their investors during the fund raising process, and initiatives such as the Principles for Responsible Investment’s standardised Limited Partners' ESG DDQ, released earlier this year, are helpful tools to assist less familiar investors and managers while also streamlining the due diligence process.
But once a fund manager has adopted a policy and agreed to various investor requests on ESG, it is obviously vital that this is maintained throughout the life of the fund and incorporated into the investment process. A welcome addition to the ESG toolkit to assist fund managers and their portfolio companies in this regard was the publication last month by Invest Europe of a standardised ESG questionnaire. It contains a list of questions on issues such as health and safety, board composition and the enviromental impact of a portfolio company’s activities. Developed by both fund managers and investors, this questionnaire can help established managers fine tune their current ESG checklists, and assist those creating one for the first time. In addition to ensuring that investor requirements are satisfied as part of the investment process, the list will be a vital tool in managing ESG issues in portfolio companies on an ongoing basis.
The ESG DDQ is another important addition to the toolkit produced by Invest Europe and its members, alongside other initiatives such as the Professional Standards Handbook and Investor Reporting Guidelines, in a bid to raise standards across the board. It is further evidence that, while ESG is hugely important to investors, it is also an area being embraced by private equity and venture capital fund managers.