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    Responsible Investment: Why Should Private Equity Care?

     

     
     
    International Trade Forum - Issue 4/2009

    Never before have the objectives of the international community and the business world been so aligned. Through the UN Global Compact, common goals, such as building markets, combating corruption, safeguarding the environment and ensuring social inclusion, have resulted in unprecedented partnerships and openness among business, government, civil society, labour and the United Nations. Executive Director of the UN Global Compact, Georg Kell outlines the importance of the public and private sectors working together
    for a sustainable future. 

    Private equity and the United Nations have some important common objectives that relate to the creation of a more sustainable and stable global economy. We are in the midst of a historic convergence between the goals and interests of the United Nations, on the one hand, and those of business and finance on the other. There is a shared desire to create sustainable, stable and inclusive markets that are good for business, investment, peace, security and development. The good news for private equity is that these platforms now exist, and offer a range of immediate and longer-term benefits.

    In early 2009 the Private Equity Council - a network of some 550 institutional investors representing roughly US$ 18 trillion in assets - officially adopted a set of guidelines resulting from collaborative discussions with the UN-backed Principles for Responsible Investment. (PRI).  The guidelines represented a milestone in recognizing that the management of environmental, social and governance - or so-called "ESG" - issues can be material to business and asset performance, and should therefore be incorporated into both investment analysis and the management of the underlying asset. The guidelines make explicit reference to the UN Global Compact that provides companies and their management teams with a strategic policy platform to manage ESG issues.

    Global context

    The world is in the midst of profound transformation. With the shadows of the "great recession" still looming in many places, it is clear that more than three decades of deregulation have largely come to an end. Meanwhile, the global economic centre of growth is shifting to Asia, while at the same time the political will to sustain market openness is weakening in many parts of the world. One of the greatest experiments ever - building a rules-based, open economy that has enabled hundreds of millions of people to lift themselves out of poverty, that ensures that technology and innovation diffuse rapidly around the globe, that connects cultures and people, and that ultimately is our best bet to create a peaceful and prosperous world - hangs in the balance.

    We are also faced with a true systemic emergency. The impact of climate change threatens to disrupt societies and markets around the world and, if unaddressed, could reduce global economic output by an estimated 20 per cent by mid-century. There is increasing consensus that today's global threats and challenges - be they related to the economic and financial upheaval, the climate crisis, or other urgent environmental and social issues - are too large, interconnected and complex for any one sector to solve alone. Hence the United Nations is reaching out to form new partnerships to address these challenges. Collective action and collaboration is the order of the day.

    The UN's transformation

    There has been a radical change within some parts of the UN that has brought the UN closer to the worlds of business and finance. As a result of the long decades of the Cold War, indifference and mutual suspicion characterized the relationship between the UN and the corporate sector as recently as the late 1990s. This began to change with the launch of the Global Compact ten years ago when the UN invited companies to align their operations with ten universal principles covering human rights, workplace issues, the environment and anti-corruption. The idea was that by embedding global markets in shared values and offering opportunities for collective action through learning, dialogue and partnerships, greater sustainability for markets could be achieved while ensuring that the benefits of economic efficiency spread faster and wider. Business executives were asked to make the principles part of strategy and operations, and to disclose progress made on an annual basis.

    The UN Global Compact was not an exercise in philanthropy but rather a new management paradigm that sees ESG issues as integral to long-term business success. The UN, for its part, offers collaboration, partnership opportunities and a neutral space for solution finding. What started as an experiment, with only 47 companies present at its launch in July 2000, has grown into the world's largest voluntary corporate sustainability initiative. There are currently more than 6,000 business participants and stakeholders from more than 130 countries involved, with an additional 100 companies signing up every month. The companies represent almost every conceivable industry and sector, and hail from both developed economies and emerging markets. Moreover, while the Global Compact includes some of the biggest public companies in the world, more than half of business participants are privately held, and include both large and small enterprises.

    Why are management teams joining the Global Compact?

    The ethical imperative of addressing ESG issues remains as important today as it did ten years ago. Some say even more so given the recent crisis in markets and the related erosion of trust in business. But questions of risk management, improving productivity, reducing costs and sizing new opportunities by making the Global Compact and its principles part of business strategy and operations have established themselves as additional, and arguably far more potent drivers, of the agenda. 

    The business case for what we call "corporate sustainability" - that is, the management of ESG issues - is increasingly clear. As the authors of a major article on corporate sustainability argue in the September issue of the Harvard Business Review: "In the future, only companies that make sustainability a goal will achieve competitive advantage." (See Why Sustainability is Now the Key Driver of Innovation)

    There are countless examples of companies that are generating value-enhancing benefits - including securing new revenue streams, lowering operating costs, attracting the best talent, and generally enhancing their corporate and brand reputations. What's more, markets appear to be recognizing these new realities. For instance, a recent study by RiskMetrics of the equity performance of our 70 top publicly traded companies in terms of their disclosure on sustainability practices found that the group has consistently outperformed the global market by an average of 7.3 per cent since March 2007. In fact, the index beat the MSCI in every quarter during the past two years, including during the worst months of the crisis. Similar studies by Goldman Sachs support the premise that effectively managing ESG issues can contribute to market out-performance. 

