Responsible Investing: Finding the right approach

THE BOARD-LED APPROACH

When pan-European buyout house Cinven was developing its approach to ESG, it had two definite ‘don’ts’ in mind: don’t have a one-size-fits-all mind-set, and don’t make the reporting piece overly burdensome to the portfolio company.

“We were very conscious that under private equity ownership there are a number of reporting requirements already, and we wanted to ensure that whatever we were asking portfolio companies to do on ESG was something that outlived our ownership and was properly embedded,” says Vanessa Maydon, corporate affairs director at Cinven.

As a result, the firm decided to ask its portfolio companies individually to define their own ESG-related KPIs based on a materiality basis.

“Our approach to ESG has focused on our portfolio companies developing their own bespoke KPIs that are relevant to their business and aligned with the ESG metrics they are already recording as material to their business,” Maydon says.

Cinven prepared guidelines to help its portfolio companies carry out a materiality assessment on ESG and to help them structure their reporting framework.

“Within that we recommend that if they don’t have a dedicated head of ESG or sustainability, that one way of pulling all the data together and reporting on it is to put an ESG steering committee together, and on that to have board representation,” Maydon says. A specific member of the company’s board, therefore, takes responsibility for ESG within their own company, rather than an external member of the Cinven team.

“How they then structure their internal reporting framework in practice, and who that board individual is, is up to them. We haven’t wanted to be too prescriptive about it because the way companies are structured is slightly different [in different geographies].”

Cinven currently uses iLevel reporting software internally for financial reporting and operational KPIs within each of its portfolio companies, and it is in the process of integrating ESG KPIs into the system to streamline the reporting process.

THE PUBLIC MARKETS APPROACH
Like its similarly-sized peers, funds managed by Apax Partners invest in many companies with an enterprise value of more than €1 billion, and therefore at least several of them are highly likely to end up being publicly quoted. As a result, Apax always has one eye on what the public companies are up to.

“We found that public companies were increasingly including non-financial metrics in their annual reporting in line with stakeholders’ demands for transparency of their ESG footprint,” says Ellen de Kreij, ESG implementation lead for Apax Partners.

Having worked predominantly with external advisors on ESG due diligence and value creation within its portfolio companies, in 2012 Apax brought in Credit360, a sustainability software system used predominantly by the public equity community to track ESG-related KPIs.

“It’s typically used by large multinationals with different divisions in different regions that have to do a lot of data collection and quite a bit of reporting around it,” de Kreij says. “If you think about it, that’s the profile of a large-cap private equity firm. Funds advised by Apax control a variety of global groups across four sectors and have a requirement to do quite a bit of reporting.”

Apax has come up with around 80 sustainability-related KPIs, covering everything from resources usage to workforce diversity to regulatory compliance. Individual portfolio companies input their data into their own section of the cloud-based system which, where necessary, has been tailored to them. This data can then be collated and analysed across portfolio companies, which allows for comparative analysis across similar businesses across the four sectors in which the Apax funds invest, and tracking of how individual portfolio companies are improving year-on-year.

As well as providing a rich source of information for Apax itself, the information collated through Credit360 is reported back to LPs through an annual sustainability report, which distils the data to give investors a picture of ESG progress within the portfolio. For those that need a more detailed breakdown, the data is readily available for Apax to provide.

THE BESPOKE GROWTH MARKETS APPROACH
For LPs investing in growth markets private equity funds, how fund managers approach ESG is a major consideration.

“Especially in some of these markets in their early stages, our investors were very keen that we were adhering to the right levels of governance,” says Wahid Hamid, a partner and global head of The Abraaj Group’s Performance Acceleration Group (APAG).

Abraaj considers responsible investment to be an integral part of its DNA. However, it was keen to move beyond compliance and risk mitigation towards measuring the impact of the private sector and propelling it “up the learning curve in areas of sustainability”.

“We’re firm believers that the private sector has a very strong role to play in promoting these practices, and if we could play a part in that, if we can infect [these markets] with the virus and make sure that they’re focused on these aspects in the broader sense of the word, then we’d have a positive impact in terms of the private sector’s contribution to issues of sustainability in these markets,” Hamid says.

As a purely growth markets-focused investment firm, Abraaj found that none of the measuring or reporting tools already in use were a good fit for the businesses in which it invested. In 2008 the firm developed the Abraaj Sustainability Index (ASI), a system which measures its portfolio companies’ development impact from a private sector perspective.

“We had to develop something bespoke, something that reflected the nature of the companies we were investing in,” says Hamid. “The metrics and attributes that we felt were important measures of sustainability for our markets were slightly different than for the others.”

The ASI has recently gone through an internal review; its six pillars of sustainability have been narrowed to four, and its 70-plus KPIs have been trimmed to around 50. Abraaj is also launching an online system through which its portfolio companies can directly input their ESG data and do their own analysis, including benchmarking themselves against peers within the Abraaj portfolio.

“The one thing that we constantly struggle with is keeping this simple, because if you make it too complicated or we focus on too many things, it’s not going to see the light of day, because these are also companies that are rapidly growing. They’ve got many other priorities and a sense of urgency to scale the business, so we’ve got to pick our battles,” Hamid says.

“Even though we have 50-plus metrics that we’ve identified, we tend to hone in on a few that we focus on with the partners to get them to improve.”

THE COLLEGIATE APPROACH

Arguably the best authority on how to overcome ESG issues in portfolio companies are portfolio company management teams that have already overcome similar issues. French private equity firm PAI Partners recognises that many common ESG issues affect multiple portfolio companies, and therefore sharing best practice and experience across businesses is paramount.

In 2011 it created the PAI Sustainability Club. Its biannual meetings bring together ESG managers and teams from all of PAI’s portfolio companies for seminars, presentations, workshops and lessons with ESG and consulting professionals. Discussion topics in recent years have included responsible procurement, reporting, and human resource management.

Bringing management teams together helped to bring on board those more reluctant to embrace ESG monitoring and reporting, says Blaise Duault, head of compliance and public affairs at PAI.

“When you are investing in the management and strategy, you want them to have specific views on ESG,” he says.

Keen to continually develop its approach to ESG, in 2015 PAI launched an ESG reporting software system.

“We decided to work on a tool that would create a dialogue with our companies and be more interactive with them,” says Caterina Romanelli, head of responsible investment and ESG at PAI.

Duault adds: “Having worked on ESG since 2010, we had developed some expertise on what the expectations of LPs were on the subject, which was very useful in tailoring the tool.”

The reporting tool includes 145 ESG indicators, out of which PAI identifies those that are relevant to each portfolio company. The tool can then be used to track progress and to report back to investors.

Not content to stop there, in November PAI joined with fellow French private equity firms Apax, Ardian, Eurazeo and LBO France to launch the ‘Initiative Carbone 2020’ to address the carbon footprint of portfolio companies. The firms jointly committed to measure both the direct and indirect carbon footprint of 30 sample portfolio companies, raise climate issue as a strategy across all controlled companies and publish company data as of 2020.