Five ‘Monday morning priorities’ for private equity investors looking to progress on sustainability

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Shrinal Sheth, Project Lead, Financial Innovation, World Economic Forum, Meagan Andrews, Community Curator, Investors Industries, World Economic Forum, Vinay Shandal, Managing Partner and Director, Principal Investors and Private Equity in Canada, Boston Consulting Group, Greg Fischer, Partner and Director, Sustainable Investing and Social Impact, Boston Consulting Group, Tariq Nanji, Partner, Canada, Boston Consulting Group & William Lubega, Project Leader, Boston Consulting Group (BCG)

• Private equity investors are under increasing pressure to deliver on environmental, social and governance issues.
• Sustainable investing offers investors an opportunity to create real financial value, but it requires leadership to drive impact.
• The industry is at a critical point where it needs to respond to quickly evolving societal goals and expectations.

The pressure on private equity investors to deliver real impact on environmental and social issues alongside financial returns – often referred to as ‘sustainable investing’ – has rapidly escalated.

Leadership on this issue will position private equity to drive tremendous social and environmental impact. However, failure to activate a critical mass of general partners (GPs) and limited partners (LPs) committed to such impact could expose the industry to heightened reputational and regulatory scrutiny – so it must act now.

Private equity well placed to lead on sustainability

This action does not have to simply be a compliance consideration, as there is an opportunity for private equity investors to create real financial value. In fact, with its full ownership model and relative freedom from short-term pressures, the industry is well placed to lead the way in capturing value through sustainability.

Several players in the industry have recognized this critical moment and are motivated to act. However, as they look to make progress towards their aspirations, they grapple with complex challenges in identifying strategies for engagement, building organizations that can cultivate impactful opportunities, and effectively engaging key stakeholders.

To assess the current state of the industry in navigating these questions, we conducted interviews with more than 30 leading GPs, LPs and industry experts. Our findings are summarized in the white paper ‘Creating Value through Sustainability in Private Markets’, written in partnership with The Carlyle Group, California Public Employees Retirement System (CalPERS), and Boston Consulting Group.

‘Monday morning priorities’ for private equity investors

While there is no one-size-fits-all playbook, drawing from these interview insights, we have identified five ‘Monday morning priorities’ for private equity investors looking to take a step forward towards their sustainable investing aspirations:

1. Invest in capabilities and culture

The gap in capabilities is one of the primary barriers to action for LPs and GPs today. Installing champions with the right multi-stakeholder experience to straddle both the traditional investment and the sustainability worlds can be a vital first step in building institutional capabilities. However, operational responsibility cannot be isolated under these champions alone. LPs and GPs must intentionally shift their organizational culture, creating a sense of ownership for sustainability imperatives at all levels.

2. Focus on a long-term plan

Developing capabilities and driving a cultural change to develop value proofs will take time and likely involve false starts along the way. To stay the course, private equity LPs and GPs need to take advantage of the greater time horizon flexibility in private markets and optimize for the long-term outcome, not just quick wins – for example, by embracing experimentation and lengthening hold periods.

3. Communicate the plan, along with measurable milestones along the way

Given the lengthy time horizon required to see results at the asset and portfolio levels, communicating the long-term plan and progress towards it to all stakeholders is vital to securing and maintaining buy-in. Communicating progress requires both standardized metrics, to enable comparisons, and customized reporting, to accommodate the unique aspects of each investment. Asset level transparency is critical, given that different assets have varying considerations and portfolios turn over approximately every five years.

4. Don’t just divest, transform

Divestment and sector rotation offer quick wins for a single investor, but they do not remove sustainability-laggard assets from the global mix. As these assets continue to operate, the systemic risks they engender will ultimately affect returns across the market.

Larger investors who are essentially universal owners and may have long-term obligations cannot divest their way out of these systemic risks. Sustainability challenges need to be addressed head-on by deploying capital to transform these grey assets. This is an area in which the private equity industry as a whole has the opportunity for disproportionate impact, and individual investors have the chance to develop differentiated capabilities.

5. Collaborate to address key barriers

Addressing measurement challenges and establishing the right incentives cannot be accomplished in isolation. LPs and GPs across the industry must continue to collaborate to set standards and policies. The current momentum and relative maturity of measures to combat climate change can provide a testing ground for action on these ecosystem challenges, providing templates for system-wide collaboration across a broader set of sustainability topics.

Industry must respond to changing expectations

Private equity is at a critical point where the industry needs to respond to rapidly evolving societal goals and expectations on sustainability.

Financing Sustainable Development

The world’s economies are already absorbing the costs of climate change and a “business as usual” approach that is obsolete. Both scientific evidence and the dislocation of people are highlighting the urgent need to create a sustainable, inclusive and climate-resilient future.

This will require no less than a transformation of our current economic model into one that generates long-term value by balancing natural, social, human and financial conditions. Cooperation between different stakeholders will be vital to developing the innovative strategies, partnerships and markets that will drive this transformation and allow us to raise the trillions of dollars in investments that are needed.

To tackle these challenges, Financing Sustainable Development is one of the four focus areas at the World Economic Forum’s 2019 Sustainable Development Impact summit. A range of sessions will spotlight the innovative financial models, pioneering solutions and scalable best practices that can mobilize capital for the the world’s sustainable development goals. It will focus on the conditions that both public and private institutions should create to enable large-scale financing of sustainable development. It will also explore the role that governments, corporations, investors, philanthropists and consumers could play to deliver new ways of financing sustainable development.

This presents not only financial, reputational and regulatory risks to be navigated, but also prospects for long-term value creation. Private equity must take action to seize this opportunity. We encourage you to read the full publication.