Whether you’re starting a fund or formalizing your firm’s ESG program, it’s daunting to stand at the foot of the “ESG mountain.” The climb is challenging, fraught with risk, can be very expensive, and the summit keeps moving. As ESG specialists, we have compiled a list of ten practical pointers to guide your efforts and help ensure you do this correctly and maintain credibility in the eyes of LPs and regulators.
1. Don’t get overwhelmed: The ESG ecosystem contains a long, growing list of terms. Stay focused on what’s most relevant to the industry, strategy, geography, and purpose of your fund—and consider an ESG materiality assessment. Let the priorities of your LPs and other important stakeholders be your guide. For example, decarbonization and infrastructure-focused funds may emphasize climate change, whereas venture funds may focus on D&I. Although your LPs will not expect you to have all the answers on day one, they will expect you to have a plan. That means reporting to them on certain items regularly. If you have an empty ESG folder in your fund VDR or can’t articulate your ESG strategy, that will be a red flag for investors.
2. Get practical help early on: It takes more than a few webinars and online articles to figure this stuff out. Best practices have evolved in recent years, and your LPs will not thank you for trying to do something dramatically different. Kick things off with some quick wins by taking smart, basic first steps. This means putting in place the necessary ESG infrastructure and resources within your firm, which will include:
3. Tone from the top & accountability throughout: Make sure your firm’s senior leadership understands why ESG matters. This will help them embrace your plans for ESG monitoring and reporting. To manage expectations both internally and externally, accountability is key. Incorporate the ESG performance of your investment professionals and portfolio management teams into their annual reviews, so it will drive compensation and promotion decisions.
4. Integrate an appropriate (and proportionate) monitoring program: Establish procedures that aren’t onerous. Create a system that involves asking your portfolio companies for certain reasonable information and data each year. Consider having a set of KPIs upon which each portfolio company is benchmarked, with a scorecard system charting where each investment is against those KPIs—along with reasonable actions for each management team to achieve before the next reporting cycle.
5. Training, training, training: Institutionalize regular ESG training each year, including internal ESG updates/case studies from your own portfolio and hosting external speakers. This training should ensure your team fully understands the following:
Regular training by the right specialists will help lock in and build the foundations for a top tier ESG value system at your firm.
6. Don’t forget the “G”: Climate change and diversity have, for good reason, dominated the ESG headlines in recent years—but don’t neglect “governance.” It’s a fundamental pillar of any best-in-class ESG program. Apply the same scrutiny at sourcing and diligence stages as well as through the hold period for the investment on areas such as board processes, executive compensation, anti-bribery and corruption, political lobbying and donations, data, and cybersecurity, to name a few.
7. Keep your ESG disclosures clear, consistent, and accurate: Communicate in the clearest way possible using plain language and ensure responses to DDQs and other external statements mirror the disclosures in your annual report. If you have set up your ESG program thoughtfully, you will be able to report clearly and on a consistent basis around your KPIs or other metrics and, hopefully, show year-on-year progress. Once your written ESG disclosures leave the firm, whether in an annual ESG report, in response to a written DDQ, or on an AGM presentation, they are in the public domain and can potentially be used against your firm by one or more aggrieved parties or by a regulator. ESG litigation/enforcement has arrived, so you will want to be accurate with your ESG disclosures (and ensure your legal team has signed off on all external ESG communications). Avoid hyperbole and things that are simply not true.
8. Practice what you preach: As a manager, you must be able to demonstrate your own sustainability credentials. Besides setting a good example and being a desirable workplace to attract talent, this can come up in LP diligence. Examples of GP-driven ESG success can include emissions reduction, energy use, waste management, D&I, and work-life balance.
9. Think twice about hiring ESG personnel: Whether raising your first or third fund, carefully question the value of hiring someone to run point on ESG at your firm. Much of the initial lift for your ESG program could be managed with external providers and oversight from a COO or CFO. Most smart funds focus less on paying for broad-brush advice on ESG—instead they value guidance for the quick implementation of ESG policies, processes, and tools that are in step with investor and regulator expectations and built for scale.
10. Keep an eye on the horizon: As the world of ESG reporting in private equity shifts from the qualitative to the quantitative—and as regulators rapidly roll out their respective ESG reporting regimes—you’ll find constant reminders that this is a rapidly changing landscape. It will differ depending on industry, strategy, geography, and investor base. This means investment managers must keep a close eye not only on evolving regulations, but also on how peer firms are addressing ESG. Expect to see changes in generally accepted ESG best practices over the short to medium term.
Don’t try to do it all by yourself. Without a trusted partner, you may end up getting expensive by-the-hour ESG advice that fails to provide anything useful or actionable. At Petra, we focus on practical ESG policies, processes, and tools. Leveraging our experience of having built out a sophisticated ESG monitoring and disclosure program for a $40+ billion fund manager, we can help you establish ESG best practices early on and enhance your reputation in the eyes of your investors.
