July 10, 2016
Interviewed by: David Snow
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ESG: How to Report, How to Mitigate Risk

ESG in private equity is evolving on two important fronts – reporting and risk mitigation. GPs with ESG platforms are becoming more sophisticated in how they blend financial and social impact. In addition, identifying risk is becoming more about seizing opportunity than killing deals, say three ESG experts.

ESG in private equity is evolving on two important fronts – reporting and risk mitigation. GPs with ESG platforms are becoming more sophisticated in how they blend financial and social impact. In addition, identifying risk is becoming more about seizing opportunity than killing deals, say three ESG experts.

Reporting and Risk Mitigation ESG
ESG in Private Equity Comes of Age

David Snow, Privcap:Today, we’re joined by Elizabeth Seeger of KKR, Andy Kuper of LeapFrog Investments and Michael Rogers of EY. Welcome to Privcap today. Thanks for being here.

Unison:  Thank you.

Snow: Andy, your firm has been in business for about 10 years, correct? Over those 10 years, how have you refined your approach to ESG, whether it’s the kind of people you put into the function or the way you define it or the way you execute it?

Andrew Kuper, LeapFrog Investments: The key insight for us, as the years went on, was that you could not have financial reporting and then separate environmental, social and governance reporting because the portfolio company CEOs would focus on the financial and then, at the end of the quarter, an analyst would tick through all the boxes that were provided. So, we were committed to doing something fundamentally different, which was to create an integrated reporting for the portfolio companies and for LeapFrog itself. And so we defined a system called FIRM, which stands for Financial Innovation Impact and Risk Management reporting, all together.

You focus rigorously on those metrics and then take those metrics and turn them into a dashboard that every company reports on, that then can be brought up to the portfolio level and reported on to investors as well as used for managing companies.

The power of that idea of integrated reporting is something that we have unfolded and unfolded and unfolded through the years. And we’ve discovered that there are far more synergies than even we thought in the portfolio where purpose drives profit and profit drives purpose. There’s a new argument, which is [that] there’s a synergy here and that synergy is highly quantifiable.

That’s a complete Jujitsu, a complete flip of how people have begun to think about it. And that gives me a lot of hope for the entire ESG effort globally. I see it with our investors and our portfolio companies across 35 markets that we work in or get investments from.

Snow: Elizabeth, what have you learned from seven years at KKR? How have you refined the process?

Elizabeth Seeger, KKR: I’ve learned there’s always more to do, more people to learn from and more playbooks to copy. I hope that’s public—your reporting methodology. I mean, I’m joking, but it’s true.

One of the things we’ve recognized—that I’ve recognized personally anyhow—is that there are certainly a number of companies in the U.S. and globally who are doing some very exciting, innovative things. [They] have their data, are able to report it to you, or are able to report publically, have the capability to engage with their stakeholders. But then, there’s a large number of companies in the global economy who aren’t ready for that yet or don’t have the systems in place, or need an investor like KKR to come in and say, “Let’s help you. Let’s partner on this.” 

Michael Rogers, EY: That is one of the biggest drawbacks or holdups we have with ESG—the ambiguity around it. And I [agree with] what Elizabeth’s talking about in terms of rule, standard setting—so that people can understand what data should be collected and how do you report it. I sympathize with these folks trying to put that into some sort of technology that people understand and it translates to the marketplace.

Snow: Let’s talk a bit about risk now.  Can you give some examples of your ESG being used as a screen in either buying a potential portfolio company or helping it avoid stepping into a quagmire? That is, you can attribute it to your ESG program.

Kuper: There’s a group called Shriramwhich is one of the leading providers of financial services to the base of the perimeter across India—the largest provider to Tier 3 and Tier 4 towns.

There was a particular product that was disallowed by the regulator. And, whereas competitors took about two years to transition from that product to another product, Shriram took about six months because they saw it coming. They had the relationship with their clients. They understood how to design a quality, affordable and relevant product that people would pick up and they made the shift very swiftly. The kind of impact that has versus two years of transition on your company is enormous. Therefore, you’re able to actually grow market share, which Shriram was able to do. So, I think on both sides we’re seeing the advantages—both on the risk and the reward side.

Snow: Elizabeth, without necessarily naming names, can you think of times when maybe applying an ESG screen to due diligence has led your firm to maybe pass on an investment or at least have an important insight into the risks of an investment?

Seeger: Yes, absolutely. It happens probably every week or so. Not where we pass on an investment, because we see our role not as the gatekeepers—

Snow: —The deal killers. All right.

Seeger: “The deal killers,” yes. Don’t start saying that. We’re not the deal killers. We see our role as helping understand risk and opportunities in a way that will enable us to drive value in the long term. More often what we’re doing is looking at these investments and saying, “Based on this industry and area of operation, in our experience in this sector, we think these are the key issues. Let’s go in there and see how the company is managing those issues.”  

Sometimes we find that the company is managing those issues just fine, so we just monitor the issue over time. In other cases, we see that there might be an opportunity to create a code of conduct, implement employee training or engage with stakeholders on the topic and we will then utilize our internal resources as well as our network of external partners to support the company in that journey.

Rogers: Without naming any specific situations, but overall in terms of due diligence that we’ve done for folks, we’ve identified risks around human rights, which I think everybody understands. Even for public companies, whenever there is an issue around this, stock prices get hit. It has huge diminishing value on company stock prices, for example. Then also, resource vulnerability is an issue.

One of the things we’ve seen with the ESG component is that this really has moved from more of a compliance component to more of an opportunistic. How do we take advantage of that? How do we make this a differentiator?

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