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  • North Asia

ESG & operations: Compliance corner

  • Tim Burroughs
  • 01 March 2021
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Few mid-market private equity firms in Asia have dedicated ESG personnel and this is not necessarily an obstacle to progress. As compliance and reporting burdens increase, the status quo may change

Takaharu Itoh was recruited by Japanese mid-market buyout firm NSSK for the operational insights he has accumulated during a career spent working for the likes of Pfizer and Amgen. That expertise will now be recalibrated in the pursuit of a different goal: ensuring the GP’s environment, social and governance (ESG) policies are properly executed.

“The ESG audit officer will check whether the KPIs [key performance indicators] are realistic, what processes we should put in place to execute against those objectives, and whether we meet them or not,” says Jun Tsusaka, a managing partner at NSSK. “He is like our ESG policeman – the traditional English policeman around the corner who was a neighborhood ally and protector, but who would come and see you if you did something wrong.”

NSSK already has an ESG committee that sets policies and reviews progress. This is in line with what is gradually becoming an industry norm. However, dedicated ESG personnel remain a relative rarity in the middle market and below. The likes of Navis Capital Partners, Adamantem Capital, Everstone Group, and Openspace Ventures remain the exceptions to the rule. With COOs noting a significant increase in their ESG workloads, will it stay this way?

“Everstone was always careful on ESG without having significant formalized processes until 2013-2014 when a senior member of the operations team took on the mantle of ESG operations officer,” says Sanjay Gujral, the firm’s chief business officer. “We had a robust system of ensuring hygiene and then a couple of years ago we decided to ramp up what we were doing. We became a UN PRI signatory, we published our first sustainability report, and we are seeing how we can tie what we are doing into the SDGs [sustainable development goals].”

Everstone now has an ESG officer for each of its three strategies, but other GPs have become just as adept by allocating oversight to an individual who has other duties.

Among firms with less than $2.5 billion in assets, nearly 40% assign responsibility to the COO, CFO, CIO or senior portfolio manager, according to EY’s 2021 global private equity survey. A further 18% leave to the board of directors, while 12% have an internal ESG taskforce. Moving into the middle market, where assets are in the $2.5-15 billion range, more than one-third have a taskforce, 12% have an ESG head, and about 30% rely on the COO, CFO, CIO or senior portfolio manager.

Who’s responsible?

The ESG committee – or taskforce – is typically led by a managing partner and may include the COO, head of legal and compliance, and various investment professionals. Many private equity firms point to this committee as evidence of how ESG percolates through their investment process.

Steve Okun, founder and CEO of APAC Advisors, a consultancy that specializes in ESG, sustainability and stakeholder engagement, doesn’t dispute the importance of the ESG committee. Ultimately, effective ESG oversight involves ensuring that material risks are identified during due diligence, presented to the investment committee for consideration alongside any mitigating actions, and then tracked during the holding period, with progress reported to LPs. The ESG committee ensures the systems and processes are in place to make this happen.

However, there must be a designated individual who checks whether the mechanism is functioning properly. “It could be the head of the ESG committee, the CFO, COO or general counsel, there is no right or wrong answer, but someone has to do it,” says Okun. “If you don’t have a single person responsible for ensuring that ESG is integrated into the entire process, something will go wrong.”

A dedicated ESG officer exists in parallel to this oversight structure. They are the one-stop-shop for the deal team when it comes to identifying material risks and devising ways to manage them. Once an investment is made, they check that the deal team is sticking to the plan.

“If you want to do it well, you must have someone who is dedicated to ESG – or have an investment team that is dedicated enough and trained enough to do it,” says Jaclyn Seow, head of ESG and impact at Openspace. “If you outsource ESG due diligence, you will probably get some quality work. But you can’t expect an investment manager to get into detail regarding supply chain visibility, data management procedures, and whether employments are in line with regulations.”

Prior to Seow joining, Openspace would have a couple of slides in investment committee memos about politically exposed persons or low-cost manufacturing. Even if they had wanted to go deeper, guidance materials supplied by development finance institutions tend to focus on risks involving traditional businesses. For the B2B and B2C platforms Openspace backs, minimum user age requirements, detecting online harassment, and anti-money laundering are more relevant.

“It’s not like I have a library of policies that can be adjusted for different industries,” she observes. At present, Seow is working with companies directly on implementing the mitigation actions identified by Openspace, but she accepts that consultants will have to play more of a role in the longer term.

Push and pull

Some private equity firms are already heavily reliant on third parties for implementation or recommend that portfolio companies make direct hires. In each of its last four investments, Navis recruited health, safety and environment (HSE) professionals. Michael Octoman, the firm’s COO, notes that HSE manager and human capital director are classic areas of weakness, regardless of whether they have been certified by suppliers.

Navis started paying attention to ESG 15 years ago because CDC Group – an LP in one of the early funds – demanded it. Four years later, when it was time to deliver exits for that fund, the emphasis that strategic buyers place on ESG became abundantly clear. Navis now has four people concentrating on ESG across integrity, governance, HSE, and human capital, respectively.

If LPs represent the push factor on ESG, asking managers for details on policies, processes and reporting because they are increasingly scrutinized by their own stakeholders, then trade sales remain a compelling pull factor. Mid-market GPs may feel it more keenly than most.

“We are backing gritty, $50-150 million turnover businesses in Southeast Asia, the ESG edges are very rounded before we invest. We identify the gaps, get buy-in from management, hire an HSE person who reports to the CFO, and help management implement best practice,” says Octoman. “When selling to strategic buyers, that is so fundamental to what we do.”

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  • Topics
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  • Asia
  • Navis Management
  • NSSK
  • Openspace Ventures
  • Adamantem Capital
  • Everstone Capital

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