January 30, 2013
Interviewed by: David Snow
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GP “Buy-In” for ESG Implementation

The second in a series on ESG in emerging markets private equity, “GP ‘Buy-In’ and Implementation of ESG” brings together two major backers of emerging-markets GP: Jeremy Cleaver of CDC Group and Dushy Sivanithy of Pantheon Ventures, with Sandile Hlophe of EY. The program concludes with an expert Q&A with Sandile Hlophe of EY, the sponsor of this series.

This is the second of a three-part series; Part 1 is “How ESG Creates Value in Emerging Markets.”

The second in a series on ESG in emerging markets private equity, “GP ‘Buy-In’ and Implementation of ESG” brings together two major backers of emerging-markets GP: Jeremy Cleaver of CDC Group and Dushy Sivanithy of Pantheon Ventures, with Sandile Hlophe of EY. The program concludes with an expert Q&A with Sandile Hlophe of EY, the sponsor of this series.

This is the second of a three-part series; Part 1 is “How ESG Creates Value in Emerging Markets.”

David Snow, Privcap: We are joined today by Sandile Hlophe of EY, Dushy Sivanithy of Pantheon Ventures, and Jeremy Cleaver of CDC group. Gentlemen, welcome to Privcap today. Thanks for being here.

We are talking all about ESG and the emerging markets. It’s a big topic. But today I’d like to really dig deep into the fact that managers of private equity firms increasingly are adopting ESG programs. So what does that involve? Is it expensive? Is it a pain in the neck? And what is the value? So maybe we could start with Jeremy. I know your organization works very closely with private equity firms across the emerging markets to help them implement and monitor ESG issues. What is that like?

Jeremy Cleaver CDC Group: Sure. Well, CDC invests in both existing fund managers and new fund managers. And let me start with the latter because it’s really a focus of ours. We will work with new fund managers for as long as it takes really to develop the right policies and procedures around ESG and, frankly, broadly across their requirements. So from that perspective we engage heavily with them on due diligence.

We share our ESG toolkit. We provide them with training. We’ll comment and advise when they’re looking to engage ESG resources

So we really spend, as I said, as much time as we need to to get them to the point where we and they feel that they can attract additional external investment capital. And that may take six months, it may take three months, it may take a year. But we’re happy to spend that time and work with them through the process.

Snow: What is the attitude generally like when it comes time to say and now it’s time to adopt ESG? Are they typically very enthusiastic or  is there some hand holding that needs to take place?

Cleaver: In the markets that we invest in, which are generally emerging markets and sometimes or often fragile markets, most of the GPs that we work with understand that to attract DFI capital they need to adopt ESG policies. And, in fact, many of them understand that ESG can really provide a significant uplift in efficiency for their investees as well. So we don’t find it to be something that’s a problem and most of the GPs that we work with are very happy to work with us in response.

Snow: Dushy, your firm Pantheon invests across the world but including you have a significant investment program in the emerging markets. Can you talk about how you interact with the managers that you back on ESG issues? How do you make sure they have a program and then make sure they follow the program?

Dushy Sivanithy, Pantheon Ventures: Sure. So I think the first thing that we do is make sure the managers understand how important it is to us so there are no surprises later on when we start talking about them. We’ve also run workshops so those managers that haven’t got standards that we feel are sufficient, we’ve run, you know, internal workshops that we’ve had. Consultants come and talk to them about it.

We do expect to see policies and procedures. But I think the real test is you’ll get a nice pitch back that says we’re ESG compliant, all of that. But if you can talk to the deal executive and they can’t answer the questions around ESG issues, you know that it hasn’t really kind of permeated the firm, and that’s what we spend a lot of time on.

So we will look at portfolio companies and we will look at the specific issues that we’ve identified and then we would engage with the specific deal executive, not the investor relations person, not the head of the firm, but the deal executive that looks after that company. And if they can’t speak knowledgeably about that topic, it means it’s not being dealt with properly. So it’s a real focus.

Snow: A follow up question– how often is it that you find a lack of detailed knowledge about ESG in one of your partners and that signals a need to perhaps educate them a bit more?

Sivanithy: I have to say in the emerging markets it’s pretty good. I think those GPs have always been more attuned to the issues around ESG, particularly because of the good work the DFIs have done in terms of putting in good practice to begin with. In developed markets I wish I could say it was the same. They often come up short.

Cleaver: I think we find, as Dushy said, in general the systems are very strong. The most recent issue that we’ve identified is just around implementation and making sure that actually the policies translate into on the ground implementation. And it really is at the margin. It’s not with the majority of our GPs. But there are areas where we need to engage to make sure that what they say they’re doing is actually what they’re doing.

Snow: Sandile, you are working with private equity firms across Africa in doing deals. Do you see meaningful differences in the way that each manager approaches ESG due diligence and ESG issues?

Sandile Hlophe, EY: Yes, so there are marked differences in sort of a certain investors. We find that in certain particular sectors there’s always a requirement– for example, mining and manufacturing– for that to be part of the diligence upfront. But some better practice that we’ve seen evolve is more under post investment, actually, than the awareness workshops and the engagement and having regular management meetings where the topic is just pure ESG.

So we find that the difference is in making sure that the executive management who are tasked with executing on those policies are fully aware. So the difference is some people– for some investors focus on doing it upfront, doing the high level diligence. And then better persons that too much more focused in post investment, we actually even get the actual investee portfolio company to cover the cost of that advice and those workshops, having regular management meetings that just purely focus on the ESG topic.

Snow: So what are the baseline resources and people that are needed to create and implement a meaningful ESG program in a private equity firm? Maybe, Dushy, you could talk a bit about just what is needed to just make it happen.

