www.pwc.com/sustainability                              Responsible investment:                              creating valu...
ContentsSection 1 – Executive Summary	                                  2Section 2 – Findings	                            ...
About the survey   Based on our experience of working with clients from the private equity (PE) industry, we   have seen a...
Section 1 –    Executive Summary    There are two key drivers of             differentiate themselves and to secure    The...
Interestingly, the survey did not           A challenge common to all remains               Attention to ESG issues is set...
Recommendations                          diligence, and ensuring that action       4) Ramp up reporting    Drawing on our ...
Section 2 – Findings                                       2.1 Drivers for responsible investment activities              ...
Risk management and interest from              “ ncorporating ESG concerns                                                ...
In terms of the allocation of day-to-                                                                                   da...
2.3 Policies and procedures                                          Policies    50% of the houses we                     ...
Investment cycle – hold period             Two of the US-headquartered housesHouses take very different              The w...
It’s difficult to quantify the extent   Investment cycle – exit                  there is anecdotal evidence that it      ...
“ ortfolio companies will be reporting back to us for the first time this                                             P   ...
“ his is an imprecise science      T                                             However, despite these difficulties, the ...
There is limited public reporting        2.5 External reporting                       2.		 houses are cautious about      ...
A geographic perspective: contrasting approaches     between US and European-headquartered PE houses     One interesting t...
2.6 Looking ahead                          Will investors pay more or less              Will PE houses do more or lessWe a...
Editorial team:                  Key contacts:     Shami Nissan                     John Dwyer     PwC UK                 ...
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional ...
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Investissement responsable : la création de valeur à partir des enjeux environnementaux, sociaux et de gouvernance

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PwC s'est entretenu avec 17 sociétés de capital-investissement, dont six figurent parmi les dix plus grandes sociétés mondiales de capital-investissement, 11 parmi les 50 plus grandes, et six parmi les sociétés de taille intermédiaire. 10 sociétés ont leur siège social en Europe et sept aux États-Unis. Sept des groupes sont signataires des Principes pour L'investissement Responsable de l'ONU. L'étude relève qu'un examen du processus de conformité pour les membres signataires des PRI était déjà en cours. Il est possible qu'à l'avenir une communication obligatoire soit exigée des signataires.

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Investissement responsable : la création de valeur à partir des enjeux environnementaux, sociaux et de gouvernance

  1. 1. www.pwc.com/sustainability Responsible investment: creating value from environmental, social and governance issuesInsight from our survey ofthe private equity industryMarch 2012
  2. 2. ContentsSection 1 – Executive Summary 2Section 2 – Findings 52.1 Drivers for responsible investment activities 52.2 Internal capacity 72.3 Policies and procedures 82.4 Measuring value 112.5 External reporting 132.6 Looking ahead 15Glossary of abbreviationsESG: Environmental, social and governanceGeneration Y: The group of people born in the 1980s and 1990sGP: General PartnerLP: Limited PartnerPE: Private EquityRI: Responsible InvestmentUN PRI: United Nations Principles for Responsible Investment
  3. 3. About the survey Based on our experience of working with clients from the private equity (PE) industry, we have seen a notable rise in attention to responsible investment (RI) and the management of environmental, social and governance (ESG) issues over the last few years. We have also observed what seems to be an emerging common challenge – to demonstrate the value of implementing a responsible investment strategy. Does managing ESG issues really help to create value? And if so, how? Our survey seeks to explore the PE industry’s response to this question. We also examine what drives PE houses to focus on responsible investment, and how they are tackling the challenge of valuing and measuring their efforts. And we look ahead, asking how the industry’s commitment to addressing ESG risks and opportunities might evolve over the next five years. This report summarises the results of our survey and presents our view on the key issues arising. What is responsible investment? Responsible investment is an investment approach founded on the view that the effective management of environmental, social and governance (ESG) issues is not only the right thing to do, but is also fundamental to creating value. Responsible investors believe that companies which are successful in avoiding ESG risks whilst capturing ESG opportunities will outperform over the longer term. Environmental issues: encompass pollution and contamination of land, air and water; related legal and regulatory compliance; eco-efficiency (“doing more with less resources”); waste management; natural resource scarcity; and climate change. Many environmental challenges also present opportunities for value creation, for example, generation of incremental revenue from new technologies, products and markets such as ‘green’ / sustainable products and services. Social issues: encompass the treatment of employees; health and safety; labour conditions; human rights; supply chains; and treating customers and communities fairly. Governance: in a responsible investment sense, this term is generally held to encompass the governance of environmental and social issue management, plus the areas of anti bribery and corruption, business ethics and transparency.Our approachWe spoke to 17 private equity Interviews were conducted with Interviews were supplemented withhouses, including: members of senior management desk-based research on each PE house,• six of the top ten largest global – either with dedicated ESG or including consideration of company PE houses¹ sustainability specialists/teams websites and relevant reports (e.g. where these exist, or with individuals Citizenship/Corporate Responsibility• 11 of the top 50 largest global drawn from other functions and reports). Interviews were undertaken PE houses¹ roles (e.g. Operations, Public Affairs, during the period from November 2011• six mid-tier houses Communications, Investor Relations through to January 2012, and relied• ten with headquarters in Europe, and or Legal Counsel) who have additional upon a common set of questions being• seven with headquarters in the US. responsibility for the ESG agenda. posed to each participant. Interviews, unless specifically agreed otherwise, were undertaken on a non- attributable basis.