Private equity snapshot 2018

The snapshot presents a concise overview of responsible investment (RI) practices in private equity globally, based on 486 signatory responses to the PRI Reporting Framework.

It is intended to support PRI private equity signatories as they enter the new reporting cycle by allowing them to benchmark their responses against their peers. It also illustrates the extent of investor progress, by looking at comparable data points from 2015 and 2018.

This page summarises our key findings, but we also invite readers to explore the full report here. The snapshot report allows the reader to:

• View the complete list of public respondents to the Limited Partner (LP) and General Partner (GP) modules in 2018;
• Filter GP data according to investment strategy and region (by signatory headquarters);
• Analyse GP assessment data for the Strategy & Governance and Direct – Private Equity reporting modules;
• Filter LP data according to region; and
• Search qualitative data by keyword to look for specific examples.

See the methodology for the data collection process and limitations of results.

Private equity reporting by numbers

PRI signatories report:

• US$1.1trn invested indirectly by 349 signatories via externally managed private equity funds;
• US$1.05trn invested directly by 431 signatories in private equity assets: this accounts for approximately one third of global private equity assets under management (AUM), using an estimate from data provider Preqin of US$2.83trn as of June 2017.

Private equity represents 2% of total reported PRI signatory assets under management (8% of indirectly managed assets and 1% of directly managed assets).^[1] Of the 1449 signatories who responded to the 2018 PRI Reporting Framework, 703 hold private equity assets.

Although a significant majority of private equity signatories are headquartered in Europe, the AUM distribution chart below shows an almost equal split in signatory private equity assets between Europe and North America. This is because some of the largest LPs and GPs in private equity (headquartered in North America) are signed up to the PRI.

 

Increasing numbers of signatories are reporting to the PRI. Specifically:

• 189 signatories reported on their responsible investment practices for their indirect investments in private equity funds in 2018, compared with 126 in 2015; and
• 332 signatories reported on their directly managed private equity assets in 2018, compared with 209 in 2015.

Respondents to these modules are listed on page 4 of the snapshot report, with a record of who also responded to the voluntary climate-related indicators which, were introduced to PRI reporting in 2018.

What are GPs doing to implement the six Principles?

Out of 1449 responses to the 2018 PRI Reporting Framework, 431 signatories reported that they invest in directly managed private equity assets – 94% of which apply RI considerations to these investments. Of these, 332, accounting for 80% of private equity AUM directly managed by PRI signatories, completed the Direct – Private Equity module. Their responses provide the basis for the GP data analysis in the snapshot report, summarised below.

Embedding responsibility within the firm

There has been a significant increase in the inclusion of RI in development/training plans across responding firms, from partnership level down:

• Over 60% of signatories that reported in both 2015 and 2018 now include RI in their development or training plans for portfolio managers and investment analysts, up by approximately 25 percentage points from 2015; and
• For signatories that reported in both 2015 and 2018, more than one third have processes in place to link RI objectives to the their portfolio managers’ and investment analysts’ key performance indicators.

This implies an increasingly integrated approach to ESG throughout the firm and the investment process. Meanwhile, in terms of dedicated resourcing, the number of GP signatories that employ RI staff has risen from 89 in 2015 to 134 in 2018.

Formalising and communicating on RI commitments

A high percentage of respondents report that ESG is incorporated in their fund set-up processes, which indicates that RI practices have marketing value and are also considered to be a formal component of fund governance:

• 86% of signatories referred to RI in their latest private placement memorandum (PPM) or similar;
• 69% of signatories made formal commitments to RI in their latest fund terms, either using limited partnership agreements (LPAs) or side letters, or both.

Readers can view publicly disclosed examples of how ESG factors are being included in fund terms on page 13 in the snapshot report:

 

GPs can also refer to the PRI Limited partners’ responsible investment due diligence questionnaire to understand what information they might proactively disclose to prospective LPs through the PPM.

In addition, PRI guidance on Incorporating responsible investment requirements into private equity fund terms is intended to help GPs understand how they might formalise their ESG-related commitments in the original draft of the LPA, or respond to LP requests to negotiate these into a side letter.

