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Private investment ESG: An emerging force in capital markets

Private investment managers (PIMs) have an advantage in preparing investee companies for ESG compliance and sustainability, and they should focus on developing reliable measurement systems, reporting, and prioritising specific ESG factors based on the nature of each business

Private investment ESG: An emerging force in capital markets

Strong crosswinds are blowing in the ESG arena.

At the same time that ExxonMobil and Chevron shareholders rejected proposals that would cut emissions and accelerate the transition away from fossil fuels, US president Joe Biden’s climate change envoy John Kerry finally conceded that transition fuels like natural gas fit into global climate goals.

Meanwhile, BlackRock has appointed the CEO of oil industry giant Saudi Aramco to its board, recognising the enormous impact oil companies can make in building the new climate economy.

Is this a sign that investor support for climate action is losing momentum? Not at all.

The same shareholder activists who pressured ExxonMobil, Chevron and BlackRock are growing in numbers. In 2022, the share of board seats in the US won by shareholder activists reached an all-time high of 61%, up from 47% in 2021.

It was, after all, shareholder activists who also forced out Francis DeSouza, the CEO of the biotech group Illumina who resigned in June following a proxy battle with activist investor Carl Icahn.

None of this prevented Illumina from moving full steam ahead on its ESG strategy. The company released its ESG roadmap a week before DeSouza’s ouster and it held its annual ESG event a day after he resigned.

All trends considered and green-hushing notwithstanding, the ESG growth trajectory is here to stay.

The ESG space is taking clearer shape through two forces. One is the slow but sure advance of ESG regulation and enforcement in the US and Europe – particularly in the climate and governance categories bolstered by powerful data trends – and the other is shareholder engagement.

Where does that leave private investment managers?

Preparing for enhanced ESG disclosures in public investments

For public investments, the trends are unavoidable, requiring them to prepare for enhanced ESG disclosures, particularly for carbon emissions. Public company executives are unenviably expected to revamp ESG when embroiled with activist investors and changing regulations, often resulting in a lack of coherent strategy.

For private investments, managers have time to form a more considered view of how and where to focus to best position investments to enter the public realm and meet regulations as they roll out to private markets.

Private investment managers who do not market themselves as ‘impact’ have even more flexibility to prepare companies for public status and the coming wave of regulation-inspired activism.

Let us not lose sight of ESG’s essential purpose, which is to ensure that businesses operate in a responsible and sustainable manner. When he took over as President of the World Bank in June, Ajay Banga said the bank’s mission was to “create a world free from poverty on a livable planet.”

It’s all about E (Climate Change), intertwined with P (Poverty). Whether via shareholder activism, UN initiatives or market enforcers, ESG is a geopolitical pillar.

If we are to manage climate change, immigration and social upheavals, government and the World Bank cannot do it alone. They need to harness the power of markets to drive actual change.

So where should private investment managers (PIMs) begin?

Prepping investee companies for ESG compliance

Rather than getting swept up as more expansive EU rules covering both public and private investment managers extend into the US, or the US SEC extends rules to PIMs, PIMs have an advantage, being able to prep investee companies further from the public glare.

PIMs in emerging markets have done this for decades given their multilateral sources of funding that are subject to layers of mandates on ESG frameworks.

On a micro level, PIMs have the ability to focus on a variety of climate, societal and governance enhancements. Confronting one of the biggest challenges – reliably measuring ESG impact – these managers have time and means to develop measurement systems and reporting to enhance value and sustainability, which is a winning game.

They can start by redesigning their own investment policies, similar to the HarborVest last year, such that the ESG team reports directly to the head of investments and participates fully in the investment process.

The golden rule: PIMs need to do what they say they do. If a manager touts certain Sustainable Development Goals (SDGs) – like female participation in the workforce or management – then the investee companies need to create measurement and reporting systems that reliably work.

Forget the high gloss, the devil is in the details

For private companies, ESG is not one issue, it is an interdependent web of weightings that depend on each business. Unlike cybersecurity, which poses a key risk for all investments, ESG is not uniformly salient and merits prioritisation; hospitals and energy production entail externalities requiring more urgency, whereas telecom and banking services typically less so.

Nearly all PIMs have a designated ESG team looking at all levels of the investment process – which companies are selected for a portfolio, how they develop ESG and to whom they are sold.

Providing critical capital to private business, most PIMs have the ability to appoint and remove top management, which is the first critical lever for systematic input. They also hold board and board sub-committee seats, another high-level lever.

The ESG team does the heavy lifting to overlay ESG within a growing private investment – working to get buy-in at the top of main operational lines of each business and then layering it down through operations, touching all reporting lines top to bottom.

Third-party contractors can be tricky so employees who contract them need responsibility for direct reporting to ESG and confirming that all contractors have compliant Human Resource System training manuals. All employees close to the issues operationally should be trained and motivated.

But the ESG team does not go into the organization with a set notion of what to measure or measurement methodology. On the contrary the ESG team works within each company to come up with what the business can and should measure, looking at climate effects, board diversity and workforce evolution.

If the company targets growth in employee training, the PIM should wait a good period of time – a year – after installing measurement mechanisms to assess results before touting the enhancement.

Some trade secrets:

  1. Obtain concessional financing for certain ESG work – often among their shareholders PIMs have investors willing to provide concessional or even free financing for ESG enhancements, such as energy efficiency audits or workforce inclusivity assessments;
  2. Create an ESG steering committee of the board, staffed with non-board member experts.

As PIMS tread inevitably into ESG terrain and align their ESG disclosures with foreseeable regulations and best practices, benefits abound.

Carolyn Campbell is a Managing Partner and Co-Founder of Emerging Capital Partners, a pan-African and emerging market private equity company

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