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What’s Driving ESG in Private Equity?

ESG has become a key strategic priority for private equity firms in the last few years. But where has this sudden sense of urgency come from?

Part 1 of a 3-part special series on ESG in private equity.

By Tom Eagar, Head of ESG Search at Sheffield Haworth 

As part of the AESC conference, I chaired a panel discussion on the evolving role of the ESG leader in Private Equity. I assembled a panel which had perspectives from asset owners, sustainable private equity investors and current PE ESG leaders, to give as rounded a picture as possible about the future for talent in this side of the industry.

Over three parts, we will share the discussions and explore the implications of what was said and consider what the future for ESG leadership in PE really is, and what is driving this.

Part one: ESG has become a key strategic priority for private equity firms in the last few years. But where has this urgency come from?

Alison Collins, one of our panellists, is the Head of ESG at Pollen Street Capital, a mid-market London-based asset management firm. She noted that when she “joined Pollen Street Capital four years ago and didn’t even have ESG as part of my agenda. I suppose over the last four years, it’s moved from being 0% of my job role to about 95%.” Clearly, PE has been on a dramatic voyage of discovery with respect to ESG over the last half-decade.

According to another panellist, John Howchin, former Secretary-General for the Council of Ethics of the Swedish Pension funds, while public listed companies in northern Europe have been working with ESG for “a long time”, in the last five years “there’s been a huge focus on private equity, and it’s really changed the whole business.”

So what has driven this change of heart?

Stakeholder pressure and regulation has compelled PE firms to take ESG seriously.

Unlike in public markets, where the client demand and market response for ESG left the regulator trying to catch up, the PE world has been slower to adjust.

While public companies already have very thorough reporting structure in place, so the stretch to reporting on ESG factors is not as large, this was often not the case for private companies. Clients were reluctant to burden their firms with objectives which may distract from the core investment goals.

Another factor is the PE industry’s mixed experience with investing in renewables and positive impact companies. As Jim Totty, our final panellist from Veritas Capital, explains: “If you go back to the ’00s and look at all of the new solar technologies that were being developed in Europe, America and Asia, pretty much all of those failed.  The VCs and some of the later-stage investors who piled in that era didn’t do at all well. LPs have long memories and they have not forgotten that era.  Many GPs did get it wrong.”

However, private markets and public markets investment managers often have the same clients and regulator, and so the education and experience from one side, has informed the other. Clients now realise they want to be able to evaluate the impact of all their investments, public or private, and regulators realise that to prove managers are doing this properly, they need to be regulated and report on the ESG activities.

As Alison puts when discussing the current state of affairs in PE; “our investors in the LP community are massively interested in ESG. When I say I spend 95% of my time on it, I’d say then of that 95%, about 35% of that time is spent on investor reporting because everybody cares about this now.”

As such, ESG has both the carrot, client demand, and the stick, the regulator’s demands, to drive up the importance of it.

Impact realisation

A significant factor in the LP interest in ESG in PE is a realisation that, after much hype from their public market counterparts, it is in private equity where investors can have a genuine and material impact.

Engagement in public markets is well touted, but how much leverage does an individual shareholder really have over a public company to make a tangible change? This is where private markets comes into its own. With the ownership model, engagement in PE can be extremely powerful, as they work with the management hand-in-glove to deliver across a range of metrics. They can genuinely have impact.

John Howchin explained; “This is very much about ownership. We can go in [to the companies, as owners] and change the policy and clean up human rights structures, governance structures, environmental position, reporting, and improve transparency.”

The net zero transition is another key factor

The specific challenge of climate change and the corporate world’s transition to a Net Zero model has also helped crystalise the importance of ESG factors in investment. While firms have been focused on the physical and the transition climate risks to their business, current affairs have catapulted the issue to the top of the agenda.

John explained: “The only positive with the horrible war in Ukraine is that we have seen that the emperor really is naked, and the transition away from carbon is going to happen now. It’s hitting us hard. It will impact your investments as well. It will very much impact the companies you own.  I think the big opportunity for private equity is that they own the company presumably 100%, and that’s both an opportunity and a big challenge”.

Please contact Tom Eagar.