Responsible investing is fast becoming an established theme for asset owners of all sizes, stripes and geographies – it has now emerged as a key focus for institutions making allocations to emerging market private equity. But they need some help benchmarking progress in this area.

It is difficult for investors to measure environmental, social and governance (ESG) factors effectively, Anne Fossemalle, director of private equity funds at the European Bank for Reconstruction and Development (EBRD), said during a webcast* earlier this month. 

Hence, she expects and wants to see acceptance of a standardised set of ESG measures. 
Anne Fossemalle, EBRD

According to the 2019 annual study by the Emerging Market Private Equity Association (Empea), nearly three-quarters (72%) of investors in this asset class now consider active management of, and reporting on, ESG factors to be important or very important.

RISING ESG FOCUS

The proportion citing them as very important stood at 34%, up from 26% in 2013. Just 9% said they were not important in the poll, which was conducted in February and March this year and released late last month.

One unnamed executive from a development finance institution (DFI) was quoted in the Empea report as saying: “We have increased our focus on GPs’ capacity and commitment to manage ESG risks, and we are looking more and more for GPs that feature a gender component with their senior investment teams or investment strategies.”

What’s more, fully half of such investors – or limited partners – now require ESG provisions to be included in fund LP agreements (see graph below). And seven in 10 expect their asset managers – or general partners (GPs) – to formally report on their ESG initiatives and outcomes on at least an annual basis.

MOST LPS NOW EXPECT SOME ESG REPORTING
(Source: Empea; click for full view)

That suggests that a growing number of asset owners may be adopting an approach to ESG similar to that of EBRD. 

A focus on ESG factors has always been core to the development bank's mandate, Fossemalle said, describing it as a risk assessment tool and a way for asset managers to add value to the companies they invest in.

“We feel it’s critical,” she said. 

EBRD is a DFI with €43 billion ($48.3 billion) under management and allocations to some 120 funds – around 45% in first-time strategies and 10-15% in equity – across Europe, Africa and Asia.

And in the last few years the shift towards a green economy has taken centre stage at the bank, Fossemalle noted. Since the Paris accord on climate change was signed in 2016, EBRD has sought to raise green financing to 40% of its investment volume by 2020, Fossemalle told AsianInvestor after the webcast. It met this target in 2017, with 43% of total financing supporting the green economy. 

SEEKING STANDARDISATION

However, to attract more capital to ESG-focused strategies, it will help if they are more easily measurable, EBRD’s Fossemalle said.

“Eventually, institutional investors will converge on a set of standardised measures, which will be very helpful to bring in more capital,” she said. “It’s important that these be simply and genuinely measurable – and it probably makes more sense to have a limited number of indicators that have real content rather than many that are difficult to measure and assess.”

Fossemalle pointed to various initiatives helping drive progress in this space, such as the operating principles for impact management from the International Finance Corporation – the World Bank’s private-sector arm.

Certain other LPs put a similarly strong focus on ESG.

Stephen O'Neill, 57 Stars

“Our intensive approach to due diligence has been consistent over the years, though we are always adding to the questions we ask,” said Stephen O'Neill, managing director and co-founder of 57 Stars, a Washington, DC-based emerging-market private equity fund-of-funds manager with $3.5 billion under management.

57 Stars spends a great deal of time talking with general partners about their internal systems and processes and studying how they demonstrate those, O'Neill said, speaking on the same webcast as Fossmalle.

"From our perspective, ESG isn’t a process that is separate from a firm’s other investment, administrative and governance processes," he added. "A GP’s solid approach to ESG is closely aligned with the likelihood that it is able to generate attractive returns."

GPs that expect their companies to adhere to ESG principles are not only advancing important governance objectives, O'Neill said, but in doing so also are working to help enhance their companies’ overall operating and earnings performance. 

*The webcast was hosted by Empea on a non-reportable basis, but the speakers, Anne Fossemalle and Stephen O’Neill of 57 Stars, agreed to be quoted by AsianInvestor when approached after the event.