Sivanithy: Sure. I think one of the key factors is buy in from the top. So if the head of a firm or the senior members of the firm buy into it, it does tend to kind of get out. It gets taken up by the rest of the team, which I think is key. It depends on each firm. But a dedicated resource, particularly in emerging markets, can be helpful so they are picking up best practice in each of the areas.

But again, it’s just empowering each of the deal executives to understand what they’re investing in, what they should be looking out for, and actually implementing– going back to this point on implementation– pushing management to actually get it done, and reporting. So I think those are much more important in terms of just having the systems and procedures in place isn’t enough. It’s making sure that you have a feedback loop to make sure that you are actually checking you are where you want to be. And I think that’s the point that often gets missed is the intention is good but the implementation is poor. 

Snow: Do you agree?

Cleaver: Yeah. I think buy in is absolutely critical, both at the management level and then that then flows down into the investment level. I think from– perhaps Dushy and I end up looking at slightly different funds. And we, CDC, look at a number of quite small funds. So we have to be sensitive to the kinds of requirements that we then pile on to them.

So for a small SME fund that’s looking at less high risk industries, for example, it may be possible for them to use part of a person’s time to manage the ESG issues. Having said that, for a large pan African fund that might look at construction or mining or a series of more high risk sectors, actually, they would probably likely need to not only dedicated resource within the fund but also resource from externally as and when required. There are a number of training sessions that are put on by CDC and others across our markets. And so those are most often made available to all of our GPs, which we hope will help.

I think that there’s always a bit of a view perception that implementation of ESG should require more resources, more cost. But we’re finding that a lot of companies actually adopt that as part of the deal executives– or in the fund’s, depending on the size, having a person dedicated. But the more of your deal executives that are aware of it helps. And then, two, there are a lot of focus training programs that are provided by DFIs and various financiers of funds to actually better increase awareness and from that perspective. So we find that making it part and parcel of the day to day activities of monitoring and executing a deal, it’s much more easier to drive the implementation and follow through and awareness, versus doing it as an event from that perspective.

Cleaver: And what Sandile says is true. There are DFIs that provide technical assistance for the development of ESG policies and then their implementation as well.

Snow: Because I would imagine that one frequent form of push back that you might get from a GP is how much is this going to cost me, or, you know, OK, you want me to perform extra due diligence? I’m already spending so much money with my advisers on due diligence. Why do you want me to check these extra boxes? Do you hear that quite a bit?

Cleaver: Yes and no. Going back to our previous discussion, most of our GPs in emerging markets already understand that in order to attract development and finance institution capital, they really need to do this. So they bought in upfront. Sure, there are times when we might request that they do more than they are currently doing or they look at strengthening their policies or their implementation. And in those cases we just need to work closely with them and provide them with as many resources as we can to help them across the line.

Snow: Dushy, it sounds like the final frontier for ESG is going to take place not in the emerging markets but actually in the developed markets.

Sivanithy: It does feel like that sometimes. I mean, going back to that point on cost, a lot of the discussions we had with GPs when we first started in the developed world was around this is going to cost me something. Transitioning that conversation onto, A, it’s a necessary cost and actually it’s going to protect your return and even in a market where there’s muted macro, there’s actually an opportunity to create value here, that’s when people start getting interested. And also if you tie it to if you don’t do this fund raising is going to be difficult, it’s amazing how quickly they become attuned.

Hlophe: Yeah, I was going to add that you’re finding that there’s more and more focus in tracing ESGs in the fund raising strategies. The better practice we’ve seen is that when that follows through even to the strategy. So the thesis that gets put forward as to why a firm should do that investment includes around the ESG side. So you’re finding that– that’s why you find there’s more adoption and understanding in the emerging markets because whenever funds go into fund raising sort of a drive, they have to have an element, a dedicated section in the presentation, pitch back that focuses on how do they as a firm address ESG in that investment and during the portfolio life cycle, which is why I think you’re finding the developed markets where there isn’t a big focus on the way that they fund raise. That is why it takes time for them to actually get to grips and understand the importance of having ESG in their programs.

Cleaver: That’s true. When we see a GP come to us raising capital that either already has an ESG resource engaged or has clearly thought about it very carefully, it’s much more attractive to us from the outset.

Expert Q&A With Sandile Hlophe, Africa Service Line Management Partner, Transaction Advisory Services, EY

Privcap: What investment framework is required for successful private equity investing in Africa?

Hlophe: The ability to understand the social governance issues related to a particular sector and the drivers of growth and drivers of value in the particular sector become important. And these you learn, and improve. You understand your sector as you do more portfolio company investments in that particular sector and as you evolve. So we found that PE firms that focus on particular between three and five specific sectors are quite successful.

And then number two, having a good understanding in terms of which parts of the African continent are you going to invest in. There’s always a perception that Africa is just one big country. It’s actually 54 different countries. And with probably about five different regional and economic zones. So having good sector focus, good understanding of which countries and which regions, and as to what the returns expected for that sector would be gives you a better understanding of the investment horizon.

Privcap: What is the importance of local knowledge when investing across Africa?

Hlophe:  Africa’s become quite a big investment destination so that a lot of companies are finding that they are aware that there are a lot of suitors out there. So it’s become quite competitive. So unless you have a local partner to assist you in focusing and engaging almost exclusive discussions with particular targets, it could be quite difficult in actually doing an investment. You might find the premium is much more significant.

Number two, Africa growth is driven by a lot about family-owned, small to medium size businesses that are not traditionally listed, that have grown exponentially, that have the ability and power to grow across various countries and regions. Those aren’t publicly listed. There’s very little information available in public around them. And that is where we’re finding that a lot of PE firms are leveraging our footprint and network.

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