¹ ased on Private Equity International’s 2011 ranking of the top 300 private equity firms by size, ranked on the amount of private equity B direct-investment capital each firm has raised over a five-year period (www.peimedia.com/Pages.aspx?pageID=3155). Responsible investment: creating value from environmental, social and governance issues March 2012 1
  4. 4. Section 1 – Executive Summary There are two key drivers of differentiate themselves and to secure There are some interesting contrasts responsible investment in the PE and maximise their access to capital. between the approaches of US- industry: risk management and The other leading driver of RI activity headquartered PE houses and that of investor concern is risk management, followed by cost their European counterparts. The Investor concern, founded on the view savings, ‘tone from the top’ and US-headquartered participants tend that ESG issues have the potential to regulatory pressure. to focus primarily on realising value materially impact the valuation of through a focus on eco-efficiency investments over the longer term, has The PE industry response initiatives whereas their European- been ramping up in recent years. to responsible investment headquartered peers are more likely Indeed, for some PE houses, this has is evolving rapidly to incorporate a broader range of been the key catalyst for adopting a Notably, all of the houses we spoke environmental and social issues into responsible investment (RI) approach. to consider environmental and their investment decision-making The importance of investor pressure is social issues to some extent during processes. Many houses, regardless set to grow in the near future: 88% investment appraisals. However, of where domiciled, are of the view of survey respondents believe that houses take very different approaches, that the PE business model already Limited Partner (LP) attention to ranging from ad hoc and case-by-case places great scrutiny on governance ESG issues will increase in the next through to the more progressive and that this issue is already well five years. In an increasingly approaches, such as that of Apax managed by most. competitive fundraising environment, Partners, where purpose-built ESG managing ESG risks and opportunities due diligence frameworks are followed is another way for PE houses to for every potential acquisition.2 PwC
  5. 5. Interestingly, the survey did not A challenge common to all remains Attention to ESG issues is setreveal any correlation between the that of quantifying the value of to increasesize of the PE house and the maturity ESG programmes or responsible As of now, the industry’s overallof their approach to RI. This finding investment strategies response to the RI agenda can beis consistent with our own experience Whilst a resounding 94% of the characterised as very much a ‘work inof the PE market. participants surveyed believe that progress’. But that looks set to change: ESG activities can create value, far 94% of PE houses surveyed said thatWhilst there has been much fewer are attempting to measure the their attention to ESG issues willprogress in developing and value of these activities. Measuring rise over the next five years. Whatimplementing RI strategies over the value created through will they be focusing on? Many haverecent years, our results indicate environmental and social initiatives, plans in place to develop theirthat there is still some way to go: relies on the availability of relevant responsible investment or ESG• 50% of the houses we surveyed financial data and for most PE houses programmes further, citing policy lack a policy on ESG issues and/ this is not yet readily available at development, valuation and reporting or responsible investment a portfolio level. Some PE houses as focus areas for 2012 and beyond. (e.g. KKR and Doughty Hanson)• only 40% have put systems in place have successfully measured cost to measure value created from savings achieved from eco-efficiency initiatives (this is particularly initiatives but even the more advanced relevant for initiatives addressing PE houses are struggling to measure environmental and social issues the intangible benefits of their ESG which tend to have more direct initiatives. While this challenge is impacts), and common to other sectors, developing• 47% of the houses surveyed do a best practice approach to valuation not report publicly on their ESG is perhaps particularly pertinent for an programmes or their responsible industry focused on creating value. investment strategies.Summary survey findingsA snapshot of the present Investment cycle Policy Acquisition Hold Exit Reporting 50% of participants All participants Approaches to It is difficult to 47% of participants lack a policy on consider ESG issues managing ESG quantify the extent provide no, or ESG issues and/or to some extent issues during the to which strong limited, reporting responsible during investment hold period are ESG management on ESG issue investment appraisals diverse contributes to a management good exit valuationFive years from now 94% of participants believe that ESG The majority of participants believe 94% of PE houses believe their issues will become more material to that LP attention to ESG issues will attention to ESG issues will increase their business increase Responsible investment: creating value from environmental, social and governance issues March 2012 3
