By Andrew Malk, Founder and Managing Partner of Malk Sustainability Partners (MSP)
Part III: The Fine Print of ESG Underwriting
In the second installment of this series, we highlighted how private equity fund managers can drive value creation across their portfolios by integrating efficient resource management expertise into operational teams and broader corporate strategy, as well as by bringing in experts in resource saving practices where appropriate. Major funds have found that doing so is an effective tactic to identify substantial cost savings while also producing broader strategic benefits. Today, we move upstream in the investment cycle to the acquisition phase to examine how private equity general partners (GPs) can benefit from enhanced consideration of environmental social and governance (ESG) factors during the due diligence process.
For prudent investment managers, robust due diligence is fundamental; in considering acquisition of a company or asset, due diligence is a chance to ‘test drive’ the investment and look for risks or opportunities which might affect value in the future. GPs are accustomed to looking closely at a wide range of issues during due diligence, from company financials and quality of earnings to operational issues and corporate governance.
Private equity due diligence has traditionally incorporated basic environmental, health, and safety diligence, including compliance with local law and – where relevant – the development of environmental impact studies. However, GPs are increasingly expanding their focus on ESG issues such as resource efficiency, mitigation of long term environmental risks, working conditions, and good corporate governance practices.
There are multiple drivers behind this increasing focus on ESG in the diligence process. Prominent among these is the expectations of important stakeholders including the large institutional investors such as pension funds, university endowments, and development finance institutions which invest in GPs. These organizations, which are expected to generate stable returns over long periods of time, see ESG issues such as resource efficiency and the social license to operate as integral to the long term success of their assets. As a result, they have begun to place higher expectations on GPs.