GPs need more than just an ESG mindset

For many GPs in the region, ESG already forms part of the due diligence process as they seek to develop an understanding of how challenges such as climate change might impact a target company. However, a subset of LPs wants to see evidence of policies being implemented on an ongoing basis during the investment period. Their number is likely to increase.

“What the LPs demand is [that] the expectation is you should be able to get data not just where you have strategic interest but it’s necessary beyond that and in other verticals - infrastructure, energy, real estate and even credit,” said David Katz, a director and head of public affairs for KKR in Asia.

While data collection is naturally easier at companies where GPs have majority control, those making minority investments will have to increase pressure on founders and management teams to comply. Raising awareness within portfolio companies is important, for example showing them how ESG can drive value in their businesses rather than just being an additional cost. Technology will help in these efforts, especially as reporting requirements increase.

The long-term implications of failing to get ESG right could be tougher fundraising processes. Tellingly, Blackrock chairman Larry Fink said in his annual letter to CEOs earlier in the week that climate risk would be a driver for “significant reallocation to capital” in the new decade. Not only will LPs require concrete data that validates any assessment, but these numbers will also have to stand up to scrutiny.

“The other direction we're headed when you're talking about impact is moving from an output to an outcome perspective,” said Steven Okun, CEO of consultancy APAC advisors and ASEAN representative for EMPEA. Outcome-oriented approaches differ from the status quo, he claimed. For example, a company’s decision to hire more women is more likely to be considered a socially beneficial decision if it led to women outside the labor force getting gainful employment.

Fanglu Wang, a senior managing director at CITIC Capital, warned that the transition to stricter compliance with ESG standards common in Western nations could take longer in Asia. However, harmonization is expected to happen eventually, driven by rising incomes and changing millennial attitudes.

At the same time, impact investment or specialized strategies that seek to support companies with a view to directly improving ESG-related outcomes are on the rise. This means that issues such as climate change – a prominent current theme in Asia given Australia’s bushfires – will become more prevalent in investment circles generally and GPs must keep them in mind.

Ultimately, it is in a PE investor’s long-term interest to be involved with companies that are aware of the risks.

“Why is it important to know these things? From an operational perspective, if you are going to be subject to water rationing in Thailand and you're about to invest in a factory, that could really impact your operations and cost,” added Okun. “There are going to be more regulations coming, more laws coming when it comes to addressing the climate emergency in Indonesia. You need to know that as an investor.”

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• Topics
• Greater China
• Regulation
• Investments
• Asia
• ESG
• Emerging Markets Private Equity Association (EMPEA)
• CITIC Capital
• KKR