GP-LP communication key to effective ESG policy – AVCJ Forum

Anders Stromblad, head of alternative investments at Swedish pension fund AP2, said this effort would have to be tailored to the resources and needs of the firm rather than pursued through the application of a standard procedure. Success in this approach may require engagements on values that gradually address sustainability and ESG issues with increased depth.   

“We try to create relationships with managers a very long time before we make investments and understand how they are thinking, how they’re acting, and how do they think about culture in the firm. Knowing that a little bit, it’s easier to start the discussion of how they approach different topics like ESG,” Stromblad said. “It’s not something that you do very rapidly. If you develop ESG, it should be done reasonably slowly and thoughtfully.”

Once cultural alignments are established, GP-LP dialogue will increasingly revolve around quantifiable progress and compliance standards. To this end, Jie Gong, a partner at fund-of-funds Pantheon Ventures, said it was incumbent on LPs to be strong advocates of ESG practices and empower GPs to integrate ESG into investment processes, while fund managers would need to adopt some behavioral changes around accountability.

“The reporting among Asian GPs tends to stick with a fixed template with very little deviation and there isn’t enough communication from the GP to the LPs,” Gong said. “That’s something that every GP can do a little better by including in their quarterly reports what they’re doing on the ESG front, what are their findings, how they have addressed it, and do that before the LP reads it in the paper or in the next annual meeting when it comes out in the presentation.”

Although pressure from LPs on these points has generally been regarded as the primary motivator to formalize ESG policies in private equity, GPs have begun to cite a wider range of inducements.

Michael Octoman, COO at Navis Capital Partners, for example, confirmed that his firm’s first ESG implementations about 15 years ago were LP-driven and considered a cost that had to be managed. But as of about 10 years ago, it became clear that portfolio businesses focused on ESG were more competitive and realized stronger exits. 

“Some of our businesses were actually getting pricing power because of ESG practices, and strategics were actually paying up for this,” Octoman, said. “So, we thought we need to invest more heavily in ESG because it does create more tangible value. Since then, it’s actually come to a level where some of our investment theses are linked directly to ESG and that’s been the main reason we’ve backed those businesses.”

Other incentives have materialized in the form of government pressure, especially in China, where environmental protocols are said to be reshaping growth plans on a number of fronts.

China-focused FountainVest Partners – which is planning to begin formal ESG reporting with its LPs next year – has incorporated discussions with regulators around possible future changes to compliance standards as part of its due diligence, as well as the considerations around the impact of new rules on portfolio companies’ eligibility to IPO. 

“Environment related considerations is now a part of the key listing approval process for Chinese securities regulators,” Frank Tang, chairman and CEO of FountainVest, said, noting that increasingly stringent regulations in the country have resulted in ESG becoming a starkly binary deal-breaker. “If you can’t meet the environmental standard, this is a killer issue – it’s just ‘no.’”

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• Topics
• GPs
• LPs
• Advisory
• Fountainvest Partners
• Pantheon
• Navis Management
• ESG
• China
• AVCJ Events