ESG Increasingly Impacts Investment Decisions, Fund Managers Report

A new report from global law firm Morrison Foerster highlights the disconnect between increasing ESG awareness and embedding ESG into deals and operations.

The report, ‘Navigating the ESG Maze’, in conjunction with AVCJ, shows that the ESG framework provides opportunities for fund managers, including; implementing ESG policies at target companies to raise company valuations; engaging ESG professionals to assist with enterprise risk assessments related to climate, Diversity, Equity & Inclusion (DE&I), and governance; and staying ahead of greenwashing claims by conducting ESG audits of their investments and marketing efforts.

As an example of the global reach of ESG, every respondent reported factoring ESG criteria into their decisions about potential investments.

General partners (GPs) see the benefits of improved ESG practices for reputation and investment opportunities, with a large majority (69%) reporting that ESG can be a deciding factor when making investment decisions.

The opportunity for ESG to increase a target company’s valuation is a strategy used across the region, with 82% of respondents indicating that they have invested in companies with negative or neutral ESG credentials with this strategy in mind.

A large majority (83%) agree that positive ESG metrics increase a target’s valuation, and 91% of GPs have found that positive ESG metrics help smooth exit processes.

Greenwashing Risks

In Europe and the United States, regulators are evaluating how greenwashing should be tackled as the number of sustainability and ESG funds has multiplied in recent years.

While ESG regulations in Asia have not developed to the same degree, the report indicates that GPs in the region may be at risk of greenwashing accusations.

Almost none of the fund managers have had greenwashing claims raised about their company or their funds, but 60% of respondents say they promote some investment activities as “green.”

Additionally, enthusiasm for ESG seems to be limited to fund managers’ investment criteria for target companies and not their own organisations, as only 22% of funds have a dedicated ESG professional and just 14% link investment team compensation to ESG goals.

In regions with more developed ESG programs, fund managers see ESG due diligence as a necessary risk mitigation strategy.

However, in Asia, less than half of respondents (46%) conduct ESG due diligence on every deal, with a further 46% doing so on most deals. Additionally, it is increasingly common in the US for fund managers to include ESG provisions in investment documentation.

But this has not taken hold in Asia, where less than one-third (29%) of respondents always require the inclusion of ESG compliance clauses in investment documents.

These clauses set out clear expectations and targets on key ESG issues and also address potential accusations of greenwashing, an area where regulators are increasingly active.

The “S” Needs More Action

While the environmental aspect of ESG captures most of the discussion, the social component has quickly come to the fore. Over the last decade, risks, both operational and reputational, and regulations have dramatically increased around human rights and equality.

This is reflected in the high percentage (88%) of fund managers who reported that communicating the importance of DE&I issues internally is the top action they have taken to promote improved DE&I in their organisations.

Embedding ESG considerations into a fund or company’s policies and operations helps not just to comply with existing laws and regulations, but also to identify company-wide risks and opportunities to drive value.

However, only 50% of fund managers say they are committed to diverse representation in leadership, and only 33% have made a financial commitment in this area.

“Our findings reveal that many fund managers are still at an early stage of their ESG journey and this provides an opportunity for fund managers in Asia to get it right from the start,” said Susan MacCormac, global chair of Morrison Foerster’s ESG Group.

“Many GPs are making the mistake of only treating ESG as a compliance issue – whereas the real benefits in embedding ESG considerations are in driving value, managing enterprise risk, and reporting.”

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