The Nordic ESG evolution

For many Swedish people, private equity is inseparably linked to one word: Caremaskandalen – the Carema scandal. In the autumn of 2011, care home group Carema Cares came under fire from the media and government after accusations of neglect and patient mistreatment, with attention eventually focusing on the company's private equity owners, KKR and Triton Partners.

Despite having been active in the region for nearly two decades at the time, the private equity industry had managed to live a relatively quiet life, with little need for transparency or public relations. That quickly changed when the Carema scandal broke and much was made of the fact that Triton's website at the time consisted of little more than an address and an investor login.

Since then, Triton has signed up to the UN Principles for Responsible Investment (UNPRI) and developed and published a formal environmental and social governance (ESG) policy for the firm with a dedicated team to administrate it.

But Triton is not alone in focusing on ESG. Nearly all the major Nordic private equity houses now have dedicated ESG teams and codified policies that inform and influence the entire private equity process – from fundraising to exit. Most recently, Nordic Capital expanded its ESG team with two new hires. Some firms, including Triton, even publish annual ESG reports.

"ESG is here to stay," says Torben Vangstrup, managing partner of Danish pension fund ATP's Private Equity Partners division. "Today, ESG issues are always on the agenda when you speak to funds about their investments and how they view being the owner of companies. ESG is very prominent."

Discussions about ESG are increasingly extensive in talks between Nordic GPs and LPs and there is a general consensus among players in the region that ESG has moved up the agenda.

"It has increased every year for the past few years, for good reasons. It is an evolution, but a fairly rapid one," says Karl Swartling, CEO of Swedish government pension fund Sjätte AP-Fonden (AP6).

He follows up by pointing out the change did not happen by chance: "It is related to the general public opinion in the Nordic countries, where environment and sustainability issues in general are seen as very important and taken seriously."

Swartling's comments are echoed by Joachim Høegh-Krohn, CEO of Norwegian fund-of-funds manager Argentum, who says the tendency also reflects the perception of the Nordic societies being particularly aware of these issues. "Most expect Scandinavian GPs, funds and companies in general to be very concerned about those issues. It is generally accepted that the regulations and the environment are functioning quite well and the culture in general is quite advanced in this area," he says.

Beyond box-ticking
In its early manifestations, ESG was often considered an exercise in box-ticking. Arguably, earlier policies boiled down to little more than avoiding investments in companies employing child labour or that were blatantly corrupt.

These days, having a formal ESG policy and being able to implement it thoroughly has become a central requirement to doing business in the Nordic market for large and mid-market private equity firms.

Morten Welo, COO of Norwegian GP FSN Capital agrees that an ESG policy has increasingly become a requirement for operating in the Nordic market. "The reason being that, today, LPs and their beneficiaries not only focus on the returns generated, but also, to an increasing extent, on the fact that these returns are generated in a responsible manner," he says.

Several industry players point out that the development from box-ticking process to sincere business philosophy has happened in tandem with local LPs also taking environmental and social issues into deeper consideration when allocating capital. The Nordic LP landscape is heavily populated by public and quasi-public pension funds and wealth funds, which will often have a more strict code of conduct in terms of investing responsibly than investors without a ‘public' connection.

But even private pension funds are likely to follow a strategy of increased care in their choice of GPs. There is some suggestion among private equity professionals that pension firms are increasingly aligning the values of their investment strategies with the values of their customers. The Nordic populations generally consider themselves very conscious of environmental and social issues, such as gender equality and sustainability, and want that reflected in how their money is invested.

Although Nordic LPs represent a minority of the overall investor base in Nordic private equity funds, FSN's Welo says his firm has seen indications of a similar shift from international LPs. He tells of a university endowment that began encouraging GPs to measure and disclose the carbon footprints of their portfolio companies, following a push by the instiution's students to do so. "This is a pattern you see: the people and customers behind the pension funds want us to do investments in a responsible manner," says Welo.

Responsible business is good business
While sceptics could dismiss ESG and corporate social responsibility as an endeavour in warm-glow giving and goodwill grabbing, the arguments in favour often focus on the risk-mitigation benefits of responsible investing.

The public in the Nordic countries is indifferent to private equity at best and openly hostile at worst. Animosity even extends as far as the political sphere: following Blackstone, Apax, KKR, Permira and Providence's 2005 buyout of Danish telecommunications giant TDC, Denmark's former prime minister Poul Nyrup Rasmussen went as far as implying LBO funds posed a threat to democracy – criticising private equity's opaqueness, leveraging practices and tax structures.

Public perception in Sweden – the largest Nordic private equity market – is also broadly negative as a result of welfare scandals, says Delphi partner Anders Lindström: "That negativity is mostly undeserved, but there is a truly negative ring and just dealing with private equity in itself – that taxpayers' money might end up in private equity firms' pockets – is seen as a problem."

