Two thirds of private equity houses now take ESG into account, but more progress remains to be made

Almost two thirds (63 per cent) of UK private equity firms now take into account Environmental, Social and Governance (ESG) principles in their investments but some firms risk falling behind as ESG rises up investors’ agendas, shows research by accountancy and business advisory firm, BDO LLP.

BDO says the majority of private equity firms are now making solid progress in making their portfolio of investments more responsible from an ESG perspective with 57 per cent of PE firms clearly setting out the changes they have implemented to make their investments more ESG-focused, and 49 per cent having become signatories of the United Nations Principles for Responsible Investment (UNPRI), the world’s most-recognised set of ESG principles.

In addition, 48 per cent of PE firms report in detail on the ESG impact of their investments, while 25 per cent have a dedicated individual or team responsible for embedding ESG into the investment process.
 
However, with only 29 per cent of PE firms making a full ESG policy publicly available more work may be needed to bring some private equity firms into line with expectations of a broader group of stakeholders.
 
BDO says that there is a growing demand among prospective Limited Partners for private equity firms to demonstrate that they have comprehensive environmental, social and governance approaches.
 
Increasingly, PE firms have to prove that their policies at least match what can be demanding ESG criteria set out by Limited partners (LPs), some of whom have been at the forefront of ESG investment for several years.
 
The move towards ESG among institutional investors, started by major endowments and foundations, is becoming more commonplace among pension funds partly due to the Pensions Regulator’s introduction of ESG reporting requirements for trustees in 2019.
 
Some insurers have also now started to report on how ESG principles affect their investments.
 
More PE houses are aware of how having strong ESG credentials can act as a key competitive advantage. Firms that are able to demonstrate not just a commitment to ESG but data to prove the impact of their approach are now in a better position to attract investment.
 
Investment consultants’ firms who act as ‘gatekeepers’ for institutional investors, are also paying closer attention to the ESG policies of PE firms and the substance behind those policies.
 
BDO adds there is an increased understanding of how investing with an ESG lens can have a positive effect on returns. For example, there is a growing body of academic evidence suggesting that companies that prioritise ESG perform better in the long term on a number of metrics, including Return on Invested Capital**.
 
The firm says that ESG reporting for private equity firms, such as under the UNPRI, are still voluntary.
 
BDO adds investors are looking for PE firms to strengthen the presence of ESG criteria in due diligence processes. ESG credentials will need to be a fundamental focus of these risk assessments, if firms are to gain the support of investors. 
 
Jamie Austin, Partner at BDO, says: “A manager’s ESG approach is becoming an important consideration for LPs looking to deploy capital into private equity.”
 
“Private equity firms have made a lot of progress in a short space of time in developing ESG principles and using them to guide their investments. But there’s still a way to go and some firms may look increasingly isolated by making no reference whatsoever to ESG.”
 
“We suspect the next stage is that investors will not just want a commitment to ESG – they will also want tangible proof of how the private equity fund has actually delivered on that commitment.”
 
“The idea that private assets mean little or no public disclosure on important issues like ESG is increasingly being challenged.”