A greater consideration of environmental, social and corporate governance can help mitigate the risks of investing in emerging markets, and help foster confidence and trust, writes Grant Thornton's Alex Grose
The emerging markets of the world cover a wide and diverse area, from Cairo to Cape Town, from Sofia to Shenzhen, from Tenochtitlan to Tierra del Fuego. The risks can make investors nervous about doing deals there, but we are drawn to high growth potential, demographic tail winds and the inevitable increase in market sizes.
One way of mitigating risks that is often forgotten or left as an afterthought is including environmental, social and governance (ESG) factors in your diligence. Furthermore, it may be a way to actively target good deals. As Laurence Fink, CEO at Blackrock, recently said: "At companies where ESG issues are handled well, they are often a signal of operational excellence."
The move to greater consideration of ESG is one way our vibrant investor economy is developing and seeking positive and virtuous cycles that can be exploited. ESG considerations can help private equity in fund raising, choosing targets, improve business performance and also on exit.
Investing in businesses that value employees and have good practices, even when not mandated by local law, helps target business with full employee engagement" – Alex Grose, Grant Thornton
What's good for the environment is good for business. Customers are increasingly including non-financial considerations in their purchasing decisions. Greentech can offer opportunity and leapfrogging technologies and long termism sit hand in hand with exit preparation.
Socially, organisations and supply chains do not operate in a vacuum. Considering all stakeholders broadens horizons and allows earlier identification of problems. The Modern Slavery act and customer preferences are increasing the focus on supply chain injustice. Investing in businesses that value employees and have good practices, even when not mandated by local law, helps target business with full employee engagement. Identifying weaknesses at an early stage enables quick improvements and gains employees' commitment where otherwise ownership change may be viewed with suspicion.
Good governance can stop you falling the wrong side of the FCPA or the UK's anti-bribery laws. In addition, clear policies and procedures on governance will help post-deal-integration and increase confidence for a purchaser. Implementing proper ESG during a hold period is likely to make investments more attractive on exit - creating more competitive tension and offering a step change in valuation and increased return.
Financial performance measures are very well developed. The creation of non-financial metrics will provide investors with another lens through which to judge the future prospects of business. These are exciting times because investors and companies are going to be able to prove that they "walk the talk" and when these things are tangibly measurable we see greater objectivity and trust.
A further benefit from considering ESG factors will be in securing funding. Capital is increasingly attached to non-financial measures. For example, the assets under management of UNPRI signatories have reached $60tn and many LPs, particularly large pension funds, require ESG reporting.
Having clear, strong policies and practices in ESG will help businesses and investors gain future funding and help investment decisions across the globe in areas that benefit from these policies, while also delivering return. While the need for ESG might seem greater in emerging markets, it is increasingly clear that wherever investments are based, a focus on these issues can only be positive.