"The industry has not received any support from politicians either. In Sweden, the former finance minister Anders Borg was not exactly friendly towards private equity," he says.

Private equity has been an easy target for the media and potential scandals in a portfolio company of a Nordic private equity firm can quickly turn into a reputational nightmare when public perception is already against the industry. The bankruptcy of Altor's Danish investment OW Bunker in November illustrated that animosity towards private equity is never far below the surface.

As such, actively seeking to invest and manage portfolios responsibly can potentially go a long way towards preventing a PR disaster. However, ESG has become more than a skin-deep aspect of doing business for most of the Nordic LPs and larger Nordic GPs, and the way the matter is approached goes much further than purely image.

The consensus in the Nordic industry seems to be that ensuring managers and their portfolio companies are environmentally and socially aware is ultimately good for business. FSN's Welo says: "To us, ESG is about doing good business and doing good business is about building the right culture in our firm and also building the right culture in our portfolio companies."

Factoring ESG into the acquisition process, as well as the development of investments, may ultimately result in better deals and more attractive assets at the point of exit. For example, improving a company's sustainability may insulate it against changes to emissions taxes, environmental requirements and cyclical changes such as energy price fluctuations. Similarly, ensuring workers are decently compensated and in good health will result in a more productive workforce and better-quality products.

"An understanding has emerged that ESG matters should be viewed as a long-term investment and one that will reward you if you do it right," says ATP's Vangstrup. "We all benefit when stakeholders feel a company has been developed to the degree it should be and has been optimised on the relevant parameters, of which ESG is one."

The policies may also turn out to have a positive effect at the GP level, where social and environmental responsibility may help soften the public image of private equity as corporate raiders or greed-driven capitalists.

This point is put forward by Delphi's Lindström, who believes reputation is still among the biggest issues for the industry in the Nordic region. "There is a real challenge there, in the sense that if working in private equity isn't seen as decent and on-the-level, you will have problems in recruiting the best talent. The industry has to start working a positive angle here," he says.

Leading from the north
To its credit, the Nordic private equity industry seems to have embraced ESG fully and is now broadly considered to be global market leaders when it comes to ESG policy development, implementation and administration.

In general, larger GPs are more advanced in ESG matters because they have the size and financial muscle to support large dedicated teams. With only a few large players in the Nordic region, non-Nordic funds at the top end of the market may be outperforming their Nordic competitors on the ESG front. "It may be that some of the Nordic private equity houses think they have come a long way with ESG matters in the investment committees, but there are others that are ahead of them," says ATP's Vangstrup. "It is not that they are not doing well in the Nordics, there are just others who have been dealing with such issues for a longer period of time."

European fund-of-funds manager LGT Capital Partners produces a yearly report evaluating the ESG credentials of its GPs and the most recent report gives merit to the suggestion that overall, Nordic firms are at the head of ESG performance in Europe. The report consists of ESG assessments of 154 GPs in LGT's portfolios.

LGT ranks fund managers on a scale of 1-4 in categories relating to ESG, and the Nordic firms trail only the UK & Ireland region in overall ESG ratings. Looking at country-specific funds, with sizes below €1.5bn, 14.3% of UK & Ireland GPs are in category 1 – the highest category – with 50% in category 2 and 35.7% in category 3. By comparison, 10% of Nordic GPs are in category 1, 50% are in category 2 and the remaining 40% are in category 3 (see figure 1).

LGT also ranks managers' commitment to ESG, in terms of the extent to which GPs have adopted a robust ESG policy, employ dedicated individuals or teams and whether the firm has embraced ESG as part of its culture. Nordic GPs lead the rankings in terms of commitment, with 20% in category 1 and 80% in category 2 – compared to the UK & Ireland's 36% in category 1, 36% in category 2 and 28% in category 3 (see figure 2). This shows that, while managers in the UK & Ireland rate slightly higher overall, Nordic managers as a whole appear to have embraced ESG to a larger extent.

"While we see good progress on ESG throughout our portfolio, this year's survey indicates that, as a group, Nordic managers are at the forefront of ESG adoption," says Thomas Kristensen, executive director at LGT. "All of our Nordic managers rate 1 or 2 on ESG commitment, which clearly shows this group acknowledges the importance of ESG and all GPs are taking steps to integrate ESG in their investment practices."

Whether or not Nordic private equity is a global ESG beacon, the evidence points to an industry that has accepted ESG as part and parcel of doing business and will only strengthen its environmental and social credentials in the future.

For GPs looking to the Nordics for lessons, one take-away is that the industry had to learn the hard way. Although private equity in the Nordics is still suffering from the negative image fostered by Carema and the like, its example on ESG in recent years might present an opportunity for the industry in other regions to avoid disaster before it strikes.

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