  6. 6. Recommendations diligence, and ensuring that action 4) Ramp up reporting Drawing on our experience, we have points from the pre-acquisition phase One notable survey finding is the four recommendations which we are integrated into the 100 day plan. relatively limited external reporting believe can help PE houses, and their Procedures should also include on RI by the PE industry; most portfolio companies, to enhance their consistent tracking and reporting participants agreed reporting is still ability to create value from RI, and of ESG performance. ‘quite superficial’. PE houses can stay ahead of the competition. benefit and adapt from the The most progressive PE houses strive considerable progress made on ESG 1) Access the right expertise to capitalise on environmental and reporting in the corporate sector (and Many of the houses we spoke with social opportunities, rather than using integrated reporting more broadly). cited lack of internal capacity and ESG due diligence only as a means of expertise as a barrier to implementing ‘de-risking’ their investments. Several PE houses are relying on their RI goals. Hiring in to build the use of case studies for reporting. in-house teams is an unlikely option, 3) easure the financial M Case studies can be a highly effective given the ‘lean’ structure of many PE value created means of showcasing progress and houses and the current economic Measuring ESG performance success, but there are several pitfalls climate. PE houses need to think improvements and ascribing financial to be aware of: there is the risk of innovatively to access the right value to these remains a challenge unbalanced (i.e. ‘good news’ only) expertise (in particular on for many. Standard valuation reporting, and the need for environmental and social issues) and methodologies (such as discounted transparency regarding the role of keep their RI programmes on track. cash flow models) can be used to the PE house in bringing about There are already some great quantify the value of RI initiatives. ESG improvements in the portfolio examples of this in the marketplace: This includes both direct and indirect companies. Finally, PE houses could PE houses are forging collaborations value drivers. The key challenge in consider proactively engaging with with third parties, hosting knowledge- conducting these exercises is the LPs to help define future ESG sharing events for their portfolio availability of ESG relevant financial reporting requirements. companies, offering ESG training to data: given enough data, it is possible deal teams and securing external to establish a credible link between expertise when required. ESG activities and intangible value. 2) Adopt best practice approaches Tips for measurement and valuation Approaches to managing include focusing on quality not environmental and social issues quantity, aiming for consistency not during the investment cycle are uniformity (given material issues diverse. Following best practice will for each portfolio company will help PE houses to maximise value vary depending on their sector and from their RI activities. This would geographic location), and considering include adopting a consistent and qualitative assessment options if the systematic approach to ESG due costs of gathering quantitative data are prohibitive.4 PwC
  7. 7. Section 2 – Findings 2.1 Drivers for responsible investment activities We asked each of the PE houses what motivates them to pursue a RI approach. Many cited the same drivers – but not necessarily in the same order of importance. These are the most commonly cited reasons (from most common to least).Risk management and investor Importance of identifying and understanding ESG risksinterest are the two most and managing regulation and compliance throughout the Risk management lifecycle of an investment.significant drivers for action,by some margin Increased interest (and questions) from LPs, many of whom Interest from are signatories to the UN PRI, prompted participants to investors define their RI approach and collect information from portfolio companies. Opportunities Participants can see opportunities to realise additional for cost savings/ value through performance improvement and operational operational efficiencies, in particular eco-efficiencies. efficiencies Those at the top of the organisation place a great emphasis Tone from on the importance of a RI approach. the top For participants operating in the UK both the UK Bribery Act and the UK Government’s Carbon Reduction Regulation Commitment Energy Efficiency Scheme were cited as drivers for action. Responsible investment: creating value from environmental, social and governance issues March 2012 5
  8. 8. Risk management and interest from “ ncorporating ESG concerns I A few houses mentioned reputation investors are the two most significant into the investment process is and competitive differentiation as drivers, by some margin. Value creation about good, long-term investing drivers for RI activities – but not major did feature among the top four reasons, – GPs and their portfolio ones. Or as one participant put it: but generally only in terms of cost companies need to manage these savings – as achieved through eco- issues appropriately to minimise “ his [managing ESG issues] will T efficiency programmes (doing more using fewer resources saves money risks and maximise returns.” not differentiate players for long and benefits the environment). David Russell … after all, in five years, everyone Several participants pointed to the Co-head of Responsible Investment will be doing it.” increased saleability of portfolio Universities Superannuation Scheme European-headquartered PE House companies as a driver – but there was a general consensus that it’s ‘too early The United Nations Principles for Finally, it’s worth noting that at least to show proof of concept’. Responsible Investment (UN PRI) three of the PE houses said that initiative also came up during our Generation Y is becoming an Most PE houses agreed that LP discussions about LPs. This is a increasingly important driver of the concern is a significant reason for voluntary framework which investors RI agenda. They’re key stakeholders, increasing engagement with the RI can use to incorporate responsible as either potential employees or agenda. Indeed, some are timing their investment into their decision-making consumers. And they have higher activities (e.g. drafting RI policies) to and ownership practices1. Many LPs expectations and demands for tie in with their upcoming fundraising. have signalled their commitment to responsible products and services However, there was a notable split in the RI agenda by signing up to the UN than their parents. opinion about the role LPs play in PRI, and they need to demonstrate driving change. Many houses said compliance