In June this year the Institutional Limited Partners Association (ILPA) published the latest edition of its principles under the title “ILPA Principles 3.0: Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners.”
The new principles take a much-needed step forward both in advancing environmental, social and governance policies (ESG) practices in the private equity industry and providing strong ESG governance and transparency.
The principles were first published in September 2009 to encourage dialogue between Limited Partners (LPs) and General Partners (GPs) of private equity funds. Following feedback from industry practitioners, ILPA released an updated version in January 2011, outlining best practices for private equity funds, clarifying and expanding on certain concepts from the previous version.
The third edition of the principles builds on ILPA’s previous version and refines guidance on a broad set of issues, particularly alignment of interest, governance and transparency, taking into consideration emerging industry trends. One of the private equity industry’s emerging trends includes ESG and reporting. This edition of the principles represents a fresh mindsight into ESG practices not previously covered by the 2011 version.
The inclusion of ESG in the latest principles signals that ESG has officially moved from the fringes of the investing world to a critical priority for both GPs and LPs. GPs are increasingly considering the ESG impact of their investments and the idea that investors can improve society while achieving market-related returns is rapidly becoming more mainstream. In 2019, there were over 2 500 signatories of the United Nations’ Principles for Responsible Investment (UN-PRI), up from 1 200 signatories in 2013.
A 2019 PwC survey found that almost 91% of GPs surveyed have an ESG policy in place or development, while 81% report on ESG matters to their boards at least once a year. Some 35% of GPs polled have a team dedicated to responsible investment activity. Of those without a specific ESG team, 66% rely on their investment/deal teams to manage ESG issues.
LPs have strongly driven the trend to integrate ESG factors into the investment process and are insisting that GPs consider ESG factors in the investment decision. According to Bain’s 2019 Asia-Pacific private equity survey, 60% of Asia-Pacific focused GPs feel increased pressure from LPs to focus more on ESG. The world’s largest pension fund, Japan’s Government Pension Investment Fund, with $1.5 trillion in assets under management, requires its fund managers to incorporate ESG factors and become signatories of the Principles for Responsible Investment (PRI).
Although GPs are increasingly monitoring and reporting on ESG metrics, LP expectations are not fully being met. A recent PEI study found that while 85% of LPs said that ESG is a consideration during the due diligence of GPs, only 19% of LPs agreed that GPs investments strongly reflected their ESG policies.
In formulating the updated principles, ILPA has recognised the need for setting forth recommendations for ESG best practice. The new principles provide a good starting point to close the gap between LPs’ ESG expectations and GPs’ current ESG investment practices and strategies.
For example, the updated principles recommend that “GPs should consider maintaining and periodically updating an ESG policy. The policy should identify procedures and protocols that can be verified and documented, rather than just a vague commitment to behaviour”.
The principles recommend how GPs can demonstrate their commitment to ESG and identify reporting frameworks to help LPs assess and verify a GP’s ESG integration, such as the IFC Toolkit for Disclosure and Transparency and PRI ESG Reporting Framework.
The updated principles even go as far as addressing the nascent, but emerging practice of impact investing, which the IFC defines as “investments made into companies, organisations, vehicles and funds with the intent to contribute to measurable positive social, economic and environmental impact alongside financial returns.” The principles state that “to the extent that a GP claims to pursue an impact investing strategy specifically, a framework to measure, audit and report on the impacts achieved by the fund should be adopted”.
As with earlier iterations of the principles, ILPA has based version 3.0 on its three guiding principles of an effective private equity partnership, namely: alignment of interests, governance and transparency. Unlike previous versions, ILPA isn’t seeking official endorsements for the document. Rather, it will be “encouraging industry-wide adoption of its tenets through supporting guidelines, templates and model documents with the understanding that sound practices and their impact on the health and reputation of the private equity industry are the shared responsibility of both limited and general partners”.