The latest edition of CDC Group’s environmental, social and governance (ESG) toolkit for fund managers was launched at the Private Equity International Responsible Investment Forum, co-hosted with Principles for Responsible Investment, this year.
Designed by the UK government’s Development Finance Institution (DFI) as a practical guide to assessing ESG risks, it includes sector profiles, such as manufacturing, healthcare, retail, agriculture and aquaculture, and help on issues such as how to address ESG matters throughout the investment cycle, and assessing and managing governance and business integrity matters.
It has been designed specifically for GPs, but also has wider appeal.
“We pick up a reasonable amount of feedback anecdotally that it’s used extensively by funds, but also, interestingly, by legal firms, consultants, LPs, [and] by other development finance institutions,” says Mark Eckstein, CDC’s director of environmental and social responsibility, who launched the toolkit at the forum.
“Another audience that we’re aware of is in some instances potential investee companies [are] going to our toolkit to understand what they’re likely to be asked, so getting ahead of the due diligence train.”
The toolkit is as much about helping GPs maximise opportunities as it is about mitigating risks.
“Focusing on downside risk is natural, but shouldn’t be the only lens that GPs use,” Eckstein says. “[It’s] as much a value-driver as a risk management need.”
Experts at the launch agreed that investment teams operating in emerging markets should strive for the same international ESG standards as they would in developed markets. Countries across sub-Saharan Africa have their own standards when it comes to health and safety, governance and other aspects classified under ESG.
“Our companies all meet the country standards, but there may be a higher standard globally, and so we seek to have that higher standard,” says Runa Alam, chief executive and co-founder of Development Partners International (DPI). “If it’s within a grey area that we feel, with an action plan and a commitment by management, [can] get to best standards globally, then we will invest and we will help them get there.”
Mustafa Abdel-Wadood, partner and head of the regional fund businesses at The Abraaj Group, agrees that the management team’s willingness is key.
“What you look for is not that everything is in place but that there’s an aptitude and a commitment to get things into place, and that’s part of what we evaluate in our due diligence period,” he says. “Where is it today, where would we like it to get to, and can we get it there? And if we truly can’t get it there then we have to evaluate if we still consider the investment.”
Companies that are high impact, such as those in extractive and infrastructure projects, have clear standards that are straightforward to communicate. Other sectors, such as financial services, consumer goods and services and pharmaceutical companies, sometimes require more explanation around why GPs need them to implement these international standards, says Michael Hall, sustainability manager at DPI.
“You have to understand what the risks are in that company first, and then implement the standards to the level that makes sense,” Hall says. “Otherwise you’re going to be asking them for things that firstly don’t matter, and create a lot of work and a lot of confusion for no actual tangible benefit.”
COMES WITH THE CHEQUE
It can take years for portfolio companies to ultimately reach the standards set out by private equity managers at acquisition. However, in many cases the mere introduction of private capital brings with it a host of ESG benefits.
“The beauty of private equity in a market as young as Africa is by definition you are bringing in so many fundamental disciplines, whether it’s attitude on health and safety, employment, tracking anti-bribery, making sure contracts are transparent, chasing all those things down, that by definition you are travelling an ESG road almost by default because that’s in the DNA of private equity,” says Janusz Heath, managing director at Capital Dynamics.
“In Africa I would say it just comes with the cheque, and if it doesn’t come with the cheque then you shouldn’t be investing in that manager because they don’t have the inherent skills to add value.”
Whereas in developed markets regulators can view private equity with wariness, in African markets the reception has been much warmer, says Pantheon principal Dushy Sivanithy.
“If you look at the way African financial regulators have responded to private equity, they see it as a very positive development,” he says. “Where we get a lot of flak in other markets, the Africans have said, ‘Actually, we like this form of capital, we think it’s a very positive form of capital, it has a very important role to play, not least in improving standards.’”
What’s more, the heritage of the majority of private equity firms operating in Africa means ESG has been on the agenda from the start.
“I think Africa is ahead of a lot of the developed world because the whole industry was started by DFIs. From day one we’ve reported on ESG, from day one we’ve reported on impact,” says DPI’s Alam. “This is not a new conversation for African PE funds.”
Sivanithy agrees that the standards of reporting on ESG by Africa-focused funds is exceptionally high.
“Because their funding has come from DFIs for so long, unlike some groups it’s been ingrained in the way they operate from day one because the DFIs have such high standards in this area,” Sivanithy says. “When I see the level of reporting that I see from African GPs on this subject, it’s better than pretty much anywhere else I’ve seen in the world.”
MORE THAN BOX-TICKING
This comfort with ESG should empower GPs to lay down the ground rules when it comes to reporting, Eckstein argues.
“GPs should be more confident in defining the reporting agenda to LPs,” he says. “You can see a laundry list of expectations arriving on the GPs’ desks, and I think ultimately that’s not hugely helpful for the GP because they become focused on the reporting template and completing all the boxes, which ultimately may not inform the LP in terms of really what’s happening across the fund’s portfolio.”
The emphasis, Heath agrees, should be on substance over form. “The output is the important thing. Are you changing society? Are you, by setting up a factory somewhere, helping the community as part of that?”
Giving GPs the opportunity to make a judgment on what is material and allowing them to focus on concrete achievements will make ESG reports shorter and “they might actually focus on impact rather than just the representation of data”, Eckstein says.
“Be more confident in telling the LPs what the fund has achieved rather than just representing a bunch of data about greenhouse gas emissions or whatever. Be more intelligent about what you’re reporting back.”