How to integrate ESG factors within the organisation and governance structure.

There is no one-size-fits-all approach to ESG integration.

The process involves more than simply formalising what a GP is already doing. A GP has to examine, in depth, whether it is taking into account the full spectrum of ESG issues in its investment analysis and working with portfolio companies on all issues relevant to the business. To do this, it is important that an appropriate organisational structure and culture is in place.

COMMIT TO ESG INTEGRATION SET ESG OBJECTIVES ENGAGE WITH STAKEHOLDERS 
Ensure formal commitment from the top to guarantee sustained institutional dedication and resources. Set and communicate objectives for ESG integration. Engage with collaborative initiatives.
Appoint a person or team responsible for ESG-related processes with the relevant expertise. Educate employees on the rationale, strategy and practices for ESG integration. Establish an operations group or use consultants to monitor portfolio companies. Engage with LPs.
Link ESG objectives to employee evaluation.    

1. Commit to ESG integration

The first step is to establish and communicate the organisation’s willingness to commit to ESG integration. This helps ensure the organisation has the support necessary to develop an approach to ESG integration which is both aligned and embedded within its overall mission and strategy.

1.1 Ensure formal commitment from the top to guarantee sustained institutional dedication and resources

A GP could appoint one or two senior partners (or other senior individuals) to champion the implementation of an ESG programme. Lack of internal support and resources are two frequently cited hurdles to integrating ESG factors. Strong commitment from senior executives can ensure that ESG integration is recognised as part of their organisational strategy and incorporated into their investment practices.

“One partner was the sole catalyst for ESG at our firm.”

In practice

Examples of dedicated senior partner commitment can be found across regions and investment strategies, whether in North America with GPs like First Reserve and TPG or the France-based GP Apax Partners MidMarket.

At Apax Partners MidMarket, a senior partner personally oversees the process of integration and leads the team with a focus on ESG considerations. This team reports directly to the firm’s President. This buy-in from the top signals to the other employees that ESG considerations are important.

1.2 Appoint a person or team responsible for ESG-related processes with the relevant expertise

A GP could:

  • Appoint a dedicated individual or team to be responsible for ESG integration who is knowledgeable and experienced with the PE investment process. Employees with PE investment experience will be more likely to influence their colleagues on the value of integrating ESG factors.
  • Assemble an ESG committee involving employees from across different functions and levels of seniority to oversee the process of ESG integration. Such a committee could be used to handle specific ESG issues identified in the investment process and also to provide support to the investment/operational teams in case of ESG-related incidents.

Assigning responsibility to a person, team or committee should not be seen as a way to compartmentalise ESG integration. Instead, the purpose is to ensure accountability for embedding ESG considerations within the organisation and investment processes.

“You need to have a dedicated person – otherwise, you will hit a brick wall.”

In practice

Permira, a UK-headquartered PE firm, has instituted an ESG working group which brings together investment professionals, the Chief Risk Officer and a member of the Investment Committee to monitor ESG issues and facilitate engagement and discussions with those less engaged on these topics.

UK-headquartered GP Doughty Hanson’s ESG efforts are coordinated by a dedicated Head of Sustainability who is a Partner within the private equity team. In-house ESG expertise is supported by a wide network of external specialists.

First Reserve, a US-based GP, has appointed a team to implement its ESG policy. First Reserve’s Legal and Compliance Team conducts an ongoing review to ensure that First Reserve is complying with its ESG policy.

1.3 Educate employees on the rationale, strategy and practices for ESG integration

A GP could:

  • Start the ESG integration process with an offsite training day for all staff, or make use of appointed time within a firm’s annual offsite meeting. Discussion topics could include: a general introduction to ESG factors and how these factors can impact investment performance, the organisation’s beliefs and values with regard to ESG factors, what integration entails for a GP and an overview of what its peers are doing.assemble an ESG committee involving employees from across different functions and levels of seniority to oversee the process of ESG integration. Such a committee could be used to handle specific ESG issues identified in the investment process and also to provide support to the investment/operational teams in case of ESG-related incidents.
  • Include training on ESG factors in the induction process for new employees.
  • Introduce continuous training or knowledge sharing through the use of newsletters, regular presentations on topical issues, themed case studies or other ESGrelated findings revealed through reporting from portfolio companies.

By investing in employee training, the GP can ensure that knowledge and messaging on ESG integration is spread throughout the workforce.

“We try to raise awareness of what our firm stands for.”

In practice

EQT, a PE firm founded in Sweden, assigns an associate on a rotational basis to their ESG working group, which also consists of the responsible Partner, the Responsible Investment Director and a Legal Manager. During this one or two year rotation, the associate will be given an in-depth introduction to ESG and its relevance to the PE industry, investment and operations. An advantage of involving the new generation of investment advisors is that they often demonstrate a keen interest in ESG and will typically apply dedication and vigour to their role. The ultimate outcome is that ESG knowledge and experience are being continuously integrated into the firm’s culture.

