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How ESG is changing the private markets

24 September 2021 Alex Merola

For private market investment managers, ESG is no longer optional.

Once a niche investment topic, 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 is already impacting firms' day-to-day operations. Ninety-three percent of respondents said they have incorporated ESG analysis into their due diligence processes before making an investment decision, and 68% say 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 or EMEA with at least US$1 billion of AUM, illustrated how firms are responding to several driving forces. Chief among them was pressure from investors and policymakers.

Policymaker pressure

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 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.

Taking ESG factors into account when making investment

Investors' expansive expectations

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 investor concerns is 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, EMEA-based respondents 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 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 more fully embrace ESG 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 firms to meet regulatory obligations and respond to investor demands.

Download the whitepaper to see the full results.

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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.


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