Worldwide private equity firms say their action on environmental, social and governance issues (ESG) is set to increase over the next five years, largely driven by investor concern, according to a report issued by Professional Services Firm PwC.

Many firms have plans in place to develop their responsible investment or ESG programmes further, citing policy development, valuation and reporting as focus areas for 2012 and beyond.

In the new report by PwC examining the private equity industry’s actions on responsible investment issues, 17 private equity houses were interviewed. This included six of the top ten largest global firms, and a further eleven of the top 50 largest global firms.

Jayne Mammatt an Associate Director within PwC’s Sustainability and Integrated Reporting Department, says that private equity firms in Africa are starting to take a look at ESG matters as a result of an increasing focus on responsible investment by institutional investors and the recognition of the genuine business value created by responsible practices.

“Worldwide investors and other stakeholders are placing more pressure on companies, pension funds and private equity firms to change their mind-set. Companies need to be responsible about how they conduct business. Investors are looking at the full financial, environment and social effects on companies in the longer term,” she says.

A Call for Private Equity Firms to Develop Responsible Investing Policies

The Code for Responsible Investing in South Africa took effect on 1 February 2012. Under the new Code, institutional investors such as pension funds, insurance companies and their service providers will have to disclose in their reporting to stakeholders the extent to which it has been implemented. The Code is supported by legal measures such as Regulation 28 of the Pension Funds Act. Finance Minister Pravin Gordhan recently warned that if organisations do not adhere to the Code on a voluntary basis, more regulation may be considered by the Government.

Mammatt points out that responsible investing and corporate governance guidelines in South Africa are largely voluntary.

Some jurisdictions, such as the UK, have introduced a corporate governance code for institutional investors. The UK code is intended to create better engagement between shareholders and companies and create a stronger link between governance and the investment process.

Mammatt says that the new integrated reporting requirements of the corporate governance principles contained in the King III report will also assist listed companies in promoting greater ESG transparency.”Investor pressure is set to grow in the near future. Responsible investors believe that companies which are successful in avoiding ESG risks while capturing ESG opportunities will outperform over the longer term.”

Although some private equity firms said they had made progress in measurement, reporting and evaluation, there is still some way to go toward embedding rigorous, systematic measurement, monitoring and reporting on ESG action and value created, says the PwC study.

The report shows that a number of private equity houses are carrying out ESG due diligence on potential acquisitions. However, very few firms are actually linking these due diligence assessments to concrete actions in the hold period. Unless this happens, the report warns that ESG action points risk being sidelined as niche issues, rather than being integrated into core business strategy and practice.

Private Equity Firms Must Understand and Report on the Value ESG Creates

Mammatt says: “It is not surprising that only a handful of private equity firms have found a way through this complex area. The challenge is for the rest to keep up with pace because expectations are only going to get higher.

“It’s crucial that private equity houses develop a systematic approach to collecting relevant ESG and financial data from their portfolio companies if they are to fully understand and report on the value ESG creates.”

Other findings of the study include:

· Only two in five firms have put systems in place to measure the value created from ESG activities

· 47% do not report publicly on their ESG programmes

· 94% believe that ESG activities can create investment value, with many identifying cost savings, incremental revenue generation through new products, or enhanced reputation

· Half of the private equity houses interviewed lack a policy on ESG issues or responsible investment

· Risk management, investor interest, cost savings, and regulation were among the most commonly cited drivers for action

· There was no correlation between the size of the private equity house and the maturity of their return investment approach. Similarly, there was no clear difference in the return on investment approach between listed and non-listed private equity houses.