A guide to responsible investment policies for private equity

The ESG (Environmental, Social, Governance) movement is sweeping the investment world, and private equity is no exception. Stakeholders ranging from investors to portfolio companies to employees are demanding businesses and investment firms demonstrate a commitment to ESG and sustainability.

A 2020 Capgemini survey of 7,500 consumers and 750 executives globally found that 79% of buyers were changing their preferences based on sustainability. Data from Nielsen estimates that, in the US alone, buyers will spend up to $150 billion on consumer-packaged goods viewed as sustainable by 2021.

In turn, fund managers are moving swiftly to develop strategies, management systems, reporting tools, and communication campaigns to satisfy stakeholders as the ESG landscape shifts from exception to expectation.

However, monitoring ESG progress and outcomes has been challenging without regular, reliable data and disclosures from private equity firms. To close these gaps, fund managers are creating responsible investment policies, a critical step toward ESG integration.

The “what” and “why” of ESG responsible investment policies

A responsible investment policy demonstrates a company's commitment to incorporating ESG concerns into investment decisions in order to better manage risk and achieve long-term profits. A policy's purpose is to encourage investment professionals to consider the ramifications and value implications of investments within an ESG framework. These policies also provide benefits, such as:

• Clear direction and a consolidated, effective statement of policy for employees, limited partners, and other stakeholders that communicates the firm’s core beliefs and responsible investment approach
• Aligns expectations and builds trust with relevant stakeholders including investors, investment professionals, regulators, portfolio company employees, and local communities
• Establishes the framework for a consistent approach to implementing and integrating ESG considerations

A responsible investment policy should, at the very least, describe the firm's overarching objectives, approach, governance, and scope when it comes to recognizing and managing ESG factors across the investment lifecycle.

Who should create the policy?

A responsible investment policy necessitates the collaboration of a group; senior oversight and cross-functional expertise is essential. Typically, an executive or a member of senior management will be in charge of formulating the policy, getting buy-in, and allocating resources to implement it.

Individuals tasked with creating the policy will be in charge of:

• Defining the policy's goals and making a business case for its implementation
• Writing the policy
• Engaging internal stakeholders to gain opinion and buy-in across the firm
• Identifying and enlisting the help of external stakeholders or partners, if needed
• Overseeing the sign-off process at multiple levels and departments
• Creating an implementation plan that includes training, processes, and controls for putting the policy into practice

They may also receive assistance from team members in handling the day-to-day tasks of stakeholder engagement, content development, and sign-off. Once the policy is adopted, it is crucial for a senior person to take ownership over endorsing, implementing, and promoting adherence to the policy.

Establishing a cross-functional working group or committee to guide the policy through the various stages of development is also critical. This gives key members of the firm the opportunity to provide comments early on in the process. In order to produce a policy that can be successfully implemented, investment and portfolio teams should also be included in policy creation and sign-off.

Committee responsibilities often include:

• Providing input and approval, as well as supporting policy implementation
• Socializing the policy and engaging with different departments such as Investor Relations, Client Relations, Legal, Public Affairs, etc.
• Increasing internal and external awareness of ESG investing and the new policy
• Supporting internal training

What are the key policy components

There is no one-size-fits-all approach when it comes to ESG investing policies. The approach will be influenced by the firm's investment strategies, and the policy should be tailored to the fund's investment profile and views. There are, however, a few key elements that should be addressed and included in any policy.

Purpose
ESG policies should communicate a clear purpose and clearly state why the firm has committed to specific issues. For example, a firm may be looking to address limited partner concerns, manage risk, or create value for portfolio companies. Ask: “What does our firm hope to achieve by embedding these ESG policies into our investment strategies?”

Priorities
Fund managers should concentrate on addressing "material" ESG challenges and requirements. Firms with specific emphasis areas (such as a sector, geography, business, or asset class) should also consider outlining the material concerns that they will frequently address. The Principles for Responsible Investing (PRI), the American Investment Council's Responsible Investment Guidelines, the UN Global Compact's Ten Principles, and the United Nations Sustainable Development Goals provide helpful resources and guidance on setting and understanding priorities.

Scope
The policy should specify which assets and asset classes are covered, as well as whether the policy applies to present investments or solely to future investments. Fund managers should also include language detailing their approach to minority and non-control investments, as well as global and regional business stakes. The firm should also consider tailoring its engagement strategy with portfolio companies to match its level of influence.

Governance
The policy should be sure to include the governance structure and explain who is ultimately responsible for the policy and its day-to-day implementation throughout the investment lifecycle, i.e., ESG officers, committees, operational teams, regional teams, board members, etc. The policy should also specify who is responsible for incorporating ESG factors into investing decisions.

Implementation
Firms should explain how they plan to implement their ESG commitment across the investment lifecycle, both pre- and post investment. The policy should also consider any investments the firm will exclude due to products and services that have potential negative impacts on society and the environment. Defining due diligence, such as how to screen for ESG risk and opportunity, is part of the pre-investment process. Firms should also evaluate ESG risks and value creation opportunities in the portfolio after investing, create ESG expectations for portfolio companies, track progress toward those objectives, and assist portfolio companies in meeting them.

Reporting
Fund managers should specify how they’ll report to investors and/or other stakeholders on ESG practices and policy execution, as well as when and how the reports will be made public. Depending on the desired level of transparency and if the company is a PRI signatory, companies can pick from a variety of voluntary and mandated reporting frameworks.

Revisions
Firms should commit to regularly updating their responsible investment policy to reflect future changes in the firm's portfolio, external best practices, or regulations, as well as changes in the firm's growth and investment strategy, business drivers, asset class expansion, investor demands, and emerging themes. Always include a date on your policy to inform stakeholders when it was written or modified.

Once finalized, the firm must implement and uphold the policy. Make sure a clear implementation plan has been developed with measurable action items, including portfolio-wide key performance indicators and improvement plans. Other critical steps include communicating the policy to appropriate stakeholders, training investment professionals on the policy and its relevance to their functions, and measuring results using key performance indicators, ESG software, and/or measurement tools to demonstrate outcomes and show the value of the policy.

Strong policies guide positive commitment

Across the financial industry, investors and their stakeholders are utilizing ESG criteria to screen investments, manage risk, enhance returns, and tailor portfolios to a group of increasingly socially conscious investors. Trends such as climate change, increasing environmental regulations, technological innovation, and social activism are merging with a new era of transparency that makes ESG management critical.

A practical, effective responsible investment policy demonstrates a firm's commitment to ESG issues and provides a foundation by which institutional investors and stakeholders can hold fund managers accountable. Responsible investment policies can also address misconceptions around fiduciary duties, provide a common language around ESG issues, and establish clear mandates to guide investment teams.

ESG materiality assessments

With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.

An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.

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Ryan Nelson

Ryan Nelson is Conservice's SVP & General Manager, ESG. He has over 20 years in enterprise software and management consulting experience, including supply chain software implementation and process optimization for fortune 50 companies. Since 2009, Ryan has been focused on helping companies amplify their ESG impact with technology.

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