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ESG and Socially Responsible Investing in the Private Equity Industry

Although consideration of environmental, social and governance (“ESG”) factors in the course of making investment decisions has long existed, ESG and socially responsible investing have become much more prevalent among private equity sponsors in recent years. Globally, the World Bank estimates that assets under management by impact-focused private equity funds have increased by approximately 19% annually over the past 5 years. As ESG considerations and socially responsible investing continue to become more mainstream, sponsors should expect rising demand from limited partners and various other stakeholders for increased non-financial reporting.

Today, there are over 150 investment managers and asset owners in Canada who are signatories to the UN Principles for Responsible Investment (“PRI”), including the five largest Canadian banks along with a majority of Canada’s largest pension funds. PRI is an initiative to promote responsible investment across various asset classes, including private equity, and requires each signatory to publicly report on its responsible investment activity.

Considerations for Sponsors

Diligence: Consideration of ESG factors can play a large role in mitigating risk. During the fundraising process, sponsors should have an ESG policy in place and be ready to respond to ESG questionnaires from limited partners, including being able to provide information with respect to its due diligence process. The adoption of an ESG policy should not considered a simple check-the-box exercise. Sponsors will want to have information readily available regarding their ESG reporting framework at the portfolio company level and will want to be able to speak to how they are incorporating ESG metrics into evaluating portfolio company performance. Sponsors should also consider proposed exit opportunities and consider the availability of responsible exits that do not comprise their, or a portfolio company’s, social mission.

Regulation: As momentum continues to build, new regulatory risks are also emerging for sponsors and their investors. Soft regulation continues to develop through the use of voluntary regulatory regimes and a range of laws and regulations pertaining to ESG issues are already in place in certain industries. Although disclosure requirements are generally based off of materiality, as ESG considerations become more prevalent, it is possible that disclosure requirements could evolve to include such considerations. Sponsors may also face increased pressure from all levels of government as governments respond to their local and international commitments to address ESG impacts for companies operating within their jurisdiction. Increased regulation may lead to increased legal, reputational and financial risk for sponsors and their investors in situations where sponsors fail to manage ESG issues effectively.



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