Allocate 2018: ESG gains traction with European LPs

Environmental, social and governance (ESG) policy was a much-discussed and keenly debated topic at Unquote's inaugural pan-European private equity event Allocate. On a panel dedicated to advancing the traditional understanding of ESG, Elias Korosis of LP-GP hybrid Hermes GPE suggested it could be time for a new acronym: "We look at ESG as integral to the investment function and operational management. Perhaps it is time the industry considered evolving from using 'ESG' referring to a separate function; I prefer DYJ: 'Do your job.'"

Hermes is not alone in demanding a greater ESG emphasis from its GPs. During the panel discussion, Adam Black of Coller Capital said the portion of LPs that see this issue as "critical" has increased. "The latest edition of our twice yearly Global Private Equity Barometer demonstrated the growing importance of ESG to LPs," said Black. "When considering a new fund commitment, 39% of European LPs said a GP's ESG policy was an essential component in deciding whether to commit."

However, Tycho Sneyers of LGT Capital Partners says ESG engagement is about more than just fund selection: "Just because a fund scores a low rating, it does not necessarily mean we will not invest. If their attitude is good and they are willing to engage, then it can be an opportunity for us." LGT has developed a system of ranking its managers with a score of 1-4 for their ESG competency, assessing them for four key areas of their ESG practice: manager commitment, investment process, ownership and reporting.

When considering a new fund commitment, 39% of European LPs said a GP's ESG policy was an essential component in deciding whether to commit" – Adam Black, Coller Capital

LGT's latest report shows good progress from managers globally, with 58% of managers receiving a rating of excellent or good in 2018, compared with just 27% in 2014. Similarly, 17% received a poor rating in 2018, compared with 43% in 2014. While the US is showing some improvement, it is still lagging behind, with 30% of US-based GPs receiving a rating of poor compared with just 9% in Europe. Coller's Black says it is not just GPs. Again citing the barometer, he said: "The report also shows that North American LPs are behind on this issue, as only 9% considered it to be essential and 30% considered it to be a small or negligible part of their decision to commit."

The LGT report shows the UK and Nordic GPs as clear regional leaders in Europe, closely followed by France. Eurazeo has been a leader on ESG policy in the French market, and corporate social responsibility director Sophie Flak sees the increased LP interest as a double-edge sword. "LPs are asking for more data, which is a good thing to drive progress on CSR within the private equity industry," she says. "Yet, we currently see a large variety of reporting requests. We need to agree on an LP-GP reporting standard in order to focus on material topics and drive effective progress. There is a maturity curve."

Triton's ESG head Graeme Ardus has similar thoughts about the volume of requests. "In terms of reporting, we are seeing an increasing number of our investors asking more detailed ESG questions, with some LPs asking for granularity as far as company-level reviews and ratings," he says. This could be part of the reason that large and mega managers score better on the LGT manager rankings than small and mid-market managers, although LGT said it is not asking for anything too arduous and does not accept being a small manager as an excuse not to be a responsible investor.

Getting feedback
In any case, both Ardus and Flak agree that LP feedback is essential. "One of our LPs submitted a carbon questionnaire, which was fantastic," says Flak. "This type of input is appreciated because it helps us keep our game at the best level."

The ESG policies created by this type of dialogue have resulted in some decisions not to invest. "We looked at an investment in a wholesale agricultural producer and distributor, which involved a global production footprint, as well as transportation and distribution in Europe," Ardus says. "When we looked at the production base, we identified environmental factors and social issues that we believed represented potentially material risks to the investment. While the investment would not have triggered investor excuse rights, the ESG risk factors influenced our fundamental rationale for the investment."

If LPs are concerned about what their GPs are invested in, they are even more concerned about what they are investing in directly through co-investment programmes. LGT's Sneyers highlights a borderline case as an example: "We had to consider an investment in a bottle manufacturer. Some LPs have restrictions on investing in alcohol, which raises the question of whether they can invest in a beer bottle manufacturer. Different clients came to different conclusions on the ethics of this."

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• Topics
• GPs
• LPs
• Benelux
• CEE
• DACH
• France
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• Southern Europe
• UK / Ireland
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• ESG
• LGT Capital Partners
• Hermes GPE
• Coller Capital
• Eurazeo
• Triton Partners