publicly (including that interest from LPs was their main probing general partners on their driver – but this was more common approach to responsible investment). among PE houses with their Similarly, as investors themselves, headquarters in Europe. more and more PE houses are signing up to the UN PRI too. To date, 41% of the houses we surveyed have signed up. Our point of view In the near future, certainly for In our experience, another driver The challenging nature of ESG risk European-headquartered houses, for RI is moving into growth management in growth economies the UN PRI is likely to take on economies – whether it’s the PE is consistent with findings from our more significance as a driver of RI. house itself that’s expanding, or its recent report Getting on the Right There is anecdotal evidence that portfolio companies. ESG risks and Side of the Delta: A Deal-maker’s many PE houses are seriously opportunities are inherently higher Guide to Growth Economies2. This considering signing up to the UN in growth economies – because report found that doing deals in PRI. If they do, they’ll have to report national and regulatory frameworks growth economies remains publicly and regularly on their are generally weaker and due to incredibly challenging. approach to ESG issue management cultural differences. As a result, – and that, in turn, is likely to we’ve noted that many PE houses sharpen their focus on procedures apply greater scrutiny to ESG issues and metrics. Progress will need when their portfolio companies are to be demonstrated from one expanding into growth economies. reporting period to the next to retain credibility. ¹ y 2011, GPs and LPs representing US$30 trillion of assets (representing 20% of the world’s capital) had signed up to the UN PRI. B www.unpri.org/publications/annual_report2011.pdf ² www.pwc.com/gx/en/deals/doing-deals-in-growth-economies/index.jhtml.6 PwC
  9. 9. In terms of the allocation of day-to- day responsibility for managing RI programmes, different houses adopt different approaches. At one end of the spectrum, there is a small number of PE houses with dedicated in-house RI teams. Most of the others have made RI activities an additional responsibility of an existing role or team (usually public affairs, investor relations, operations or legal counsel). This type of set up is at times resulting in the PE house having to limit their RI focus to a sub-set of portfolio companies, rather than being able to adopt a portfolio-wide approach. Many PE houses agreed that lack of internal capacity and expertise is a barrier for progress in the management of environmental or social issues. 2.2 Internal capacity With regards to rewards and Virtually all the participants we talked incentives, at least one PE house to were able to identify a senior or with a dedicated in-house expert executive level sponsor with ultimate told us this individual is assessed and responsibility for overseeing the rewarded on exactly the same basis house’s RI strategy. Three of the PE as their colleagues in the operational houses we interviewed have Executive- efficiencies team (whose job is to level committees that are responsible realise operational efficiencies across for overseeing their responsible portfolio companies). Only one house investment strategies. mentioned that ESG objectives are woven into the job specifications of all staff.Our point of viewLack of internal capacity and • Forge partnerships and • Join/consult with industryexpertise can be a major barrier to collaborations – examples associations which provideimplementing responsible investment in the market include KKR and guidance, e.g. UN PRI andprogrammes. Hiring in to build Carlyle partnering with the the British Private Equity andin-house teams is an unlikely option, Environmental Defense Fund Venture Capital Associationgiven the ‘lean’ structure of many PE to drive eco-efficiencies, and have developed RI guidelines.houses and the current economic portfolio companies working • Engage external consultantsclimate. What can PE houses do to closely with special interest groups to support with the developmentaccess the right expertise? such as the Marine Stewardship and implementation of RI Council and the Forestry• Develop internal capacity of strategies. Stewardship Council to generate deal teams (e.g. via training revenue from new product ranges programmes) to help integrate Private equity industry associations (sustainable seafood and management of environmental could also consider providing sustainable timber, respectively). and social issues into investment training programmes on RI for decision-making. • Facilitate knowledge sharing their members. between portfolio companies – Apollo Global Management and TPG have both hosted portfolio company events for this purpose. Responsible investment: creating value from environmental, social and governance issues March 2012 7
  10. 10. 2.3 Policies and procedures Policies 50% of the houses we The vast majority of the houses we Our point of view surveyed lack a responsible surveyed believe that ESG issues Publishing a RI policy in the public investment policy will become more material to their domain will create an business and 94% believe ESG activity expectation with stakeholders can help create value (see section 2.4). and make PE houses accountable Despite this 50% are yet to develop a for following through and specific policy to manage it. putting their plans into action. Two of the participants we talked to An effective policy: said they were in the process of • clearly sets out the investment developing a policy, or expected to ethos of the house and drives have one within the next 12 months. consistency of approach Anecdotal evidence shows that houses with formal policies usually have more • lists excluded sectors and sophisticated procedures to manage clearly communicates ESG risks. minimum standards, and • explains how commitments Several participants felt that even are underpinned by robust though they don’t have a formal procedures. policy, it doesn’t necessarily reflect a lack of commitment or action on their part. They argue that paying attention to ESG issues has always been ‘business as usual’ – so it exists, even though it’s not officially called ‘ESG’ or ‘responsible investment’. Investment cycle – acquisition All the houses we spoke to consider Everyone we spoke to said they think Our point of view ESG issues to some extent during about potential ESG issues as part of • During the