PRI signatories’ public disclosure on their application of RI (beyond the publication of responses to the PRI Reporting Framework on the PRI website) is weak in comparison with other RI activity and has not progressed since 2015:

• 21% disclose to the public;
• 58% disclose to clients only;
• 21% do not disclose any ESG-related information to their clients;
• Even when restricting the analysis to those who have been reporting since 2015, there hasn’t been material change, with just a slight increase in public disclosure from 24% to 30%, and a minor overall drop in those who don’t disclose at all;
• However, on a regional basis, there has been notable progress in ESG disclosure among North American signatories who have reported in both years. In 2015, 29% did not disclose any ESG-related ESG information; by 2018, this figure had dropped to just 13%.

Materiality: the financial risk and opportunity of ESG

The PRI Reporting Framework captures whether GPs have processes in place to identify and act on ESG-related investment risks and opportunities. This year’s disclosures showed that:

• 69% of respondents reported that ESG issues have helped identify investment risks;
• 62% reported that ESG issues help identify opportunities for value creation;
• 49% reported that identifying ESG issues led to the abandonment of potential investments;
• 26% reported that ESG factors affected the price offered and/or paid for an asset; and
• 52% reported including ESG in the 100-day plan and 31% in the sale and purchase agreement.

While most respondents use ESG factors to identify risks and opportunities in potential investments, far fewer report their impact on the price offered and/or paid; a more common approach is to incorporate ESG factors into the post-investment action plan. Publicly disclosed examples of ESG issues that were considered and managed across the investment process, from initial screening to exit, can be found on page 20 in the snapshot report. 

 

When it comes to exiting investments, 52% reported including ESG in the pre-exit information (this figure excludes those who did not have exits in the reporting year). Proving the value of ESG management at exit is the ultimate endorsement for an RI strategy for both the fund and its LPs. Publicly disclosed examples of how ESG was considered at exit can be found on page 19 in the snapshot report.

For signatories that reported in both 2015 and 2018, the proportion who measure ESG performance and/or the impact of ESG on financial performance within the portfolio has risen from 25% to 47%. Publicly disclosed examples of how signatories are measuring this relationship can be found on page 22 in the snapshot report.

It is worth noting that larger GP signatories are more active than their smaller peers across all of these areas of activity. It is part of the PRI’s role to support more resource-constrained GPs as they seek to improve their processes for integrating ESG into investments and to understand its impact.

What are LPs doing to implement the six Principles?

Similarly, LPs that represent larger organisations tend to be more active in integrating ESG across fund selection, commitment and monitoring.

Publicly disclosed examples of how LPs addressed ESG factors in their manager selection, appointment and/or monitoring processes during the reporting year are set out on page 31 in the snapshot report. 

 

Of 1449 respondents to the 2018 PRI Reporting Framework, 349 signatories report that they invest indirectly in private equity – 89% of whom report that they integrate ESG in these investments to some extent. One hundred and eighty-nine signatories reported on their indirect private equity investments through the Indirect – Manager Selection Appointment and Monitoring module, accounting for 82% of private equity AUM indirectly managed by PRI signatories; their responses provide the basis for the LP data analysis in the snapshot report (including funds of funds and secondaries signatories).

Fund selection/due diligence

As part of the process for reviewing PE fund managers,

• 89% of LPs report that they use some form of RI due diligence questionnaire or request for proposal;
• 42% report that they are using the PRI LP Responsible Investment DDQ;
• 55% review GPs’ PRI Transparency Reports; and
• 30% review GPs’ PRI Assessment Reports.

From this data, the PRI understands that more work needs to be done to encourage PRI LP signatories to leverage the tools that have been created to support ESG integration in the due diligence process. The PRI’s intent in developing these tools is to move LPs towards a consistent industry approach on ESG-related due diligence and monitoring, in response to significant demand from both LPs and GPs. There is evidently a need for PRI to build awareness around these resources and to promote more LP-to-LP dialogue and knowledge-sharing regarding best practice. This will be a core focus for the PRI private equity programme throughout 2019/20.

