This article is sponsored by Navis Capital Partners.
How is ESG viewed in Asia and what does this mean for compliance, risk and value creation?
Bence Szegedi: I have been involved in renewables and sustainability-related investments for the last 15 years in various roles, including M&A. The approach to ESG in Asia has developed from a simple compliance and risk management exercise into a lever for unlocking value-creation opportunities and driving business transformation.
Michael Octoman: We have been working on ESG at Navis Capital since 2005, and it started for us with the implementation of business principles outlined by CDC [now known as British International Investment], one of our LPs. Initially, ESG was driven by risk and compliance, but by 2010 we could see that implementing ESG in portfolio companies was creating value on exit. We are a growth buyout investor, and we sell to strategic buyers, who place a premium on a clean business.
From 2010 onwards we invested further in our ESG capability, and we have built out a large ESG team over the years, with the focus shifting noticeably from compliance to value-add.
Through this period, ESG in Asia has evolved and we have noted an acute awareness of its importance across the market. That said, the practicalities of implementation, particularly in the mid-market, remain challenging. The reality is that in markets like Southeast Asia, where we invest, there are a range of competing priorities that can make ESG challenging to drive forward.
There are still gaps and much work to be done, but ESG has come a long way in the region across the last 20 years, and there is an awareness of the value of ESG in Asia today.
When thinking about ESG as a tool for value creation, is that value self-evident or can you attribute a portion of the multiple on exit to the ESG performance of a business?
MO: When you are selling an asset to a listed US or European strategic buyer, you become acutely aware of how important ESG is. You quickly realise that when a company has everything ready on the ESG front, a sales process generally goes a lot smoother.
That is not just an anecdotal observation. We have actually back-tested our portfolio, and our analysis showed that businesses executing drastic improvements in ESG or very good ESG practices outperformed other businesses by between 300 to 400 basis points.
How does ESG fit into your investment process and portfolio management approach?
MO: We have invested significantly in our in-house ESG expertise. Bence has come in as our senior director for sustainability and ESG portfolio operations, and we have two environmental, health and safety senior managers, with one being embedded in the portfolio. Our human capital director due diligences all the staffing aspects of a deal against International Finance Corporation and International Labour Organisation standards. We also have a governance director and a senior integrity specialist as an adviser.
Our ESG team are involved in every deal we look at from the outset. They help to scope third-party ESG due diligence and they also work directly with investment teams and management teams to prepare the 90-day plan.
They will identify gaps in basic standards, as well as value-creation opportunities. Our human capital director, governance director and Bence all sit on the investment committee and have a voice independent from the deal teams. Bence will also participate in the partner vote on a transaction with an ESG lens.
For every investment, we lay out an environmental and social action plan, which is discussed and aligned with the chief executive and senior management team. There is follow-up through quarterly reviews and progress reports. Our internal audit regime now also covers ESG.
Another initiative that we implement across all new investments is a whistleblower and grievance platform. That is a powerful tool, as it gives a voice to a lot of people around governance and ESG matters.
So that is the playbook, and it works, but the biggest issue about getting good ESG practices in place in Asia is securing the engagement and commitment of the senior people at portfolio company level.
We encourage this engagement pre-investment to make sure there is buy-in from the management team and the right people are in place to drive ESG implementation independently from within the business.
BS: The human capital piece is essential. Southeast Asia is still catching up with Europe on ESG standards, and because of this it can be difficult to find management teams with high level ESG expertise and experience. Entrepreneurs aren’t always aware of what ESG is and don’t understand the value uplift that investing in ESG can provide.
For every company we back, we therefore always insist that the business hires a designated ESG officer. Finding that person is one of the biggest challenges, given that ESG is still developing in Asia. I am hopeful that this will change.
We also invest in educating portfolio companies using our expertise and resources. Whether ESG is there as a spur for new product development, unlocking green finance or adding to value on exit, we put the work in to generate hard data that shows how ESG isn’t just a cost centre.
What is your approach to assessing ESG risk and upside?
BS: Materiality is a guiding principle for the firm. Different industries have different potential risks, and those specific risks will guide how we prioritise due diligence and ESG management through the hold period.
“Entrepreneurs aren’t always aware of what ESG is and don’t understand the value uplift that investing in ESG can provide”
That said, there are some overarching frameworks that are useful for identifying the most important ESG themes. As Michael mentioned, we hold all our investments to IFC and ILO standards, while the Task Force on Climate-Related Financial Disclosures is a powerful framework for addressing the financial impact of environmental risks.
Assessing the potential impact of climate change on an investment is something that we are doing more and more. We try to quantify the potential risks posed by flooding or heatwaves, and how climate will affect how assets function. We are using data analytics and climate modelling to form a decade-long view on climate impact. It is evolving into an increasingly sophisticated workstream.
Once that risk has been modelled, the emphasis is not only on filling the gaps from a risk perspective, but also establishing a base for value creation that a company can work off. This can range from simple reductions of emissions and carbon footprint to designing specific ESG products or qualifying companies to secure green financing. There is material value-add that emerges from the ESG due diligence process.
MO: Our recent exit of shoe components maker Texon is a good example of how our approach works in practice. When we first backed Texon it was following good business practice, but it didn’t have a specific environmental focus. We soon became aware that ESG and sustainability was incredibly important to the brand owners it was supplying.
We worked with the management team to develop a sustainability plan for the business that included using more recycled materials in the components and more renewable energy in manufacturing plants. It was one of our first portfolio companies to adopt a net-zero plan.
For Coats, the UK strategic buyer that acquired Texon in July 2022, this plugged straight into the business’s brand ethos, and it saw value in paying a premium. So that, to me, is a great example of how to create value with a sustainability focus.
Does the approach vary across growth buyout, venture and private credit strategies?
MO: What we have described so far is ESG in a growth buyout context. On the credit side you’re not a controlling shareholder, so while there is the same level of ESG rigour in due diligence, the ability to influence ESG may be slightly different. You may have a board seat, or you can include a provision in the documentation requiring the hire of an ESG executive. Credit can also be structured to include ESG performance terms that offer interest rate margin discounts or penalties linked to delivering pre-agreed ESG KPIs.
In venture, governance and human capital run front of mind. That requires a slightly different, but no less important, focus.
BS: While the approach varies, we strive to bring a common denominator across all these strategies because we believe that whatever you do, it will add value, both financially and reputationally.
How do you see ESG evolving in Asian private markets in the coming years?
MO: If you look at how ESG has developed in Asia, it started out with governance, but the sustainability lens has become increasingly important. It is a driver of value creation, and customers and investors want to see it in action, so it will become ever more important to develop that capability.
Another focus, and this is an area that I am personally quite passionate about, is human rights and supply chain integrity. When you are operating in Southeast Asia, that is absolutely paramount.
BS: There is huge enthusiasm and interest in ESG in Asia, coupled with confusion around what the expectations are and fear of greenwashing. Setting clear criteria is the next step in the evolution of ESG in the region.
We want to push forward in a pragmatic way and align our firm with the highest international benchmarks. To that end, we are rolling out European Sustainable Finance Disclosure Regulation-level standards across Navis Capital as a fund manager, and certain portfolio companies.
The SFDR sets a high bar, but we believe that by rolling out this level of reporting you have clarity on what your baseline is, and you can set targets to improve the ESG bottom line, which in turn will feed into value creation across the portfolio in a meaningful way.
Michael Octoman is a senior partner and Bence Szegedi is a senior ESG director at Navis Capital Partners