Weekly Viewpoints on Sustainable Investment
In this week's note a view on private equity adoption of ESG frameworks and regulators tracking the financial capitalism fingering the commodities business.
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| Connecting at JSE: AIFAM2013 24 July 2013. PHOTOCREDIT: SinCo 2013 |
PRIVATE EQUITY ESG
Private equity investments may have horizons of 5 - 12 years. Integrating ESG factors has increased as a key hygiene factor for funds raising capital. In my view, ESG in PE may better be understood as a key success factor. Different frameworks for ESG have been introduced, often from collaborative research and co-work. The European-based LPs have a guideline The EVCA Handbook Professional Standards for the Private Equity and Venture Capital Industry (Edition November 2012) (PDF) which describes that: "When making investments on behalf of the Fund, the GP should implement the Fund’s investment policy with due skill, care and diligence and in accordance with the agreements the GP has made with the LPs in the Fund. A GP should be mindful of the responsible investment impact of the conduct of its business and should give due consideration to material risks and opportunities associated with responsible investment factors such as environmental, social and governance (ESG) factors throughout the period of its investment." Most development financing institutions (DFIs) have a framework, for example the IFC (multinational), the CDC (UK) has an industry-leading ESG toolkit for its managers (PDF). DEG (Germany) has also developed an ESG framework, and the PRI disclosure practice guideline (PDF) was published in March 2013.
In conversations lately with private equity practitioners one current view of ESG is that it is about “pain and fluff”. Firstly, the pain of reporting by GPs on the portfolio company ESG and reporting that to the multiple LPs, many of which may be DFIs with their own reporting requirements. Secondly, some PE practitioners discount all the ESG work as too fluffy, too hard to quantify or offer examples of risk or return impacts on their performance. Private equity is seen as a “tax” on doing business and investment, something with little value, and as a cost to the business dealt with by hiring a worker to write up whatever their investors demand to be written. Case studies are needed. The IFC has sponsored some case studies, for example Cogitel in Tunisia (PDF) published with the Emerging Markets Private Equity Association, EMPEA in 2012. Some good examples may also be teased out of reporting by some of the major General Partners (GPs) operating in emerging markets, for example Actis based in London UK which has published some short notes which I have used in lectures. At SinCo we have been shortlisting and collating company narratives and ESG issues components for writing new case studies in PE. We wait for the right sponsor of the new research, and the right forum to present them to. The PRI PE event in Cape Town on 3 October may be one opportunity, or the annual PE events in London and Washington DC focused on the developing world economies. The PRI event is stacking up well with the PRI's Fong Yee Chan working hard with Michelle at AVCA and Erika at SAVCA (and I have been able to help some of the flow and shortlisting keynote speaker candidates this week). More soon.
In conversations lately with private equity practitioners one current view of ESG is that it is about “pain and fluff”. Firstly, the pain of reporting by GPs on the portfolio company ESG and reporting that to the multiple LPs, many of which may be DFIs with their own reporting requirements. Secondly, some PE practitioners discount all the ESG work as too fluffy, too hard to quantify or offer examples of risk or return impacts on their performance. Private equity is seen as a “tax” on doing business and investment, something with little value, and as a cost to the business dealt with by hiring a worker to write up whatever their investors demand to be written. Case studies are needed. The IFC has sponsored some case studies, for example Cogitel in Tunisia (PDF) published with the Emerging Markets Private Equity Association, EMPEA in 2012. Some good examples may also be teased out of reporting by some of the major General Partners (GPs) operating in emerging markets, for example Actis based in London UK which has published some short notes which I have used in lectures. At SinCo we have been shortlisting and collating company narratives and ESG issues components for writing new case studies in PE. We wait for the right sponsor of the new research, and the right forum to present them to. The PRI PE event in Cape Town on 3 October may be one opportunity, or the annual PE events in London and Washington DC focused on the developing world economies. The PRI event is stacking up well with the PRI's Fong Yee Chan working hard with Michelle at AVCA and Erika at SAVCA (and I have been able to help some of the flow and shortlisting keynote speaker candidates this week). More soon.