LPs tend to favour in-person meetings for conducting ESG due diligence on GPs (cited by 80% of respondents). This is understood to be the most effective route for meaningful ESG disclosure; the tools that the PRI has created are intended to be a starting point for dialogue, in line with the core premise of the ESG Disclosure Framework for Private Equity, which states:

“Due to both the diverse nature of the private equity asset class and differing LP and GP approaches to ESG management and disclosure, what constitutes effective and relevant disclosure can be defined only through discussions between a GP and its LPs.”

Fund commitment

More than half (55%) of LPs report that they typically require investment managers to define and report on ESG objectives as part of the manager appointment process. Out of the 112 LPs that chose to specifically report on their private equity fund commitment process:

• 45% of LPs report that they require ESG-related investment restrictions;
• 27% that they require adherence to ESG guidelines or principles such as the PRI’s six principles;
• 15% say they require ESG-specific improvements; and
• 65% require ESG reporting from PE fund managers at least annually.

It is worth noting that these numbers are significantly higher for European respondents compared with their North American peers.

The PRI guidance on Incorporating responsible investment requirements into fund terms offers practical options to LPs that are considering how they might negotiate ESG terms into private equity fund contracts.

Fund monitoring

When reviewing ESG objectives during the lifetime of the fund:

• 74% of LPs report that they monitor for ESG incidents;
• 73% monitor compliance with ESG-related investment restrictions; and
• 54% monitor the effect of ESG strategy on investment decisions and performance in the underlying portfolio.

This indicates that reputational and risk management are the first priority for LP signatories when it comes to ESG objectives.

Only 37% of LPs use PRI Transparency Reports, and 24% Assessment Reports, to monitor GPs that are PRI signatories. The PRI encourages more LPs to use these reporting outputs and recognise their value as monitoring resources. The PRI Data Portal allows LP signatories to access and compare reported data for a desired group of GP signatories (although private responses can only be accessed with permission from the relevant GP). The PRI has created a tutorial on how to use the Data Portal for LPs that are interested in leveraging this resource.

The PRI has also published guidance to support ESG monitoring, reporting and dialogue in private equity, which includes a section on current LP monitoring practices and a series of case studies to support LPs as they develop their approach to monitoring GPs on their responsible investment commitments.

LPs and GPs on climate change

In the 2018 Reporting Framework, the PRI introduced voluntary climate reporting to support signatories in disclosing relevant activity in line with the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD).

Two hundred and forty-four signatories with private equity holdings (113 asset owners and 131 investment managers) opted into the voluntary climate reporting module in 2018 – including 167 who also reported on RI practices specific to their PE assets through the Selection, Appointment and Monitoring and/or Direct – Private Equity modules. Of these, 74 opted to make their responses publicly available. This is an important signal to the private equity industry of a move towards transparent and public disclosure on climate risk, and it should hopefully encourage other PRI private equity signatories to release such disclosures.

Its findings include that:

• Board-level accountability for climate-related responsibility stands at 91%. In other words, fewer than one in 10 of the respondents’ own boards (or similar bodies) are not evaluated against climate-related performance;
• 83% and 86% of the respondents’ portfolio managers and investment analysts, respectively, have their management responsibilities directly linked to climate-related issues; and
• 52% of respondents say they integrate climate issues into their overall risk management.

In addition to the TCFD indicators, the PRI Reporting Framework has had some mandatory reporting on climate in place for all signatories since 2016. Among signatories reporting in 2018:

• 15% of private equity respondents currently apply climate scenario analysis tools (based on 693 respondents, including both indirect and direct investors in PE), but only 9% plan in accordance with the Paris Agreement goal of holding warming to 2-degrees Celsius or below;
• 30% apply some form of carbon footprinting; 19% measure their carbon footprint at the portfolio level;
• 17% of respondents disclose on their observed emissions risks. This is up from 9% in 2016 (based on 686 respondents).

For more results, please see the dedicated Climate snapshot report.