pre-acquisition investment appraisals due diligence procedures. However phase, houses could do more there are considerable differences in to explore opportunities the formality of the processes and the associated with environmental depth of analysis performed. and social issues rather than just using ESG reviews to A number of the houses we surveyed ‘de-risk’ their existing are carrying out ESG due diligence on investments. an ad-hoc, case by case basis (excluding • PE houses should consider basic legal/compliance checks). By the best way to act on contrast, the more progressive houses, findings from pre-acquisition such as Apax Partners, have committed ESG assessments. Unless to carrying out ESG due diligence on findings are built into the every potential acquisition – and have 100-day plan (or other targets a purpose-built framework for doing so. set for the hold period), Very few PE houses are explicitly there’s a risk that linking these due diligence assessments environmental and social to concrete actions in the hold period. action points will be sidelined Only one of the participants we as niche issues rather than surveyed said their ESG assessment being integrated into core feeds directly into the ESG targets they business strategy and practice. set for their portfolio company as part of the 100-day plan.8 PwC
  11. 11. Investment cycle – hold period Two of the US-headquartered housesHouses take very different The way PE houses manage ESG we interviewed – Apollo Globalapproaches to ESG issues during risks and opportunities in their Management and TPG – sharedthe hold period portfolio companies during the hold their novel approach to engaging period varies considerably – from portfolio companies on ESG issues ad hoc, to well-established, systematic and demonstrating the opportunity procedures. to create value. They both run ‘knowledge-sharing conferences’ Those with a more systematic for the benefit of their portfolio approach tend to have a process in companies, where they can showcase place which: their most successful eco-efficiency activities and show how they’ve led 1. dentifies potential ESG risks and i directly to cost savings, as well as opportunities (e.g. eco-efficiencies fostering the deployment of solutions, or health and safety performance programs and goals across portfolios. improvement) across their portfolio of companies“ here’s real potential to lose T 2. stablishes action plans and targets e value in a portfolio company if to realise opportunities or mitigate Our point of view you fail to focus sufficiently on risks, and During the hold period, PE managing ESG risks.” houses could undertake the 3. onitors ESG performance (or mEuropean-headquartered PE house following steps to enhance progress against action plans) management of environmental on an ongoing basis. and social issues in particular: Many of the major US-headquartered • form partnerships with houses we interviewed are following portfolio companies to identify a common model, where in-house and address environmental teams essentially act as consultants to and social priorities portfolio companies. These ‘consultants’ • set ESG objectives and targets focus almost exclusively on achieving with portfolio companies environmental efficiency in portfolio companies, rather than on the wider • baseline existing ESG environmental, social or governance initiatives to understand what issues. Typically they spend a is in place and so that progress considerable amount of time with one can be measured going forward company to produce positive results, • require regular upward before moving on to the next. reporting on ESG improvements, and • provide portfolio companies with external support and expertise. Responsible investment: creating value from environmental, social and governance issues March 2012 9
  12. 12. It’s difficult to quantify the extent Investment cycle – exit there is anecdotal evidence that it Most participants agreed that good can be a factor in the sale price. One to which strong ESG management management of ESG issues in portfolio participant, Actis, shared an example contributes to a good exit valuation companies certainly ‘doesn’t hurt’ the of how a purchaser paid an enhanced exit valuation. But they were less purchase price for one asset, partly on certain about how much of any rise the grounds of the company’s in value can be put down to ESG corporate responsibility credentials. activities. One participant said: Another interesting insight shared by Actis was that they assess the ESG credentials of potential buyers of their “ sound approach to ESG issues A portfolio companies, before agreeing can enhance both earnings and a sale. multiples. Companies with strong policies and practice in this area “ ood ESG issue management G are much easier to sell.” might lead to a small uplift in Patrick Dunne, 3i EBITDA multiples on exit, and will improve saleability Whilst it is clearly a challenge to of the asset.” quantify the impact of ESG management activities on sale prices, European-headquartered PE house10 PwC
  13. 13. “ ortfolio companies will be reporting back to us for the first time this P year on what they commit to measure.” US-headquartered PE house 2.4 Measuring value • In December 2011 KKR reported A resounding 94% of the participants that since its inception in 2008 the we surveyed believe that ESG activities portfolio companies which have can create value. But only 40% have participated in its Green Portfolio begun to measure this value by putting Programme have achieved “more formal processes in place to track the than $365 million in financial impacts of ESG initiatives. impact and avoided 810,000 metric tons of GHG emissions, 2.2 million Indeed, many of the houses that we tons of waste, and 300 million litres spoke to are still in the early stages of of water” ¹. collecting ESG performance data from • In their 2011 report ‘Private Equity their portfolio companies in a and Responsible Investment’ systematic manner. Just identifying Doughty Hanson reports savings and appropriate ESG metrics which are additional income of €18 million applicable across a portfolio can be through a focus on ESG issue challenging given the broad range of management resulting in the sectors and geographies comprising avoidance of 200,000 tonnes of the portfolios of most houses; while carbon dioxide, 150,000 tonnes of ensuring the integrity and waste and the release of 260,000 comparability of the reported data is cubic meters of water. Doughty an