3 minute read 23 Apr 2021
Integrating ESG in Private Equity

Why ESG integration is becoming the next imperative for private equity firms

By EY India

Multidisciplinary professional services organization

3 minute read 23 Apr 2021

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  • ESG Integration: The Next Big Imperative for Private Equity Firms

Environmental, Social, and Governance (ESG) investing is fast emerging as a tool to build resilience, helping investors discover social and environmental risks in equity and funds.

In brief:

  • 60 Indian companies disclosed that climate risks would have a financial impact of US$ 98 billion1.    
  • According to EY’s Global Private Equity Survey 2021, over two-thirds of investors point towards looking at ESG risks and opportunities very seriously for their investment decisions.
  • An International Finance Corporation report suggests that India has a US$ 3.1 trillion climate investment opportunity by 2030.

ESG integration in private equity has taken a forefront specially after the pandemic has created an uncertainty in the present system. ESG integration enables to gauge the issues and risks that may not have been possible through conventional mechanisms. 

ESG integration in private equity is required for the following reasons:

  1. Improved risk management and better performance: Investments in non-ESG funds are increasingly perceived as riskier. If we look at the current scenario, ESG indices (such as S&P BSE 100 ESG India Index and MSCI India ESG Leaders Index) and ESG funds have been outperforming most of the conventional peers. Indian companies are also assessing ESG risks and according to CDP 60 Indian companies have assessed ESG risks of US$ 98 million.
  2. Syncing with investors Interests: Investors are increasingly considering ESG factors before investing. Often investors are seen working with brands in value creation. An example will be the investment of Leading Global PE fund in one of the largest Chinese infant formula manufacturers, a year after the manufacturer faced the melamine milk scandal. This ESG focused approach of the PE, to create social value, enabled it to generate 2.3x returns on its five-year investment.
  3. Growing ESG urgency: ESG has been growing at a rapid pace and more than two third of the investors consider it instrumental while taking decisions
  4. Increased regulations: In 2020, EU recently released the EU Taxonomy for Sustainable Finance which was followed up with the UK Government mandating TCFD aligned disclosures. Recently, the Indian Government also joined the International Platform for Sustainable finance (ISPF) which promotes development of sustainable finance regulations to encourage private capital mobilization for environmentally sustainable investments.

Integration of ESG in enterprise risk management will improve the consistency and cohesiveness of sustainability-related risk management. This integration will help in decision making and resource allocation, minimize the financial impact and improve stakeholder confidence.

As ESG integration evolves, ESG factors play a vital role in creating long-term value creation. The prioritization of stakeholder and long-term value creation is achieved when the entire organization is aligned with ESG agenda. Further, it is also observed that an organization’s sustainability journey is a gradual and rewarding process. 

Considering the same, EY has developed a three-layer framework known as Sustainable Design to assist organizations in managing risk and opportunities arising from climate change. This framework enables organizations to integrate ESG factors into their strategy, operations and value chain of the organization. It also enables organizations to develop robust governance mechanism, and risk management. Through this framework, organizations can gain both tangible and intangible benefits such as brand positioning, long-term value, market differentiation and operational efficiency.

Developing the ESG policy

Incorporating ESG and communicating risks to stakeholder enables build a resilient business that can tackle crisis with proper governance.

The business case for sustainable finance has materialized at an extremely crucial time when the costs of inaction have proved to be far more.
Chaitanya Kalia
EY India Climate Change and Sustainability Services Leader

Ambition is the topmost layer focusing on robust governance for risk management and strategy planning with proper targets and metrices.

Action is the second layer which consists of detailed implementation roadmap related to:

  • Developing ESG policy, internal capacity and conduct scenario mapping basis relevant stakeholders
  • Materiality assessments
  • Reporting and governance
  • Developing ESG Dashboard
  • Identification of ESG indicators and impact objectives/parameters
  • Identifying ESG risks and opportunities in the areas/sectors that the fund would address
  • Developing implementation strategy and key guidelines to be integrated into investment process and due diligence

Achievement is the bottom layer of the framework which emphasises on effective monitoring of ESG performance based on:

  • Developing a decision making toolkit
  • Assessing current state screening based on the ESG parameters/high level ESG risks
  • Safety performance management
  • Non-financial performance reporting advisory (across Integrated Reporting, TCFD, UN-PRI, UNEP-FI Principles of Responsible Investment)
  • Assurance on non-financial performance parameters (such as GRI and IIRC)
  • Periodic due diligence checks, outcome measurement and valuation
  • Capitalize on risks and opportunities identified during acquisition process
  • Monitoring to mitigate risks and optimize opportunities
  • ESG benchmarking and market scan

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ESG-focused investing brings with it the advantage of greater access to investors who look at ESG as a strategic opportunity. It also allows investors to look at scenarios through the sustainability lens and make profits while creating a positive impact.

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By EY India

Multidisciplinary professional services organization