Originally published in CVCA Central, January 2018
The practice of considering environmental, social and governance (ESG) issues in investing has evolved significantly over the past two decades, reflecting greater public and stakeholder interest in sustainability, shifting regulations and the impact of social media.
MORE THAN EVER BEFORE, managing ESG issues requires collaboration and communication within companies and industries, and between businesses and communities, making stakeholder engagement a critical aspect of any ESG approach. This is particularly true for infrastructure assets — the pivotal enabling force of any community — given the essential nature of the services they provide: electricity, water, heat, transportation, among others.
Traditionally, ESG factors tended to be considered primarily in the context of acquisition due diligence with a focus on identifying and managing liabilities. Today, however, more emphasis is placed on the business opportunity that emerges from effective ESG management. With the size and increasing maturity of the Canadian private capital industry, and some of the inherent characteristics of the private capital business model, private capital managers are well placed to promote sustainable business practices by actively managing their portfolio companies throughout the entire value chain. Simply, ESG is a fundamental component of business and investment quality and directly impacts a company’s ability to “future-proof” itself.
“ESG IS A FUNDAMENTAL COMPONENT OF BUSINESS AND INVESTMENT QUALITY AND DIRECTLY IMPACTS A COMPANY’S ABILITY TO “FUTURE-PROOF” ITSELF.”
My own experience in over 20 years in Canada’s private equity sector is that proactive management of ESG matters and transparent stakeholder engagement drives value, lowers overall risk and leads to better investment and community outcomes. Numerous studies demonstrate that companies with environmental and governance issues have a higher cost of equity and debt capital, and that those with a strong ESG framework and practices tend to create tangible value for investors. A recent review by Capital Dynamics suggests that more than a third of participating global private equity general partners measured and experienced a positive impact on EBITDA due to the implementation of ESG policies. Respondents represented various investment strategies, and fund and firm sizes. In a 2013 study by PricewaterhouseCoopers, 15% of GPs cited the opportunity for value creation as a driving force for ESG implementation.
Studies similarly show that limited partners are increasingly interested in ESG-related information and reporting. A 2017 study by Intertrust found that 78% of PE investors expect general partners to increase their focus on managing ESG considerations in their portfolios over the next two years. Indeed, for many LPs, ESG due diligence results can determine whether they proceed or decline to invest with a particular manager, and they often require specific ESG clauses to be included in their side letters.
“78% OF PE INVESTORS EXPECT GENERAL PARTNERS TO INCREASE THEIR FOCUS ON MANAGING ESG CONSIDERATIONS IN THEIR PORTFOLIOS OVER THE NEXT TWO YEARS.”
Measuring and reporting on ESG-related matters can build trust and confidence among investors on how non-financial and financial matters are managed. Organizations that invest in ESG management, and accompanying robust stakeholder engagement, tend to enjoy a sustainable competitive advantage and to outperform in a number of areas on a relative basis. In the past decade, stakeholder engagement has emerged as a specific discipline in its own right, evidence of the vital role it plays in shaping dialogue and outcomes on ESG needs and initiatives, and accordingly, enabling and preserving business success.
Private capital firms — infrastructure, private equity and venture capital — have a unique opportunity to foster social and environmental value in the communities where they operate while delivering attractive financial returns to investors. And as an industry overall, well-implemented ESG measures and thought leadership help to demonstrate how our sector creates value within the Canadian economy and new prospects for both current and future generations.