RI good practice in the emerging market private equity asset class is well developed as a result of the long-standing influence of international financial institutions such as IFC and bilateral development finance institutions such as CDC, FMO and DEG (amongst many others).
Good practice focuses primarily on integrating ESG issues into pre-investment due diligence, and thereafter into on-going portfolio supervision. These issues can include:
- Compliance with host-country environment, health and safety standards and, in many funds, the relevant IFC Performance Standards and industry-specific EHS Guidelines.
- Risks that may have financial and/or reputational implications. In addition to non-compliance, such risks may include (but are not limited to) land and groundwater contamination; obsolescent pollution prevention and control technology; industrial safety hazards; labour standards and workforce relations; and sustainability standards required by the investee companyâ€™s customers.
In many investee companies, ESG issues can also be an important component in the private equity fundâ€™s value addition role. This is particularly true in relation to corporate governance. With regard to environmental issues, value addition opportunities may be presented by measures such as cleaner production.
Private equity funds are typically established as Limited Partnerships; the investors are Limited Partners (LPs) and the fund manager is the General Partner (GP). Many LPs, particularly development finance institutions, are now following a similar approach to IFC in terms ensuring that the Limited Partnership Agreement (and other relevant agreements) includes terms and conditions that:
- Specify that the fund shall not invest in activities named in any Exclusion List (or similar negative screening framework).
- Specify that the fundâ€™s investee companies must be in material compliance with the host country and other specified EHS standards (such as the IFC Performance Standards).
- Require the GP to put in place an Environmental and Social Management System (ESMS) to ensure that the above requirements are followed during pre-investment due diligence and on-going investment monitoring.
- Require the GP to provide LPs with an annual report on the above.
Some emerging market private equity investors â€“ particularly IFC â€“ provide a range of guidance publications, e-learning resources and other information and advisory services to assist GPs in developing the capacity to manage ESG issues.
Looking beyond the emerging markets to private equity in general, RI has been rising up the agenda as a result of initiatives such as the PRI, the British Venture Capital Association (BVCA) and the Private Equity Council.
- PRI investor tool on Private Equity: https://www.unpri.org/investor-tools/private-equity
- IFCâ€™s Sustainability Framework: For detailed information on IFCâ€™s approach to E&S issues in private equity funds and other financial intermediaries, see in particular IFCâ€™s Interpretation Note on Financial Intermediaries (https://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/sustainability-at-ifc/policies-standards/sustainability+framework)
- Sustainability Training and E-Learning Program (STEP) and www.firstforsustainability.org
- CDC ESG TOOLKIT FOR FUND MANAGERS â€“ helps GPs to design an ESG management system, including initial steps and advice on how to develop and communicate an ESG policy.Â
- ILPA (2019): Private equity principles 3.0