Capstone Partners, a global placement agent for private equity, credit, real assets and infrastructure firms, surveyed 140 LPs around the world on ESG considerations. Capstone has offices in New York, London, Dallas, Geneva and Singapore and has placed more than 75 funds, according to its website.
Which part of ESG is your main focus in 2021?
LPs based in Asia-Pacific prioritise governance because “a big chunk of the market is on venture and early-stage growth”, said Tiffany Howard, principal at Capstone. “The way we see G is about the hygiene of a company: how they deal with regulators, how open they are, how transparent in terms of not being corrupted, making payments to people, meeting stakeholders’ expectations, adhering to policies that they’ve put in place.”
North America’s focus on social matters over environmental matters is well-documented. Aude Pouradier Duteil, a vice-president at Capstone said: “A client recently received an ESG due diligence questionnaire from a US LP and all the questions were on the ‘S’ – only on diversity and inclusion. It was very detailed, but it was titled ‘ESG due diligence questionnaire’ and nothing was on E or G.”
Is the ESG responsible person(s) in direct contact with GPs?
Direct, daily contact between the person responsible for ESG at an LP and the GP is a sign that they are “keeping the pressure on the GP” and “the LP sees ESG as a value-add exercise”; while if the LP does its ESG analysis via indirect communication and documents or data from investment consultant memos, “this is typically evidence that it’s a risk management or tick-box exercise”, said Pouradier Duteil. “In the US and Asia-Pacific, ESG is still seen largely as a risk management exercise. But we have seen this transition in Europe from a risk-management exercise to a value-add one with pressure on the GP to deliver on their promises in ESG increasing across the life of the investment.”
Where do you see GPs struggling with ESG matters?
ESG metrics and reporting issues continue to be the most common concern for GPs, according to the GPs surveyed by Capstone. But GPs also report that juggling different reporting and data requests from different LPs is a challenge. “I think we run the risk of ESG becoming a reporting and compliance function if we continue to be focused on a growing list of disclosures and frameworks, as opposed to what it’s meant to be, which is a rigorous and nuanced report on performance quality,” Megan Starr, global head of impact at the Carlyle Group, told New Private Markets earlier this year.
Would you accept higher or lower returns?
Many investors continue to see a trade-off between returns and ESG performance. When this trade-off arises, more LPs across every region will accept higher returns for lower ESG credentials than vice-versa. Asia-Pacific LPs are the least likely to always choose returns over ESG credentials.
Do you ask for investment opt-out options for ESG reasons?
Opt-out options are sideletter clauses that permit an LP to avoid individual investments made by the fund – for example, if the portfolio company does not meet the LP’s ESG criteria. US investors have been using opt-out options for longer, said Howard. But European investors are now increasingly using this because they often believe “there’s no need to have an investment that creates waste or unacceptably high carbon footprint”, Howard added.