Investors are driving increased adoption of ESG policies

Growing pressure from LPs moves ESG from a compliance function to the heart of the investment process

Institutional investors are increasingly demanding that private equity firms adopt ESG policies in their investment processes, according to new research conducted by the London Business School’s Coller Institute of Private Equity and supported by Adveq, the private equity investor.

The study, based on responses from 42 private equity firms with collective assets under management of more than $640 billion, reveals that ESG is now a core value creation strategy at private equity firms. The London Business School authors, Professor Francesca Cornelli and Dr Ioannis Ioannou, find growing pressure from LPs is hastening the movement of ESG from being purely a compliance function to a key part of the investment process. The study shows that larger firms are feeling this pressure more acutely with 85% of the larger firms surveyed commenting that pressure from LPs to integrate ESG policies into everyday working practices is intensifying.

The research highlights that support for wider adoption of ESG is coming from the boardroom with C-suite executives driving new policies. The results also reveal that responsibility for implementing ESG policies is moving out of the compliance room and is now firmly in the hands of investment professionals.

Ioannis Ioannou, Assistant Professor of Strategy and Entrepreneurship, London Business School, said: “The private equity industry is increasingly placing greater importance to ESG, moving it from a purely compliance and risk mitigating strategy to a key long-term strategy through which private equity firms pursue value creation.

“Board members and C-Suite executives are taking the lead in making sure that their companies are implementing ESG policies throughout the whole investment process, and that they are structurally embedded throughout the organization.”

The study finds that while there is increasing adoption of ESG policies there are significant barriers to implementation, most notably the difficulty of collecting the necessary data. The idiosyncratic nature of ESG data itself as well as the comparability across investments are other issues that the respondents highlighted as presenting barriers to ESG implementation.

The research reveals that pressures to implement ESG policies are most acutely felt in Europe, while the MENALA (Middle East, Northern Africa and Latin America) region appears to feel less pressure from investors and regulators, reflecting the low penetration of socially responsible investment.

The growing importance of ESG is also evidenced by the fact that firms say that they are now using ESG on purchase of portfolio companies, right through to exit. Only 26% of the respondents said that they implemented ESG policies only at the exit stage.

Sven Lidén, Managing Director and CEO, Adveq, said: “ESG is no longer a box ticking exercise that occurs at sale time. What we hear from LP’s is that they are increasingly recognising the real value of ESG. Private equity firms are now integrating ESG policies at the early stages of the investment process, and in doing so, highlight the potentially crucial role of ESG in value-creation as well as the possibility of generating superior investor returns.

“But the report shows that there are still issues, notably that private equity firms need to find better ways of collating ESG data in order to properly implement their long-term value creation policies.”