ongoing management issue. The Hanson estimates that another €21 fact that LPs are asking PE houses for million per annum is achievable². more data on ESG management, but in a non-standardised way, makes However, few if any houses appear to developing an effective measurement have successfully quantified the framework for ESG activities even indirect value arising from RI. Indirect more complicated. value includes intangible factors such as the contribution of ESG initiatives Moreover, to assign a financial value to to customer loyalty, brand value orQuantifying the value that ESG ESG initiatives requires PE houses to maintaining preferred supplier statusactivities create is still a work in collect ESG-relevant financial data. and the benefits of RI programmes inprogress for most For example the upfront investment in terms of protecting against eco-efficiency measures and the reputational risk. corresponding cost savings in terms of energy, water or waste management, There are a number of challenges in in addition to ESG performance valuing the indirect benefits of ESG information (e.g GHG emissions, initiatives. These are similar to those water use, waste generation). Again, faced in attaching a value to other few houses are systematically business intangible assets such as“ he issue is to show how [we] T collecting such data. organisational know-how, customer are using ESG levers to create relationships or an engaged workforce. value. Only tangible benefits Some houses have begun to attach a They include the absence of a market are tracked, but there is a strong financial value to ESG initiatives by price for the asset (since intangibles belief in the intangible value too.” tracking their direct benefits. These often can’t be separately traded) and include cost savings achieved from the fact that their worth to oneEuropean-headquartered PE house eco-efficiency initiatives or revenue company may be completely different growth achieved from new more to another since companies may have sustainable products. For example: different opportunities to exploit an intangible asset through their networks, relationships and innovation processes.1 www.green.kkr.com/results2 www.doughtyhanson.com/responsible-investing/~/media/Files/D/Doughty-Hanson-Co/Attachments/WWF%20report%20Final.pdf Responsible investment: creating value from environmental, social and governance issues March 2012 11
  14. 14. “ his is an imprecise science T However, despite these difficulties, the company performance on key ESG and will evolve over time.” markets are effectively attaching a issues (e.g. environment, workplace, value to business intangible assets community and so on) against European-headquartered PE house every day. One way in which they do pre-defined ‘maturity levels’. Again, this is to use non-financial and this enables comparison between qualitative indicators. This is an companies, funds and year to year approach which has been adopted by performance. several houses to measure ESG activities (tangible and intangible). Finally, whilst virtually everyone we “ here it is feasible to measure W Whilst such approaches do not provide surveyed believes ESG activities can – do it.” data to support valuation exercises, create value, not everyone believes European-headquartered PE house they do allow the PE house to track that this needs to be measured and progress on ESG issues from year to quantified. However, as an interesting year, and from company to company. counterpoint to this viewpoint, For example, at least one PE house has respondents from at least three PE developed a defined set of qualitative houses said that despite scepticism measures, applicable to all portfolio about their programmes at first, it was companies, which it uses to monitor easier to get senior colleagues and company performance once a year deal teams on board once the hard (using a red/amber/green light evidence of financial savings started system). Another approach which was coming in. mentioned is to score portfolio Our point of view Why value the impacts of establish a credible link between that are required by all portfolio responsible investment? ESG activities and intangible value. companies, together with some There are a number of benefits to sector specific metrics. A recent publication by WWF and quantifying the financial value of Doughty Hanson discusses methods • Strive for quality not quantity. RI for a PE house. These include for ascribing value to ESG activities It is usually better to focus on helping to focus RI engagement in more detail. We provided establishing robust reporting with portfolio companies on the technical advice and guidance to protocols and processes for a most value adding activities, WWF during the preparation of that subset of data going forward facilitating communication with publication¹. than to try to cover all the possible potential investors about RI in indicators or to seek historic data terms that they can understand Some tips for getting started: of dubious quality. and establishing a robust business case for further engagement with • Take small steps. RI reporting is a • Consider qualitative portfolio companies on ESG issues. journey. Initial expectations for approaches. Qualitative self portfolio companies can be set low assessment approaches are How to value RI activities? and raised up over time. a useful option if the costs of We use standard valuation gathering quantitative data • Borrow and adapt. There exist methodologies (such as discounted appear prohibitive. global reporting frameworks for cash flow models) to quantify the ESG issues (e.g. GRI sustainability • Valuation: start with value value of RI initiatives. This includes reporting guidelines or ISO26000) drivers. If valuation is your both direct and indirect value and issue specific standards (e.g. eventual goal, the first step drivers. Commonly used methods GHG protocol). These can be should always be to map the such as conjoint analysis and real easily adapted to needs of PE key pathways through which RI options analysis can be applied to houses and adopted gradually. creates financial value and seek indirect value drivers and can be some basic business data that used to impute values to different • Consistency, not uniformity, will help determine materiality. attributes of a brand or product. is key. The material issues for This will help identify the relevant The key challenge in conducting each portfolio company will vary metrics to inform your RI these exercises is the availability depending on their sector and reporting framework. of ESG relevant financial data: geographic location. Consider given enough data it is possible to defining a core set of metrics 1 www.doughtyhanson.com/responsible-investing/~/media/Files/D/Doughty-Hanson-Co/Attachments/WWF%20report%20Final.pdf12 PwC
