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For private equity market investment managers, ESG is no longer
optional.
Once a niche topic in the private equity industry, ESG
(environmental, social, and governance) is now permeating across
the investment landscape, spurring alternative asset managers to
fundamentally change how they approach the investment process and
their communication to investors.
Our recent survey of private equity and asset management
executives underscores the extent to which this trend of adopting
ESG is already impacting private equity (PE) firms' day-to-day
operations. 93% of respondents said they have incorporated ESG
analysis into their due diligence processes before making an
investment decision, and 68% said that they have walked away from a
deal because of information uncovered in that process.
The survey,
which was conducted by Mergermarket on behalf of IHS Markit, showed
that ESG factors are influencing dealmaker decision-making and
valuations. Nearly 60% of respondents think that a negative ESG
assessment will have a significantly adverse impact on valuation,
while 53% say a positive assessment would significantly improve
pricing.
There are a variety of factors that are impacting this growing
focus on ESG. The survey, which focused on executives from
investment management firms based in North America as well as
Europe, Middle East, and Africa (EMEA) region with at least US$1
billion of assets under management (AUM), illustrated how PE firms
are responding to several driving forces. Chief among them was
pressure from private equity investors and policymakers.
Pressure from policymakers and their ESG regulations
All told, 87% of respondents pointed to regulation and political
pressure as a reason why their firm takes ESG factors into account
when making an investment; more than half said that regulation was
the primary reason.
While Europe is leading the charge with the Sustainable Finance
Disclosure Regulation (SFDR), new ESG regulatory reforms are
emerging in every region, many of which are focused on disclosure
and reporting requirements. While the United States (US) Regulators
have not issued their own reporting framework, additional
requirements are on the horizon.
Overall, policymakers increasingly are focusing attention on how
financial services businesses can drive positive change. This
pressure applies to both PE firms and asset managers, as well as to
the portfolio businesses in which they invest.
Private equity investors' expansive expectations
PE investors are also a major influence. Overall, 63% of survey
respondents pointed to investor pressure as playing a role in
driving their ESG agendas. Among institutional investors,
endowments/trusts, pension funds, and mutual funds are leading the
charge, the survey showed, as executives flagged those entity types
as placing the highest emphasis on ESG issues.
However, responding to these private equity investor concerns is
a complex task. Investors are no longer solely focused on returns
but on a wide range of issues across the ESG landscape, and
different issues take greater prominence depending upon the
region.
For instance, within the category of environmental factors, the
survey showed that North American respondents were more concerned
about biodiversity than their European counterparts, who were more
likely to focus on energy efficiency and water and waste
management. By the same token, respondents from Europe, Middle
East, and Africa (EMEA) region were more likely to rank business
ethics as their number one governance concern (67%) than their
North American counterparts (40%).
More to come
While the ways in which private equity investors push on the ESG
agenda may vary, investment managers are unified in anticipating
that investor scrutiny on this topic will become greater. A full
90% of respondents said they expect increased pressure from
investors on ESG issues over the next 12 to 24 months; nearly half
of respondents expect that increase to be significant.
In other words, for as much as ESG factors are already
influencing the investment process, their impact is likely to
become even more substantial. Indeed, 63% of survey respondents
said they expect ESG to become significantly more important in
their investment decisions in the near term; another 17% said it
will become somewhat more important.
This presents PE firms and asset managers with a key opportunity
to embrace ESG more fully as a business-as-usual activity rather
than a standalone specialty. Failing to do so will only make it
more difficult in the years ahead for PE firms to meet regulatory
obligations and respond to investor demands.
Posted 24 September 2021 by Alex Merola, Executive Director of Commercial Strategies, Private Markets, IHS Markit
IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.
