sustainable finance: integrating esg into private equity
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Final Report - UBS Capstone Project May 2017
ESG Integration for Private Equity - Page 1
Sustainable Finance:
Integrating ESG Into Private Equity Fund Manager Selection
Columbia University
School of International and Public Affairs
Capstone Workshop
May 8th 2017
Capstone Team Members:
Mona Alsubaei
Sam Schneider
Maria Surilas
Yifei Tang
Izzati Zabidin
Yuan Zhang
Sihan Zhang
Wei Zhao
Final Report - UBS Capstone Project May 2017
ESG Integration for Private Equity - Page 2
Table of Contents
Part I: Summary of the Project & Methodology
A. Project Summary........................................................................................................2
B. Methodology & ESG Integration Framework............................................................2
C. Justification for Producing A Due-Diligence Questionnaire......................................4
Reasons for Choosing the DDQ Approach.........................................................4
Part II: Literature Review & Research Findings
A. Introduction to ESG Integration...............................................................................4
B. Understanding Why ESG Integration Matters for Private Equity............................6
C. Understanding Material ESG Factors.......................................................................8
D. Interview Findings....................................................................................................9
E. List of Interviews....................................................................................................10
Part III: ESG Integration Due-Diligence Questionnaire
A. Working With the DDQ..........................................................................................10
B. Due-Diligence Questionnaire..................................................................................11
Part IV: Due-Diligence Questionnaire Working Manual
A. DDQ Working Manual...........................................................................................13
Section 1...................................................................................................13
Section 2...................................................................................................15
Section 3...................................................................................................16
Section 4...................................................................................................18
Section 5...................................................................................................20
Part V: Outlook for Next Steps
A. Conclusions...........................................................................................................21
Part VI: Bibliography
Final Report - UBS Capstone Project May 2017
ESG Integration for Private Equity - Page 3
Part I: Project Summary & Methodology
A. Project Summary
Responsible investing has become a mainstream concern within the investment industry. The
dramatic growth in the number of investors who have adopted the Principles for Responsible
Investment (UNEP, 2014) is an often cited, and telling indicator of the increased attention the
sector is paying to the integration of environmental, social and governance (ESG) factors into
investment management. Beyond that however, a variety of stakeholders, including investors, the
public, and industry groups are demanding non-financial reporting and disclosure from the
private equity industry (PWC, 2015). Investors recognize that focusing on sustainability risks
and opportunities leads to a more rigorous investment process (UBS, 2016).
With this rapidly evolving landscape in mind, our objective is to help UBS Wealth Management
assess private equity fund managers on their policies, methods, and success in integrating ESG
considerations into their different funds. We would like to provide UBS with the appropriate
tools and knowledge base to evaluate how their fund managers approach portfolio company
selection and active ownership through the lens of ESG factors and sustainability. To this ends,
we have developed a due diligence questionnaire that can be used in part, or in whole during
UBS’ regular due diligence process of fund manager selection.
B. Methodology & ESG Integration Framework
The team conducted in depth desk research to gain an understanding of the sustainable and ESG
investing industry and identify gaps. Then, we applied our analysis and findings to create a
framework for ESG and to create a due diligence questionnaire.
Our research methodology consisted of: (i) a literature review of current industry practices; (ii)
an assessment of the existing tool kits and ESG guidelines available from institutions, banks, and
international development organizations; (iii) interviews with practitioners and experts in
sustainable investing industry.
After we completed our initial research, we perceived a gap between what is available at present
and UBS needed to evaluate fund managers. Our interviews were essential in gaining more in-
depth knowledge from the practitioners in the later phase of our research. Ultimately, all of this
was critical in shaping our approach to developing a framework on the dimensions along which
to evaluate fund managers (i.e. GPs) on ESG integration. (See Table One).
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ESG Integration for Private Equity - Page 4
Table 1: Overview of the Framework
Before finalizing our due diligence questionnaire, we created a framework to visualize our core
assumptions and pinpoint which factors we were going to use to evaluate fund managers.
As seen in Table 1, our framework is based on three basic assumptions (1) Why ESG matters (2)
Understanding material factors and (3) ESG for private equity. These are core the core principles
that make up the building blocks for the framework, and that we incorporated throughout the
different sections of the DDQ.
After establishing these basic assumptions, we identified the four most important categories and
competences with which to evaluate the fund manager. These factors are: Materiality, Active
Ownership, Communication, and Integration Infrastructure. Within each of these factors, we
developed sub questions in order to form a view on how the fund managers performs with
regards to each. These four factors make up the four main sections of our Due Diligence
Questionnaire.