  15. 15. There is limited public reporting 2.5 External reporting 2. houses are cautious about PE One notable finding to come out of making any statements or claimsof how ESG issues are managed – this survey was the relatively limited about their RI policies andexternal reporting is a focus area amount of external reporting by some procedures unless they’re confidentfor 2102 PE houses on their RI approaches and they have strong enough procedures activities. On their websites, almost in place to underpin their strategies half (47%) either don’t mention RI, or – or solid stories to tell about how only mention a high level commitment management of ESG issues to managing these issues. Most creates value.“ e need to explain how we W participants agreed reporting is still Those that are reporting externally work and the benefits we provide ‘quite superficial’. Many also said tend to use case studies to highlight to society.” external reporting is an area they’ll be the ESG management ‘success stories’ focusing on in 2012.US-headquartered PE house of value creation in their portfolio companies. However, based on our In many cases, there is more activity conversations, some in the market are going on than is being reported“ lot of LPs are asking how this A troubled by the use of case study based externally. There seem to be two main gets measured... they are looking reasons for this ‘under-reporting’: reporting. They query the role of the for integrated financial reporting.” PE house in the ‘success story’ and, in 1. houses are nervous to say too PE particular, whether the achievementsUS-headquartered PE house much because there’s limited are down to the portfolio company common understanding of what management’s own strategic vision constitutes best practice in reporting and planning, rather than an outcome (so they find it difficult to predict of the PE house’s RI approach. how they might be viewed), and Our point of view • learn from considerable progress Beware the pitfalls of using To develop and improve reporting, made on sustainability reporting, case studies: PE houses should: including integrated reporting, elsewhere in the private sector. • nless PE houses show how their U • link their environmental RI approach played a role in Right now, the UN PRI is reviewing and social risk management bringing about ESG improvements, its annual assessment process of activities to value generation they run the risk of being signatory compliance. This review challenged. Is the portfolio • identify material ESG factors will affect the reporting and company’s sustainability success and focus on these disclosure requirements (Principle down to management’s strategic #6). It’s possible that there will be • proactively engage with LPs to decision-making, rather than an element of mandatory reporting shape and streamline future RI driven by the house RI strategy? for signatories in the future. For reporting requirements – this will The harshest sceptics may see those PE houses that are (or are put PE houses on the ‘front foot’ such reporting as an attempt to soon to be) signatories, it would be rather than having to react to take credit for the portfolio wise to revamp their reporting to multiple requests for information company’s work. include better quality, more robust presented in different ways information. • E houses also run the risk of P • be transparent – share successes being accused of unbalanced as well as challenges and make For more guidance on good practice reporting, i.e. ‘good news’ sure that claims are not made reporting, including sustainability reporting only. that cannot be supported reporting and integrated reporting, please visit our dedicated portal at • report against targets, including www.pwc.com/corporatereporting. year-on-year, and Responsible investment: creating value from environmental, social and governance issues March 2012 13
  16. 16. A geographic perspective: contrasting approaches between US and European-headquartered PE houses One interesting theme to emerge Most of the US-headquartered PE from our survey is the difference in houses said that social issues are ‘on attitude and approach to RI between their radar’ and conceded that they the US-headquartered PE houses and are yet to be tackled in earnest. A few those in Europe. mentioned this would be an important focus area for 2012. US-headquartered PE houses are focusing squarely on the environmental Likewise, governance is an area that pillar of the responsible investment came up much more frequently in agenda – in particular, eco-efficiency. our discussions with European- Such initiatives deliver cost savings headquartered PE houses. Many of from using less energy and water, these houses noted that the UK Bribery cutting waste and making production Act (which came into force in July processes ‘leaner’. The efficiencies 2011) has helped to deepen their achieved are relatively easy to measure understanding of the way their and can be expressed in cash terms. portfolio companies manage bribery, corruption and ethical risks. As a result By contrast, European-headquartered of their recent efforts to comply with PE houses appear to be addressing a the Act, many houses are now armed broader range of issues, on the whole with better quality management – not just the environmental aspects, information on bribery/corruption. but the social and governance ones too. As a result, there’s more focused Several houses described how they’re effort going into strengthening any working with their portfolio companies weaknesses in this area. Anecdotal to improve the way they manage evidence suggests that the next step ‘social’ issues like labour issues in for some of these houses is to apply supply chains, health and safety, the same level of scrutiny to and employee management. In these governance across all of the cases, the benefits are intangible (e.g. companies in their portfolio – decreasing turnover and attrition, especially in emerging markets. boosting morale to increase productivity and retention, attracting new customers, and enhancing Are large PE houses doing more on the responsible reputation and brand). investment agenda? From our own experience of the PE market, there does not seem to be a correlation between PE house size and commitment to a RI. Our survey backs this up – we found no clear dividing line between the two groups of PE houses. In fact, contrary to expectation, 50% of mid-tier participants are UN PRI signatories, compared to 36% of larger houses. Interestingly we also found little evidence that RI approaches are more developed in publicly owned PE houses. Indeed, a higher proportion of non-listed PE houses had RI policies compared to their listed peers. These findings seem to imply that a key determinant of commitment to the RI agenda is the PE house strategy/ethos, rather than simply size of assets under management or type of ownership.14 PwC
