News & Insights
The Responsible Investor
29th November 2018
Shauna Powell, Partner, Clyde Blowers Capital
Over the past decade, Clyde Blowers Capital (CBC) has witnessed a significant shift in how private equity (PE) managers approach ESG. Historically the focus of a PE manager’s investment case was the quantifiable and tangible financial returns for its investors. Discussion around the intangible metrics of socially responsible investment was a small voice in the investment committee. Driven in part by regulation, in part by investor influence and in part by the social conscience of the PE manager, the agenda has now changed. Responsible investment is now seen as a key tenet of the investment decision making process with commitment to ESG policies and standards appearing widely in investment polices and side letters with investors. In a 2018 survey on “Responsible Investment”, RBC Global Asset Management concluded that “ESG- based investing continues steadily to gain credibility and establish a solid position alongside other fundamental investment approaches”. The survey showed that whilst in 2017, 66% of respondents used ESG principles in some form as part of their investment approach and decision-making process, this had increased to 72% in 2018. Undoubtedly, for today’s PE managers, the importance of developing and implementing a robust ESG policy is now irrefutable.
A clear framework leading the way
The PRI initiative, a UN- supported network of investors working together, is now, by in large, the accepted bench mark against which PE managers are measured. Whilst “voluntary and aspirational”, the six principles of responsible investment set down by the PRI provide clear guidance which can be tailored to each individual PE manager’s strategy. No longer can the excuse be made that adopting an ESG policy into the investment decision making process is an administrative burden and hindrance. These principles provide the framework for an ESG policy commensurate with the size and strategy of the individual PE manager.
Using ESG to address current issues
Whilst the six principles of the PRI set out the framework for PE managers, along with investor policies, global regulation is also driving the content and substance of PE managers’ policies and assessment of potential assets.
Stamping out corruption has been a huge focus for governments around the world. With authorities in many countries including the UK, USA, China, Brazil, Italy, Germany and Spain enforcing anti- bribery legislation, and with the US and UK legislation having extra- territorial application, it is now simply unheard of for PE managers and their portfolio companies not to have in place adequate policies and procedures to deal with bribery and corruption.
Climate change legislation in countries has also been a prominent focus for PE managers. PE managers are now seeking to ensure that portfolio companies are focusing on energy reduction initiatives, encouraging recycling and implementing, where appropriate, water management programmes. Whilst the primary driver for these polices is ESG driven, undoubtably the efficiencies that can be driven from this active management will also drive value within the business.
Within the UK, legislation mandating social responsibility has seen businesses focusing on the action they take to ensure their business and supply chains are slavery free. With low cost supply chain solutions playing a material part in margin improvement for portfolio companies, no longer can business turn a blind eye to such practices within its supply chain, whilst pursuing strategies to increase performance.
Gender diversity continues to play a key role in ESG with large employers in the UK being mandated to provide gender pay gap reporting, with CBC’s portfolio group, Ferguson Marine Engineering, reporting a lower than average gender pay gap in the UK in 2017. Gender diversity is also being actively pursued within the financial services industry with PE managers and investors becoming signatories to the “Women in Finance Charter” promoted by HM Treasury in the UK. This commits signatories to amongst other things “setting internal targets for gender diversity in…senior management”. Whilst this initiative not only fosters good governance, the promotion of gender equality is now well recognised as improving financial performance. At a 2016 Harvard Law School Forum on Corporate Governance and Financial Regulation, it was reported that research from The International Monetary Fund determined that “incrementing a board by just one woman board member, while keeping the board size unchanged, is associated with a higher return on assets”.
The cost of failure
Cases of businesses failing to adopt and implement proper and appropriate ESG practices within their businesses have been well documented in the press. 2008 saw Siemens paying fines of US$1.6m in the US and Germany for bribery and corruption offences.In 2016 Sports Direct was severely criticised at a governmental level for poor labour practices in the UK, with the the Business, Innovation and Skills committee saying that the retailer was treating workers as “commodities” rather than human beings.
Along with the negative public perception of a business or the impact of fines on a business for failure to implement ESG, failure to implement appropriate polices has wider ramifications for the PE manager today. With many investors now having a significant focus on ESG, PE managers who choose to ignore or pay lip service to this issue, may find this impacts their ability to raise funds in such a highly competitive fundraising market. If they do raise the capital and fail to ensure that ESG is a priority within the portfolio, they may find themselves with a business whose value is negatively impacted by poor practices or even at the extreme, an unsaleable business.
In today’s society, it is incumbent on the owners and investors in businesses to ensure the commitment to ESG to create a more sustainable future for us all. This is not at the expense of value creation however, with it now being well documented that a strong commitment to ESG at both the PE manager level and the level of its portfolio companies will drive increased value and better returns.
As a responsible investor, CBC’s operational, value creation model ensures that a full assessment of ESG issues is made at the investment stage. The oversight and annual reporting from our portfolio companies on ESG ensures that not only our investor returns are maximised and protected but that the businesses we invest in are creating a sustainable future for the next generation.
*All information contained in this article was correct to the best of the author's knowledge at the time of publication. All opinions expressed in this article are based on the views of the author and should not be taken as investment advice or guidance
Environmental, social and governance
Principles for Responsible Investment
Modern Slavery Act 2015
Equality Act 2010
Corporate Board Member publication “Women on Boards Reduce Risk, Increase Profits” by John Kador