France-based GP Ardian’s Mid Cap Fund employs an external consultant to conduct an annual ESG survey on the portfolio. As part of this process, the consultant applies an internal ESG appraisal system by which all portfolio companies are compared on their ESG performance. This survey has proven to be a good inroad for training the investment teams to embed ESG into their monitoring processes. Investment managers have the opportunity to review and learn from good ESG practices across the portfolio. This collaborative exercise is complemented by a naturally competitive element among the investment teams when comparing portfolio companies on their ESG performance – this and the practical approach of focusing on the business of portfolio companies means that the survey process has gained traction with the investment teams as an effective way to engage with them on ESG integration.

1.4 Link ESG objectives to employee evaluation

A GP could explicitly link ESG-related value creation and protection to employee evaluation. This will help a GP ensure that its employees are committed to its ESG objectives. One way of doing this is to create an association between employee evaluation and the specific ESG-related performance of the fund and/or portfolio companies. For this to be effective, a GP could have a fund and/or portfolio company level reporting structure which links relevant indicators for the fund and/or portfolio company to the GP’s ESG objectives and targets. This will help employees understand what is required from them and will reinforce the GP’s commitment to ESG integration.

2. Set ESG objectives

2.1 Set and communicate objectives for ESG integration

A GP could formally determine and communicate its objectives for incorporating ESG considerations. It could set broad objectives such as achievement of operational excellence and/or value protection and creation.

By starting out with clearly defined objectives for ESG integration, a GP can increase the efficiency of the integration process. It may be more difficult for the GP to effectively integrate ESG factors without this point of reference to guide its efforts in this field.

In practice

Blue Wolf Capital Partners, a US-based PE firm, has built its value creation proposition with a focus on the social dimension. Over the years Blue Wolf has gained considerable experience with underperforming companies, almost always involving significant social issues. By aligning incentives, improving overall industrial relations and engaging with various constituencies, such as governments, unions and local communities, the firm actively solidifies the foundations of its portfolio companies.

2.2 Establish an operations group or use consultants to monitor portfolio companies

A GP could deploy a dedicated operational team or employ external advisors to bring technical expertise on ESG matters to the table when reviewing portfolio companies. This allows the GP to better understand the business potential of the investment, to calculate ESG impacts and to assess the quality of company management. During due diligence or ownership, this operational team or external advisor could be responsible for performing a baseline review to assess the ESG factors impacting the portfolio company. This would in turn help with monitoring any changes or advancement towards the GP’s specific ESG objectives and targets.

In practice

The US-headquartered investment firm KKR’s Green Portfolio Program, which KKR launched with the US-based NGO Environmental Defense Fund,10 is a well-known example of a GP deploying a dedicated team of operations experts to assist participating portfolio companies with their ESG activities. At the core of this program is a set of analytic tools that helps portfolio company management teams to identify and monitor improvements across various environmental performance areas (e.g. greenhouse gas emissions, water and waste) with the aim of improving a company’s impact and bringing about measurable business benefits.

3. Engage with stakeholders

3.1 Engage with collaborative initiatives

A GP could engage with collaborative initiatives to support ESG integration both within their firm and the broader PE industry. There is valuable information available for GPs which are proactive and engaged. In this regard, joining global and/or regional initiatives which support ESG integration (e.g. industry associations or the PRI) can help a GP to obtain a better understanding of the field. These initiatives may provide useful guidance in the form of resources, topical programmes or events.

Many GPs and LPs have been promoting ESG integration within the PE industry by sharing knowledge with their peers via case studies, articles and speaking at industry events. Additionally, many GPs and LPs cooperate to develop resources such as this document. GPs and LPs are also encouraging parties in the wider investment sector to engage on this issue, such as consulting with bankers, lawyers and accountants.

3.2 Engage with LPs

A GP could engage with its LPs to better understand their ESG-related expectations. This is particularly relevant for GPs which are in the early stages of integrating ESG into their operations.

It can be difficult for a GP which is new to ESG integration to know which questions to ask LPs, and in turn what level of reporting requirements LPs expect them to achieve. GPs could look to the ESG Disclosure Framework for Private Equity which aims to facilitate an informed discussion between GPs and LPs. It is a practical guidance tool which provides a set of relevant questions that may be helpful in guiding the dialogue between LPs and GPs on ESG disclosure. This framework was developed in collaboration with LPs, GPs and PE associations.

It is also important to note that LPs have differing ESGrelated expectations, and GPs should find a way of efficiently addressing all or most of those varying expectations.

In practice

Apax Partners MidMarket conducted a survey of their LPs to gauge levels of interest in ESG integration. The survey focused on three main topics:

  1. Whether a GP should address ESG because of risk management issues or value creation potential
  2. What the LP was currently doing to assess a GP’s ESG practices
  3. How the LP was currently following up after due diligence

The survey revealed that the majority of respondents see ESG issues as increasingly important, beneficial from a risk management perspective, and a means to create value. For Apax, this reinforced their commitment to their ESG s

trategy.

A general partner's guide to integrating ESG factors in private equity