Study: Portfolio companies ‘resistant to ESG’

Convincing portfolio companies of the importance of ESG remains challenging in emerging markets, according to research from CDC Group.

Resistance from investee company management and poor enforcement of regulations are the main ESG-hurdles general partners face in emerging markets, according to a study from UK development finance institution CDC Group.

More than 50 percent of organisations surveyed by CDC said resistance from investee company management was “very challenging”. The survey interviewed 53 individuals, representing 44 institutions across Africa, South Asia, Asia Pacific and Latin America.

“Many companies get ESG, but to some companies that are operating in difficult market conditions in emerging markets who are dealing with a wide range of business challenges, ESG may appear to be an onerous, nice-to-have but not essential component,” Mark Eckstein, director of environmental and social responsibility at CDC, told Private Equity International. 

“Naturally some investee companies will say, ‘This is another thing you are asking us to do and we are very busy.’ The particular role that fund managers need to play is making the business case and to get across it’s a fundamental business driver that is growing and it won’t be going away.”  

However, convincing management at portfolio companies that ESG is worth their time can be easier said than done, as some companies will push back hard, according to Eckstein.

“There probably are decisions made behind the doors of our GPs where they decide that the costs and dealing with this reluctance is more than they want to pursue, so they walk away from it,” he said, adding that GPs won’t always find these problems in due diligence.

Additionally, poor enforcement of regulations is another important hurdle – with 44 percent of respondents saying this is very challenging.

“ESG is much more significant in emerging markets because in many of the countries we operate in and our funds operate in – the laws may not be as good as in [Western] countries and even if they are, their implementation may not be as rigorous,” according to Eckstein.

The third biggest hurdle for implementing ESG programmes is the conflicting ESG agendas of LPs, the study found. LPs would have a greater impact if they agreed on a common ESG agenda for each fund, rather than requiring managers to fit different LPs’ priorities into the scope of a single ESG improvement plan, GPs noted.

Despite these issues, the survey also showed almost all emerging market fund managers now consider ESG to be integral to their investment approach and have developed sophisticated ESG systems and processes as a result. 

“I find a much greater receptivity in emerging markets now than I did 10 or even five years ago,” Eckstein said. “The needle is swinging towards recognition that these are material issues.”