How DACH players are adapting to ESG

Attendees at Unquote’s German Private Equity Forum in November 2019 took part in an interactive poll to rate what they regarded as the key regulatory challenges. ESG was the top-voted factor, demonstrating that the topic is at the forefront of the minds of market players in the region.

Ali Floyd of Campbell Lutyens points out that Germany’s industrials-based economy is by no means a barrier to successful ESG implementation: “You see groups like Ambienta buying industrial businesses in Germany specifically to implement a positive environmental thesis. Just because the German economy is more industrial and automotive-based, it does not mean that it is lagging behind other parts of Europe on this issue.”

Indeed, Daniel Heine, head of private debt at Patromonium, notes that exclusionary ESG criteria have been considered in investments for a number of years, but not by this name and with a different emphasis. He cites the example of a coal mine: companies such as this would now be excluded for many investors based on ESG factors, but they may well also have been excluded in the past, as Germany’s coal industry is heavily dependent on subsidies and this could heighten the risk that a business model might not be able to support loan repayments.

Demands from LPs are a strong motivating factor behind ESG implementation, says Dominik Meyer of Axon Partners: “ESG is now a key component of due diligence – it is more mainstream and is regarded as a minimum requirement. [However], with some exceptions, the LPs in the DACH region are not the most demanding; the Dutch and Nordic investors probably lead the way in Europe.”

Magda Nowak of Axon Partners highlights the demand from the US: “ESG has been a growing topic in the last few years – quite a number of funds used to be more relaxed about it, but LPs are really pushing it, especially following the best practices by the Institutional Limited Partners Association to standardise the industry and GP-LP communication. Most US LPs are very keen on ESG topics and the LPs that are more structured have separate operational teams who are focused on operational due diligence, where substantial parts are ESG-related. Given this demand, there has been a shift in GP thinking, as, naturally, they will face additional requests in the fundraising process – so, a lot are implementing ESG in a more coherent, structured way.”

LPs will quickly realise if the ESG implementation is a bare minimum and just on paper, or if you are really living it and trying to make a difference” - Daniel Heine, Patromonium

Investor integrity
Heine argues that ESG is essential in a competitive market: “ESG will continue to be one of the differentiating factors – LPs are super professional, and as soon as they do due diligence on you as the fund manager, they will very quickly realise if the ESG implementation is a bare minimum and just on paper, or if you are really living it and trying to make a difference. I am convinced that they will give you more credit if you are not just fulfilling the minimum – it can be a very positive distinguishing factor.”

Establishing an ESG implementation model for investors can prove to be complex, as Heine explains: “Across all four asset classes, it is exactly the same discussion: the systematic implementation of the criteria is currently very different. If you buy a building, for example, the factors are how energy-saving it is, what materials are used, and quality of life aspects – this is completely different from credit, where you look at the business model, products and the markets they are in. So, the challenge is to integrate models specific to your investment universe. This will take time but will improve year on year.”

In black and white
2020 has already been a year in which ESG has formed a concrete part of GPs’ and VCs’ investment strategies. January 2020 saw 26 DACH-based venture capital firms include a legally binding ESG clause in their term sheets and shareholder agreements, committing the parties to implementing and making their employees aware of sustainable practices.

Heine does not see the need for the market to establish a standardised model for now, however, pointing out that investor demand and the UN’s principles for responsible investment (PRI) reporting process facilitates comparable end results: “I don’t think you need a model at the beginning, but of course over the years if you create the report, the trend is that investors will ask for more and more details – not just the report that you publish under PRI, but an ESG audit on the investments, and then you need to mandate an auditor and it will become a specific ESG regulatory audit. There will be professional auditors, and the better your processes are, this will become a corrective and a determining factor for institutional investors that put a strong emphasis on it.

This article is an extract from the DACH Fundraising Report 2020, published in association with the Aztec Group. Click here to download the full report

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