Importantly, each of the four factors is be considered over the entire time horizon of a portfolio
investment. A fund manager must demonstrate commitment to each factor during the investment
process, active ownership and exit. We incorporated this timeline aspect into our DDQ by
including questions within each of the four factors to investigate the entire timeline of the
investment.
The framework above was transformed into a usable tool as a due diligence questionnaire. A
detailed manual is provided along with the DDQ to guide its usage.
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ESG Integration for Private Equity - Page 5
C. Justification for Producing A Due-Diligence Questionnaire
Reasons for Choosing the DDQ Approach
We chose to create a Due Diligence Questionnaire (DDQ) as the tool to implement our
framework because of the following advantages:
1) A DDQ is a combination of qualitative and quantitative inputs for evaluating fund
managers. As most of the questions asked in the DDQ are open-ended, it offers LPs
sufficient qualitative information and great latitude in terms of making investment
decisions. This approach also leaves enough room for future iterations of the DDQ to
assign numerical values to each question in order to produce a quantitative scored card.
For now, our DDQ is mostly qualitative. Our DDQ is well structured and follows a strict
logical framework, so it readily accessible for further analysis. It offers a solid foundation
on which to develop other more advanced quantitative evaluation methods.
1) A DDQ was flexible enough to incorporate our interview findings into the final product.
Our DDQ made it possible to integrate the insights we derived from our expert
interviews. We derived valuable insights from the interview process and we integrated
these into the final tool. Also, the DDQ is expected to incorporate our key concepts and
capture a comprehensive picture of fund managers' ESG integration practices
2) A DDQ is practical and easily adoptable by UBS. As DDQs are widely used and tested,
this approach should be easy to integrate into pre-exciting due diligence and investment
processes. This allowed us to concentrate more on the contents rather than the form of the
tool. Our proposed DDQ is expected to be used as a concrete tool to facilitate UBS in
identifying fund managers who perform well on ESG integration.
Part II: Literature Review & Research Findings
A. Introduction to ESG integration
As noted, responsible investment practices have gained increasing attention globally, reflecting a
new cognizance around values-based investing. Within this context, across the financial services
sector and around the world, investors have expanded the considerations they make during the
investment process, seeking a more holistic understanding of asset risk and value by taking more
than just conventional factors into account. This expanded notion of what is material in the
analysis of an investment is fundamentally tied to a desire on the part of investors to engage in
ethically responsible business practices.
However, what has propelled this evolution in investor thinking is not just idealism. It’s also
good for business. Studies have shown that investors who take into account Environmental,
Social and Governance (ESG) considerations may see market rate returns. Additionally, ESG
factors can have a major impact on risks and value opportunities associated with an investment
(KKR, 2016). From public market institutional investors to small-cap angels, investors
increasingly see the proper management of ESG factors by portfolio companies as important in
determining whether to invest. Of course, investors have long “screened” out businesses
involved in certain high-risk, vice industries, such as alcohol, tobacco, firearms and
pornography. What has changed is the breadth of ESG factors that are taken into account, and the
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ESG Integration for Private Equity - Page 6
depth to which they are integrated into the conventional investment process.
There are several systems commonly used by investors to ingrate ESG factors into investment
decisions. ESG performance standards and due diligence tool kits, which provide a relatively
comprehensive picture of best practices in ESG-integration are available to guide investors and
portfolio managers in integrating ESG in their investments. After thorough review of these tool
kits, our team found that most of the information needed to create a robust framework to evaluate
investees on ESG competencies - in both public and private markets - already exists in these
standards, most of which were developed by international organizations such as the United
Nations (UN), International Finance Corporation (IFC), Commonwealth Development
Corporation (CDC). We found each of these tool kits provides valuable insights for the scope of
this project. However, this intelligence needed to be adapted for the specific purpose of
evaluating fund managers instead of individual projects as most of these tool kits are designed to
do. (See Table 2 for a summary of our main findings from reviewing these available tool kits).
Table 2: Analysis of Commonly Used ESG Tool Kits
Overview & Best Practices Gaps Remaining for our Framework
IFC: Environmental and Social Performance Standard and IFC Corporate Governance Questionnaire
Provides a comprehensive set of best performance
standards of E&S integration, focusing on assessing
risks and impacts.
Divides the broad categories of E&S concept into
seven different areas with detailed requirements
provided.
Emphasizes integrating ESG throughout the entire
lifecycle of an investment, is a unique opportunity for
private market investment.
Provides material E&S factors for 61 different
industries.
Targeted towards selecting projects instead of fund
managers, therefore provides guidance more than a
general framework.
