African managers are often held up as industry leaders in ESG implementation and innovation. While the accolade is hard to prove relative to other markets, it is clear consideration of environmental, social and governance impacts is imperative for any African GP seeking to invest capital on the continent.
“When we look at our colleagues in other emerging markets, Africa is far ahead of say Latin America or Asia in the discussion of ESG,” says Michael Hall, ESG manager at Development Partners International. “It’s more common for private equity managers in Africa to be familiar with ESG, the terminology, what it should look like and how to conduct business.”
“ESG practice in African private equity meets global best practice in my experience of working within the industry,” says Dean Alborough, ESG advisor at African Infrastructure Investment Managers, a member of Old Mutual Alternative Investments. “Given the emerging market context, ESG is naturally going to be a fundamental aspect.”
Another clear reason for manager focus on ESG is their source of capital. “CDC, among many other DFIs [development finance institutions], have been involved in African private equity funds pretty much since the beginning,” says Guy Alexander, environmental and social responsibility manager at CDC, which invests both directly and through funds in Africa as a UK DFI. “In many of the funds that have been raised, a DFI would account for a significant majority of the capital.”
“DFIs are leading the way,” says Mariam Djibo, an Abidjan-based principal at Adenia Partners, which closed its latest fund, Adenia Capital IV, on €230 million. The commitments were split 50-50 between DFIs and other investors. “DFIs are our first source of capital and our first constraint. They have stringent ESG criteria from the fund documentation [onwards]. We have to tackle those issues. They want risks managed and impact.”
GPs realise “that if you’re not going to undertake ESG in a genuine and proper way, you’re not going to raise capital”, says Alborough. “The more sophisticated LPs become [regarding ESG] the more sophisticated GPs become. Over the last two years, we have seen a dramatic increase in LPs asking about our ESG practices.”
DFIs, which exist to promote sustainable development, are themselves evolving. Monitoring of managers’ ESG systems and capabilities is well-established. “DFIs have always had a clear view of what they want in terms of reporting,” says Hall. “Our DFI partners have been consistent in their approach and work together to streamline the reporting process.”
Now “the conversation has moved on from, ‘what reporting does the LP need to be confident that GPs are doing their job?’, to ‘how do we know if we are going in the right direction, what new contextual risks and themes are arising?’” says Alexander.
As African economies grow, industrialise and urbanise, there are new risks to consider. “Regulations and enforcement are weaker in some African countries,” says Ritu Kumar, CDC director of environmental and social responsibility, adding that local ESG experts are rare. “That puts the responsibility on an investor like CDC to ensure better ESG practices.”
“DFIs are becoming more engaged on what works and what doesn’t,” says Hall. “Our DFI partners are increasingly looking at technical solutions, providing assistance, whether that’s through grants, information sharing or provision of free training.”
At the same time, DFI engagement with the investment process is deepening. In the case of first-time or new managers, DFIs are asking to review ESG due diligence and give feedback to the investment committee (on which they typically have a seat), says Djibo. “This is very new,” she says, adding that LP scrutiny can extend along the value chain to encompass portfolio company suppliers and customers as investors seek to mitigate investment risk.
LP oversight can stretch to the end of the investment cycle. As DFI focus broadens from purely risk mitigation toward value creation, evidence of ESG-fuelled returns is increasingly important at exit. Demonstrating a track record of positive ESG outcomes “is becoming more valuable for future capital raising”, says Alborough. “The more focus LPs give [to ESG], the more value that track record starts to have.”
However, GP adherence to DFI ESG criteria is more than simply a means to curry favour with investors. GPs see DFIs as a deep wellspring of ideas, experience and support. “There are serious benefits to working with certain LPs and DFIs,” says Alborough. “LPs bring to the table a broad line of sight and experience. They’ve seen a lot of assets globally. When they are asking for something or pushing in a certain direction, you have to take the time to listen.” And in problem solving, international DFIs can often help by exercising their local influence, he adds.
“We try to share experiences, and with the resources we deploy help managers get the most benefit from the standards we are trying to promote,” says Alexander. “There is an alignment between LPs and GPs in terms of what we are trying to push for.”
The International Finance Corporation’s Environmental and Social Performance Standards provide a “very consistent set of expectations as to what requirements a manager needs to follow”, he says. They sit alongside the UN’s Sustainable Development Goals and the Principles for Responsible Investment as fundamental reference points for managers.
While collectively GPs understand what is required in terms of ESG, each approaches reaching their goals differently, says Alexander. However, “since there is a consistent set of LPs [invested in African GPs] there are often similar conversations taking place across a number of different managers”.
In Africa, where the scope for impact is enormous, the outcome of these conversations can be significant. Relying on veteran DFIs for both capital and expertise, African GPs are well positioned to make headway.
“Progress has been made but there’s so much that needs to be done,” says Alborough.
Taking ESG to the bank
Addressing ESG issues is imperative to build sustainable businesses in the African context, says Mariam Djibo of Adenia Partners. “When you invest in a company in Africa you have a social responsibility that is above the same company in the same sector in Europe, the US or even Asia,” she says.
Upgrading business models and processes is increasingly acknowledged as not only a means to mitigate risk but also to create value. In some cases, it delivers direct financial benefit to portfolio companies.
Djibo recalls a conversation she had with the chief executive at a bank in the GP’s portfolio about integrating new environmental criteria into its credit committee process. In the absence of regulations that would bind all banks to the same criteria, the CEO expressed concern that adopting these new parameters would slow decision-making and undermine its ability to compete.
“He was probably right,” says Djibo, reflecting that it should have been the regulator that imposed the criteria. However, the CEO was persuaded by the fact that including environmental criteria in the bank’s credit process meant it was eligible to apply for additional DFI funding to support its lending activities. “Then he was convinced,” she says.
Once Adenia wrote the processes and trained the sales agents at the bank to adhere to the new criteria, the bank took the opportunity to access new financing, which ultimately rendered it more competitive.