  17. 17. 2.6 Looking ahead Will investors pay more or less Will PE houses do more or lessWe also asked the PE houses we attention to ESG issue management about ESG issues?surveyed how they think responses to by PE houses? We asked each of the PE houses weESG issues might evolve over the next With only two exceptions, all of the PE surveyed whether they expectedfive years. We discussed future trends houses we interviewed believe that their own ESG activities to increase,in three specific areas: the materiality LPs will pay more attention to ESG decrease or stay the same over theof ESG issues, how much attention issues over the next five years. Of the coming five years. Once again, theLPs will pay to ESG management, two who disagreed, one believes that vast majority shared the same opinion:and how their own approach to RI LPs will shift their focus to other issues 94% said they expected it to go up.will change. over time. The other believes they When prompted to describe how won’t pay any more or less attention to their approach to RI will evolve,Will ESG issues be more or less ESG issues than they do now. some of the answers were:material? • formalising a policy94% believe ESG issues will become Many of the European-headquarteredmore material over the next five years. PE houses said they had seen a clear • increasing internal and external rise in questions from LPs on how they reporting on how ESG issues areThey also broadly agree that manage ESG issues, and many expect managed – many said they expectdemographic shifts in their customer this trend to continue. As we’ve to be requesting more upwardbase (Generation Y) will have an already noted, this increased attention reporting from their portfolioinfluence. The next generation tend to from investors has been a catalyst for companies in the near futurehave higher demands and expectations several PE houses to formalise and • a greater focus on measuring ESGfor responsible products and services. strengthen their RI approach. So it improvements and attempting to seems LPs will continue to be an quantify value, and important driver of ESG activity in the“ ESG issues will be] no less [ PE sector. • increased engagement with deal important but there is likely to be teams, portfolio companies and LPs. a lull due to financial markets. But these issues will return and “ nterest will grow – especially if I grow stronger in time.” value can be shown.” “ e will focus on developing a W more structured programme withEuropean-headquartered PE house European-headquartered PE house our portfolio companies. By the end of 2012, we will have met with each portfolio company at“ hey [ESG issues] will become T “ es [interest from LPs on the Y least once to discuss monitoring more important. However, management of ESG issues will [of ESG performance].” financial uncertainty will serve increase]. But to some extent, it US-headquartered PE house to push management of these will depend on progress in the issues down the agenda.” political arena on climate change.” “ e will be doing more, not less, WEuropean-headquartered PE house European-headquartered PE house especially in terms of measuring impacts/performance improvement, and in reporting.”“ ore important – especially the M environmental area.” European-headquartered PE houseEuropean-headquartered PE house Responsible investment: creating value from environmental, social and governance issues March 2012 15
  18. 18. Editorial team: Key contacts: Shami Nissan John Dwyer PwC UK PwC UK T: +44 (0)20 7213 1195 Global Head of Deals E: shamiram.nissan@uk.pwc.com and Private Equity T: +44 (0)20 7213 1133 Phil Case E: john.p.dwyer@uk.pwc.com PwC UK T: +44 (0)20 7212 4166 Malcolm Preston E: philip.v.case@uk.pwc.com PwC UK Global Sustainability Leader Lauren Kelley Koopman T: +44 (0)20 7213 2502 PwC US E: malcolm.h.preston@uk.pwc.com T: +1 646 471 5328 E: lauren.k.koopman@us.pwc.com Tim Hartnett PwC US Flora Paul US Private Equity Sector Leader PwC UK T: +1 646 471 7374 T: +44 (0)20 7212 6280 E: timothy.hartnett@us.pwc.com E: flora.v.paul@uk.pwc.com David Brown PwC China Greater China Private Equity Leader T: +852 2289 2400 E: d.brown@hk.pwc.com Richard Burton PwC Germany EMEA Private Equity Leader T: +49 69 9585-1251 E: richard.burton@de.pwc.com Charles Humphrey PwC Australia Australia East Cluster Private Equity Leader T: +612 8266 2998 E: charles.humphrey@au.pwc.com16 PwC
  19. 19. This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon theinformation contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to theaccuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers does not accept orassume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the informationcontained in this publication or for any decision based on it.© 2012 PwC. All rights reserved. Not for further distribution without the permission of PwC. “PwC” refers to the network of member firms ofPricewaterhouseCoopers International Limited (PwCIL), or, as the context requires, individual member firms of the PwC network. Each member firm is aseparate legal entity and does not act as agent of PwCIL or any other member firm. PwCIL does not provide any services to clients. PwCIL is not responsible orliable for the acts or omissions of any of its member firms nor can it control the exercise of their professional judgment or bind them in any way. No memberfirm is responsible or liable for the acts or omissions of any other member firm nor can it control the exercise of another member firm’s professional judgment orbind another member firm or PwCIL in any way.Design Media – The Studio 21036 (02/12) Responsible investment: creating value from environmental, social and governance issues March 2012 17
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