Private equity firms that fail to develop and communicate environmental, social and governance (ESG) policies are likely to find it increasingly hard to raise funds from investors, according to PricewaterhouseCoopers.

“Every private equity house recognises the pressure [on ESG] coming from investors, yet relatively few have policies and procedures,” said Malcolm Preston, PwC’s London-based global head of sustainability.

“It’s a big risk – they’re creating a huge expectations gap. It probably doesn’t matter until you get to the next financing round – then it will really hit.”

Preston was talking to Environmental Finance ahead of the launch today of a report from PwC examining how private equity funds are addressing ESG issues.

Based on interviews with 17 private equity houses, it found that 15 expected limited partner (investor) interest in ESG issues to grow over the next year, and all but one private equity firm expect to increase the attention they pay to ESG.

The same proportion agreed with the statement that addressing ESG issues can create value.

However, only half have an ESG or responsible investment policy, only seven have systems in place to measure the value created by ESG initiatives, and eight of the 17 do not report publicly on their ESG activities.

An increasing number of asset owners have signed the Principles for Responsible Investment, and are looking for their investment managers – including in private equity – to demonstrate that they are integrating ESG issues. “When a fund does its due diligence on a private equity house … what will they put in their data room? They won’t get past base one,” Preston said.

The PwC report recommends that private equity firms step up efforts to demonstrate the financial returns generated through a responsible investment strategy. “There are existing valuation methodologies that can quantify both the intangible and tangible value generated by initiatives targeting environmental or social issues,” the report says.

It also recommends that private equity houses improve ESG reporting. The report also suggests – perhaps predictably – that firms “access the right expertise”. Private equity houses “are already approaching this challenge in a range of different ways demonstrating that this does not necessarily have to involve building large in-house teams,” PwC says.

Mark Nicholls
Environmental Finance