In recent years, there has been a trend within institutional investors towards increased sophistication in the way they engage with their investees in relation to Environmental, Social and Governance (ESG) matters. And we do not believe this trend will be reversed following the UK’s decision to leave the EU. Undoubtedly, the unexpected result of the referendum has created substantial political and economic disruption in the last month and it is acknowledged there will be further impact, at least in the short term. This is likely to make the financial sector somehow cautious in its decisions. However, in this climate of uncertainty, it is critical that ESG remains at the forefront for all investors. In a globalised world, issues such as climate change and supply chain sustainability will not cease to exist beyond national boundaries. There is also an argument that in times of uncertainty, portfolio companies must remain competitive, well operated and with managed risks, that is: sustainable, not only for value protection but beyond in order to maximise the potential for value generation. As a result, the LP:GP relationship in relation to ESG matters must remain focused in order to continue to attract capital to GP funds.
In this context, we have seen a growing tendency towards more involved post-investment monitoring of ESG management by LPs, including more detailed data scrutiny, GP meetings and portfolio company site visits to determine first-hand whether what was agreed in the fundraising phase is actually taking place and that the data provided is relatively accurate. This is certainly the case with LPs that have large ESG teams, smaller LPs with simpler portfolios, or those with a specific mandate such as the Green Investment Bank. With this in mind, and in line with the aforementioned thoughts, increased engagement with portfolio companies may serve both to satisfy LP requirements and result in better risk management. In order to achieve this successfully, it is important to clearly define the ESG aspects that are material to each portfolio company, with efficient means and procedures in place to track data and consequently progress made in relation to these elements.
In a similar way, LPs now demand ongoing reporting and flow of information on the performance of the assets in which they are invested. It is acknowledged that larger LPs struggle to process data in long, detailed ESG reports from their investees and favour a streamlined approach, which may include both financial and ESG data. As part of this, some LPs like visual representation of risk and opportunity and, where possible, their associated financial implications. As a result, LPs now would broadly expect to start seeing figures around issues such as energy and operational efficiency, the management of human capital (which may result in H&S claims or high staff turnover) and value-adding matters such as job creation. However, not all ESG aspects are as easily quantifiable. Some of the softer ESG areas may be harder to delineate. For example, everybody agrees that a balanced board with different backgrounds and gender diversity is more likely to have a positive impact on the business’s balance sheet, although it is difficult to pinpoint how much of that success is due to appropriate board structure. That said, a move towards integrated reporting may make it easier to identify the correlation between ESG decisions and the impact on the financial performance of the company.
As outlined above, both monitoring and reporting are critical aspects in the LP:GP relationship and expectations are increasing, but it is the way in which both interact that is likely to make the deliverables more efficient, targeted and meaningful. The use of structured and replicable systems for data collection, as well as specialist support (whether in-house or external) to assist with materiality identification and qualitative input, will make the process of LP reporting more streamlined and therefore successful.
Article by Penélope Latorre, Waterman Divisional Director EHSQ and member of the BVCA’s Responsible Investment Advisory Board. She has co-authored the Association’s Responsible Investment Guide.
Waterman Group is a multidisciplinary consultancy providing sustainable solutions to meet the planning, engineering design and project delivery needs of the property, infrastructure, environment and energy markets.
Related documents: Baxon ESG Reporting – Integrated ESG reporting, the future is now