ESG due diligence: Which tools can identify the issues?

A number of tools to help fund managers meet the increasing demands of ESG investment launched at the end of 2016, the first being a questionnaire released in November by industry body Invest Europe.

Drawn up in collaboration with private equity fund managers and institutional investors in Europe, it covers areas such as environmental impact, health and safety processes, human rights, and labour standards across a company’s operations and supply chain.

It is designed to help fund managers identify issues requiring more detailed technical assessment, and opportunities to enhance value and mitigate risks following an investment in a portfolio company, or at one in which they plan to invest. 

“Not all portfolio companies are on the same page when it comes to ESG factors,” says Marta Jankovic, senior sustainability and governance specialist, head of ESG integration alternatives at APG Asset Management, and chair of Invest Europe’s responsible investment roundtable. “The more we can help fund managers and investors identify the potential issues and opportunities in the investment process, the more we can promote high ESG standards across the board.”

The launch of the questionnaire was followed in December by that of the European impact investor ClearlySo’s online impact assessment portal for private equity and venture capital firms in December.

The ClearlySo ATLAS programme helps firms assess the social and environmental impact of their investments, and provides suggestions for improvement action. Its methodology takes into account guidance from the Private Equity Reporting Group, Principles for Responsible Investment, European Union Directives and Red Line Voting. Results are mapped to the UN Sustainable Development Goals.

“We request data from the private equity firm, and then we do the rest. Clients pay an annual membership, and access the portal online,” John Lloyd, ClearlySo’s chief marketing manager, told sister title pfm.

The programme assesses human, economic and environmental impacts and the target company is given an overall score. This can also be broken down into area-specific scores. Firms can download the impact report and share with interested parties.

There is also a knowledge bank available on the website, which keeps clients up to date with the latest developments in the impact investing space.

The launches of the tools came a year after the United Nations-backed Principles for Responsible Investment initiative finalised a standardised due diligence questionnaire for investors, which enables them to evaluate fund managers on their commitment to these matters. Drawn up by a working group of PRI signatories including LPs, funds of funds and general partners to build consensus on matters already touched upon in various other resources.

Law firms have also bolstered their efforts on the ESG front over the past year, setting up dedicated teams to assist their private equity clients in their responsible investment practices.

Global law firm Goodwin launched an impact and responsible investing practice in the US in November, and its team will advise on ESG-related legal matters including ESG and sustainability certification, benefit corporation formation and certification, immigration law compliance, foreign corrupt practices act compliance, tax exempt status and the employee retirement income security act.

“Impact and responsible investing is among the fastest growing, most prolific forms of global financial innovation,” said David Hashmall, chairman of Goodwin.

There is a strong incentive for fund managers to use these ESG assessment services available to them. Investor demand for ESG opportunities remained strong in 2016, and in August the California Public Employees’ Retirement System’s board of administration adopted a new ESG five-year strategic plan, naming six strategic initiatives to support the American public pension fund’s efforts in sustainable investing.

While investors have traditionally been the main reason behind decisions to invest responsibly, other factors including risk management have becoming increasingly important, according to a survey conducted by PwC at the end of 2016.

The survey found risk management, such as running into human rights issues, is now the most influential factor driving a firm’s decision to make a responsible investment. Almost half, 44 percent, of the fund managers surveyed by PwC agreed with this, up from 36 percent in 2013.

Environmental and social issues, and accompanying advice and/legislation are also impacting investment decisions. The UN Sustainable Development Goals are being used as a template for investment culture by 35 percent of the fund mana-gers surveyed, with more or less the same proportion agreeing that activity in these areas creates reputational benefits.

Attitudes about investments are also changing, with just under a third of respondents saying responsible investment issues are as important, or more important, than the financial performance of the funds.

“[The point] is interesting and a real sign of change in approach by the industry. Traditional business models are profit centric, but new business models, considering the needs of wider stakeholders in the mix are now on the increase,” PwC said in the report.