Executive Summary

A number of developments are driving interest in this area from the PE industry:

Risks and opportunities

• A growing number of investors believe ESG developments can and do play a significant role in the long-term performance of investments. Historically, an integral part of the general partner’s role has been to manage ESG risks through the mitigation of operational risks and the consideration of liability costs. In recent years, the sector has become more active in identifying and managing ESG opportunities, sometimes by turning risk into opportunity.

LP expectations

• Limted partners (LPs) are increasingly asking general partners (GPs) to demonstrate they have a structured approach to managing ESG risks and opportunities. This has prompted many GPs to set up ESG programmes to more effectively manage ESG issues upon acquisition and at the portfolio level.

Licence to operate

• The risk of reputational damage and the potential for financial damage through a high profile ESG-related incident is also a driver for LPs to expect their GPs to effectively manage ESG risks and for GPs to manage their ESG risks to prevent such outcomes.

Regulation and investor-led initiatives

• While regulation is another key driver, its impact is dependent on the region to which it is applied. For instance, in France Article 225 of the Loi Grenelle II stipulates that companies of a certain size (>500 employees and >€100m in total assets or net annual sales) are required to include information on their environmental and social performance, including all of the company’s subsidiaries, in their annual report. The UK bribery Act and the UK Government’s Carbon Reduction Commitment Energy Efficiency Scheme are also cited by GPs as drivers for action.
• There are various investor-led and self-regulatory ESG initiatives (e.g. the PRI, ESG Disclosure Framework for private equity), which are increasingly required practice by LPs, peers, and the industry at large to stay competitive.

A general partners guide to integrating ESG factors in private equity guides general partners (GPs) in developing a framework for integrating ESG factors within their organisation and investment cycle. GPs are encouraged to use the practices and examples presented here as a starting point and adapt them to their organisations and investment styles. Limited Partners (LPs) can also use this guide to understand the different ESG integration practices being implemented in the market, which will in turn facilitate a more informed discussion with their GPs during both fund selection and monitoring.

Integrating ESG factors within a GP organisation

It is important for a GP to have an appropriate organisational structure and culture in place, as this enables it to take into account the full spectrum of ESG issues in its business analysis. This could include:

COMMIT TO ESG INTEGRATION	SET ESG OBJECTIVES	ENGAGE WITH STAKEHOLDERS
Ensure formal commitment from the top to guarantee sustained institutional dedication and resources.	Set and communicate objectives for ESG integration.	Engage with collaborative initiatives.
Appoint a person or team responsible for ESG-related processes with the relevant expertise. Educate employees on the rationale, strategy and practices for ESG integration.	Establish an operations group or use consultants to monitor portfolio companies.	Engage with LPs.
Link ESG objectives to employee evaluation.

Integrating ESG factors into the investment process

GPs can use the following general tips in developing and deploying their framework:

• Align your framework for ESG integration with existing tools and standards to ensure it is based on international standards and good industry practices.
• Ensure the investment team has access to ESG expertise.
• Be sensitive to regional differences that may influence the due diligence process and the level of engagement with portfolio companies during ownership.
• Perform a pilot run of the framework for ESG integration – trial it with the current portfolio and use the results to “demystify” ESG factors for your investment team.

Due diligence

Screening:

• Compile a checklist to screen for high-level ESG risks.
• Establish an exclusion list for high-level checks.

Company deep dive:

• Consider resource allocation for ESG due diligence.
• Use due diligence questions in industry toolkits.

Investment decision

• Include ESG considerations as standard practice in investment committee discussions.
• Include ESG findings from due diligence in the investment memorandum.

Investment agreement

• Share ESG objectives, policies and practices with portfolio company.
• Use templates from existing industry toolkits to integrate ESG clauses into investment agreement.
• Seek formal commitment from portfolio company by incorporating ESG issues into the deal documents and/or the 100 day plan.
• Collaborate with portfolio company to draft 100 day plan.
• Formulate a roadmap with a 3-5 year horizon with clear process benchmarks.

Ownership

Engagement:

• Collaborate with portfolio company to set up an ESG programme.
• Leverage portfolio company board to implement ESG initiatives.
• Leverage ESG expertise and experience across the portfolio.
• Conduct periodic site visits.

Monitoring:

• Define company specific or portfolio wide ESG indicators.
• Prioritise ESG issues and focus on the most important issues in the short/medium term.
• Ensure ESG considerations are consistently on the portfolio companyfs board agenda.
• Provide portfolio company with tools to monitor and measure ESG practices.
• Collect information on ESG developments from portfolio company and include in annual review.
• Monitor ESG developments in internal review meetings.

Reporting to LPs:

• Agree upon the form and frequency of reporting.