How will ESG Evolve for Private Equity Funds in 2021/2022

22nd July 2022

Amidst a rough pandemic-stricken year, 2020 marked the first year the investment in environmental, social and governance (ESG) direct funds topped US$1 trillion. The boom for ESG investing hastened the public consciousness and investor proclivity for a long term and sustainable investment strategy. The motive is quite simple; improve your ESG credentials or risk being overlooked by fund and asset managers.

Limited partners putting their money into private equity now discover that ESG investing and financial returns are not mutually exclusive. For example, Financial Times reported that ESG funds outdid the broader market in a 10-year period.

Investors Leaning towards ESG

According to the recent Callan ESG survey of October 2020, more than 30% of respondents not yet into the ESG factors of investment decisions have started considering it. More, in Q3 of 2020, 262 firms – including 43 asset owners signed up for Principles for Responsible Investment, taking the PRI’s signatory total to 3,300 firms globally.

Private Equity International’s 2021 study shows ESG factors gaining more significant numbers in LP’s due diligence processes, with 88% of investors considering ESG into account while doing due diligence, up from 80% last year.

Investors Driving Regulatory Developments

In private equity, transparency is now the maxim. As a result, there is increasing pressure on managers and companies to be lucid around ESG metrics and related risks like greenwashing.

Sadly before, there wasn’t any established regulatory body set to monitor the ESG developments. Yet, given the growing focus on ESG, this is set to change thanks to a significant number of regulatory boards emerging. More fundamental changes include the Sustainable Finance Disclosure Regulation (SFDR) that came into effect in March 2021; it focuses on enhanced transparency around ESG considerations in investment decision making.

ESG Social Pillar in the Spotlight

While the ‘E’ and ‘G’ pillars of ESG are well understood, a 2019 global survey by BNP Paribas found that 47% of the 347 institutional investors surveyed concluded that the ‘Social’ aspect proved to be the most difficult to research on and embed in the investment strategies.

This is set to change as there is more focus on local, national, a global social responsibility with the health and safety of employees and communities, bringing more attention to investors.

At a practical level, large ESG bond both in the UK and globally are deducing that asset managers and private equity have massive mandates to purchasing ESG-centralized assets. And with the Biden administration set to direct the USA to a more ‘greener’ path, transparent ESG schemes for the alternative assets sector will not only be nice to have but a necessity.

The regulatory developments and international commitments in Europe, the United States and the wider globe reflect a permanent place ESG has acquired economically. Typically, private equity sponsors should stay updated with these fast-moving developments.