ESG AS VALUE DRIVER IN PE
The compelling case for PE of “ESG as value driver in private equity” has underpinned much of the publicly-available research from major developmental finance institutions in the past decade. As I have noted before, investment, and investment analysis, in frontier and emerging markets happens across borders of regulations, guidelines and laws. ESG may act as a proxy for advanced due diligence or a marker for absent rules in the marketplace. The virtuous role of ESG has been illustrated in listed equity research of major companies in Europe. Many companies use ratings as a management tool monitoring for example the strengths or weaknesses analysis or as a means to track future trends [SOURCE: The Impact of SRI An Empirical Analysis of the Impact of Socially Responsible Investments on Companies by oekom research, May 2013]. PE deals in growth markets often intersect with building much-needed infrastructure, whether it is building the rail line for a new mine, or the 6,000 housing units for that mining company in some undeveloped patch of the world. Tharman Shanmugaratnam, the Deputy Prime Minister of Singapore was keynote speaker at the CFA Conference in Singapore in May 2013 spoke of the need for long-term investments (e.g. infrastructure), rather than short term or "indecisive" investments, but argued that there is a shortage of asset managers to facilitate these more complex investments. ESG is a value driver in infrastructure deals, shortening the timeline and increasing the possible positive outcomes. An old Harvard Business School Case that I have used as an MBA teaching tool demonstrates that “positive business and investment behavior reduces barriers to accessing investment opportunities and regulatory hurdles to doing businesses, especially in infrastructure deals” [SOURCE: Esty, Benjamin C., Carin-Isabel Knoop, and Aldo Sesia. "Equator Principles, The: An Industry Approach to Managing Environmental and Social Risks." Harvard Business School Case 205-114, January 2007]. Conversations this past Friday at a sunlit sidewalk cafe with the ESG specialist at a major asset owner in emerging markets and a political scientist reminded me of the critical role of the social factors. With the large governance and environmental footprint, it is not surprising that large infrastructure deals attract heavy-duty due diligence from analysts and investment committees. But with great scrutiny, the role of the social factors - how communities are engaged, how the stakeholders are not corrupted, how the social license to operate is renewed and respected - may become increasingly the key driver.
THE DIRTY FINGERPRINTS OF FINANCIAL CAPITALISM ON SHINY ALUMINUM
The asset management industry is going through some tough times as consolidation plays out. For example, IPE reported in June that "AUM growth at 10 largest fund managers outstrips sector", with asset increase of €1.2trn sees and globally, the 10 largest institutional managers were responsible for €12.8bn in assets at the end of December 2012. Elsewhere BCG’s eleventh annual Global Asset Management report reports that “[a]ssets and profits both nearly returned to pre-crisis levels. Still, the asset increase was driven largely by rising markets—not the flow of net new assets, which was modest.” As financial services companies seek yields and uncorrelated returns, so they are broadening their proprietary activities to parts of the real economy. Financial capitalism pervades the real economy. Unfortunately, it seems major players have been bending the rules, as a New York Times investigative report has revealed (THE HOUSE EDGE: A Shuffle of Aluminum, but to Banks, Pure Gold By DAVID KOCIENIEWSKI Published: July 20, 2013). Intermediaries have a place in making markets liquid. Regulators have first place in making them efficient, fair and/or transparent, preferably with a self-regulatory efficiency to enforcement with sanctions overlay to be flexible. And let's price the carbon costs to make sure every cost gets reflected, especially when shuffling metals. And above all, the story is another argument to pay for good quality, long-form journalism that makes it possible to write up these stories.
Even as the fate of “Fabulous Fab” (SEC won 6/7 counts of the civil fraud suit against former Goldman Sachs Vice President Fabrice Tourre) played out 4 August some five years after the CDO-driven meltdown led to the global financial crisis, the WSJ reports ["LME, Goldman Sued Over Aluminum Warehousing"] that regulators have now named Goldman Sachs and LME in the lawsuit targeting anti-competitive and monopolistic behaviour in the warehousing marketplace for commodities. Sustainable investment is as much about returning good yields on the investments, as in the way those yields are earned. Its the principle of the investment approach. Will this cause Goldman Sachs et al to review their GS Sustain ESG metrics they report on..?
Even as the fate of “Fabulous Fab” (SEC won 6/7 counts of the civil fraud suit against former Goldman Sachs Vice President Fabrice Tourre) played out 4 August some five years after the CDO-driven meltdown led to the global financial crisis, the WSJ reports ["LME, Goldman Sued Over Aluminum Warehousing"] that regulators have now named Goldman Sachs and LME in the lawsuit targeting anti-competitive and monopolistic behaviour in the warehousing marketplace for commodities. Sustainable investment is as much about returning good yields on the investments, as in the way those yields are earned. Its the principle of the investment approach. Will this cause Goldman Sachs et al to review their GS Sustain ESG metrics they report on..?
Do good work on sustainable investment that matters.
Graham Sinclair
@esgarchitect
linkedin.com/in/grahamsinclair
Skype: graham_sinclair
SinCo - Sustainable Investment Consulting
SinCo designs ESG architecture for long term sustainable investment that matters.
www.sincosinco.com
@SinCoESG
Based on my work, experience and interactions, all views and opinions expressed are those of the author and do not reflect the named individuals, institutions or SinCo, it's clients or services providers. No mention suggests endorsement. This commentary does not constitute investment advise. Issued by SinCo to professional investors and stakeholders for information only and its accuracy/completeness is not guaranteed. All opinions may change without notice and may differ to opinions/recommendations expressed by other business areas of SinCo. SinCo may maintain positions and trade in collective investment instruments referred to. Unless stated otherwise, this is not a personal recommendation, offer or solicitation to buy/sell and any prices/quotations are indicative only. SinCo may provide sustainable investment architecture and other services to, and/or its employees may be directors of, companies referred to. To the extent permitted by law, SinCo does not accept any liability arising from the use of this communication.
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