BrazilESG emerging as an imperative for private equity firms
Private equity firms across Europe are increasingly taking ESG seriously, according to a report from professional services firm RSM. This shift in focus is affecting the way private equity firms close deals and preserve value within their portfolio.
The shift towards adopting Environmental, social, and governance (ESG) represents a fundamental transformation for private equity firms, says RSM, noting that part of the reason for the shift has to do with regulatory pressures, with the EU Green Deal a future source of such pressure.
A total of 45% said that their biggest challenge was the high cost of ESG data integration and the shortage of skilled personnel. This hinders asset managers’ ability to gather the necessary data for due diligence processes.
The EU Green Deal is a proposed set of sweeping regulations on sustainability in the bloc. Though progress on the bill has been faltering in the halls of the European Union, the private sector has been preparing for compliance to strict new rules.
For that reason, ESG has been top of the agenda in recent years for many industries. Private equity, for their part, are increasingly implementing sustainable practices and monitoring ESG metrics alongside other, more traditional financial indicators.
That includes considering ESG when conducting due diligence during acquisitions and exit planning. “Private equity firms are now adding an ESG perspective to their comprehensive evaluations of potential investments,” said Mario van den Broek, partner at RSM.
Regulation is not the only push – several studies have shown that companies that lead in ESG tend to overperform their peers financially – which ultimately remains the key motivation for private equity funds. Meanwhile, staying on top of ESG risks can shield funds from disgruntled consumers, or even activist investors.
“Sustainability is not just a trend but a fundamental shift in how value is created, preserved, and realized in private equity,” said Van den Broek, who leads RSM’s Dutch management consulting practice. “Firms that embrace this shift and effectively integrate sustainability into their core strategies will be best positioned to navigate the challenges and capitalize on the opportunities of the coming decades.”
“Like in so many other sectors, the private equity sector is increasingly waking up to the reality that sustainability and ESG are no longer just niche concerns, but must be a fundamental consideration when making investments. It is more than merely regulatory pressures that are compelling this change – one of the realities is that there are potentially severe costs associated with unsustainable portfolios. Those include financial, operational, and also reputational risks.”
Barriers to ESG adoption
The transition is easier said than done, however, with ESG-minded thinking a departure from classical approaches to deal valuations and value creation. In RSM’s survey of fund managers, one of the most often cited barriers to sustainable investing was a lack of knowledge on the subject. In addition to that, investors also worry about a lack of standards, lower financial returns with sustainable investments, and limited sustainable investment options, among other concerns.
In considering the EU’s Sustainable Finance Disclosure Regulation (SFDR), 65% of surveyed private equity firms told the researchers that lack of available ESG data is major challenge. That is mainly because of a lack of standardization and data assurance.
The road ahead is clear
Looking ahead, Van den Broek said that private equity funds should work hard to overcome these challenges, to ensure they don’t miss the boat. “As global challenges such as climate change and resource scarcity intensify, the ability to navigate sustainability issues will become even more critical for business success.”
“Private equity firms that effectively integrate ESG considerations into their core strategies are likely to gain competitive advantages in fundraising, deal sourcing, and value creation. Those that lag in adopting sustainable practices may find themselves increasingly disadvantaged in an evolving market that places premium value on ESG performance. In other words, ESG integration is becoming a key differentiator between market leaders and laggards.”