    It's important to keep in mind that the core goals of the UN and the private sector are different. But in today's interconnected world the imperative of market sustainability calls for collaboration and the private sector is an important part of the solution. The UN increasingly understands this, and in some quarters, has developed capacities to partner, with both business and investors.

    The UN and the private sector share common interests, including:

    •  Building markets to advance development and reduce poverty
    • Investing in clean and efficient technologies to tackle climate change
    • Advancing good workplace practices through the supply chain
    • Introducing good governance policies
      and anti-corruption measures.

    The Principles for Responsible Investment

    With respect to investors, the UN Global Compact's work has centred on the Principles for Responsible Investment. The initiative was co-launched in 2006 by the Global Compact and the United Nations Environment Programme Finance Initiative (UNEP FI), in partnership with institutional investors. Today, the PRI is led and governed largely by institutional investors, all of whom are limited partners.

    The rationale for launching the PRI included the following key observations:

    • ESG issues can be material to investors, especially over the long term. Investors who do not take these issues into account are putting the interests and returns of their beneficiaries at risk.
    • Institutional investors, especially when working together, can have significant influence as owners and clients over companies, fund managers, consultants and brokers and can use this influence to encourage improvements in ESG performance by companies.
    • Three years ago there was no global framework in place to point investors in the right direction or to define this new era of responsible investment based on materiality, as compared to traditional sustainable and responsible investment (SRI) approaches.

    Negotiated and drafted by a group of institutional investors and other experts, the Principles for Responsible Investment were launched in April 2006 at a special event at the New York Stock Exchange. Covering areas such as investment policy, active ownership practices, collaboration and disclosure, the six core principles are designed to place ESG considerations at the heart of investment analysis and decision-making.

    The PRI is not an SRI initiative in the sense of employing negative screens or taking value judgements on companies or industries. Likewise, the focus is not on narrow clean-tech or other such specialized social funds. Rather, PRI recognizes that incorporating ESG issues into investment analysis, and improving the management of ESG issues within all companies and assets in the portfolio, can help maximize long-term investment objectives while, at the same time, aligning the investment community with larger societal goals. In other words: a double dividend.

    As with the growth of the Global Compact, the PRI has surpassed expectations. The more than 550 signatories are divided roughly in half between asset owners and asset managers, with a third category of service providers. Signatories to the PRI are demonstrating an unprecedented level of collaboration and partnership as they work together to encourage investee companies or potential investments to improve their ESG performance - for instance, by joining and implementing the Global Compact. From its inception the PRI was designed to be relevant to all asset classes, which ultimately led to the discussions with the private equity community.

    Why should private equity care?

    Clearly, the private equity industry - be it related to buyout, mid-stage, or venture capital - is a major force in international finance and in driving business innovation. In addition to being investors, the industry is also full of business managers and employers with a vital stake in the role of business in society. In many aspects, private equity firms are much closer to the fabric of economies and communities than their publicly traded peers. For these and related reasons, society's expectations with respect to private equity will only increase.

    Private equity has an enormous opportunity to leap ahead of the trends and demonstrate a new level of leadership that contributes both to their success as investor-managers, as well as to aligning objectives with broader social goals, and thereby building public trust in the industry. Fixing firms, and creating long-term value, is the prerogative of business. Yet, up until now, ESG considerations, especially with respect to environmental and social issues, have not figured prominently in investment and management decisions. This is the prevailing view held by many limited partners in the PRI who feel that private equity managers give less regard to ESG risks and opportunities than public-equity fund managers.

    What is the global compact?

    The United Nations Global Compact
    is the largest corporate citizenship and sustainability initiative in the world with over 7,700 corporate participants and stakeholders from over 130 countries. It is a strategic policy initiative and leadership platform for businesses that are committed to aligning their operations and strategies with ten universally accepted principles in the areas of human rights, labour, environment and anti-corruption. 

    THE TEN PRINCIPLE

    HUMAN RIGHTS
    1. Businesses should support and respect the protection of internationally proclaimed human rights; and
    2. make sure that they are not complicit in human rights abuses. 

    LABOUR STANDARDS
    3. Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining;
    4. the elimination of all forms of forced and compulsory labour;
    5. the effective abolition of child labour; and
    6. the elimination of discrimination in respect of employment and occupation.  
     
    ENVIRONMENT
    7. Businesses should support a precautionary approach to environmental challenges;
    8. undertake initiatives to promote greater environmental responsibility; and
    9. encourage the development and diffusion of environmentally-friendly technologies.   

    ANTI-CORRUPTION
    10. Businesses should work against corruption in all its forms, including extortion and bribery.  

    For more information visitwww.unglobalcompact.org