Designed for projects financed by IFC or the World
Bank Group, not specificly for private markets.
Difficult to be integrated with current non-ESG due
diligence process given the completely different
methodology and template.
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CDC: Toolkit on ESG for fund managers
Detailed approach for ESG integration in the
investment cycle from screening to exit specifically
for private equity.
Indicates that each investment will have different ESG
risks and opportunities and depending on its country,
sector and specific characteristics.
Emphasizes the importance of informing and
including LPs and any other stakeholders in the
process.
Indicates that all funds should have an environmental
and social management system (ESMS)
commensurate with the level of environmental and
social risks and impacts associated with current and
potential portfolio companies and that takes into
account the fund manager’s capacity and structure.
Mainly for developing countries.
Describes a limited number of sectors.
UN PRI: Limited Partners’ Responsible Investment Due Diligence Questionnaire
A good representation from an LP’s perspective to
evaluate a GP’s processes for integrating material
environmental, social and governance (ESG) factors
throughout the investment cycle.
It is referenced by a wide range of industry peers and
due diligence questionnaires.
Provides a generic starting point, instead of an
inclusive framework, for establishing the dialogue
between LP and GP.
Fails to provide more detailed measurements to look
over fund managers’ ESG effort throughout the
lifecycle of investment.
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B. Understanding Why ESG Integration Matters for Private Equity
Institutional investors are increasingly looking for ways to steer capital towards companies and
projects that provide solutions to major ESG challenges, but achieving impact at scale can be a
challenging proposition. Private equity (PE) funds are particularly well placed to catalyze ESG
opportunities because of three distinct features:
1) Active Ownership - PE fund managers are able to “actively” integrate ESG
considerations into their investments strategy as well as their restructurings of portfolio
companies.
2) Holding Period - ESG integration is especially critical for the kind of long-term active
investment found in private equity markets (avg. 4-6 years). UN PRI states that, “the
average ownership period for a private equity portfolio company is four to six years,
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ESG Integration for Private Equity - Page 8
during which time ESG-related risks and/or opportunities may arise that were not
material at the time of investment.” (UNEP, 2011).
3) Communication - The challenge of information disclosure in private equity requires more
in-depth due diligence and consistent monitoring, rigorous communication and reporting
between portfolio companies, GPs and LPs.
PE investors cite a range of benefits to proactively addressing ESG opportunities throughout the
investment cycle (PwC, 2015). According to a survey by Mercer and LGT Capital Partners,
nearly 60% of institutional investors say ESG criteria has a positive impact on risk-adjusted
returns (Mercer and LGT, 2016). Thus ESG is gaining major traction as a tool in selecting fund
managers. Investors are beginning to restrict access to capital due to poor ESG performance and
the view that integrating ESG consideration into investment analysis is within one's fiduciary
duty is increasingly widely accepted (PwC, 2015). In other words, ESG considerations are
important for risk management.
Yet, ESG integration by fund managers is important for value creation as well. ESG
materiality improves understanding of long-term value and active management can enable
value-generating influence over strategy and mission of portfolio companies (BlackRock,
2016). In terms of exit value, strong communication and reporting practices among portfolio
companies can better facilitate exits (UBS and Calvert).
As stated above opportunities for ESG focused value creation and risk management vary by
company, sector and geography. However, some general ESG factors that have proven to be
closely correlated with value-creation include (CDC, ESG Toolkit):
Access to new markets - A company may need to adapt its products or services to
satisfy regulations, standards and customer demands.
Substantial cost savings - This can be made through the adoption of resource use
efficiency measures. (especially energy and water use) and reducing the cost of doing
business by eliminating bribes and facilitation payments.
New product design - There may be significant opportunities for companies to
develop and deliver innovative products and services that address unmet
environmental or social needs.
Value at exit - sound ESG management can improve value at exit. Increasingly,
meeting ESG requirements/standards is required both by private buyers and for initial
public offerings (IPOs) in emerging markets.
Risks from litigation as well as environmental, financial and reputational risks
(Arabesque, 2015)
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C. Understanding Material ESG Factors
Materiality is at the center of all investment decision. However, Firms that consider material
ESG factors outperform those that do not (McKinsey, 2016). This is because ESG factors
have quantifiable impacts on reputational risks and broader potential consequences on
business operations. Most fundamentally, the concept of materiality recognizes that some
information is more important to investors in making investment decisions than other
information.
Firms with strong performance on material topics not only outperform firms with poor
performance on material topics, but also outperform firms with strong performance on
immaterial sustainability. Studies have showed that companies that address those material
ESG issues and ignore immaterial ones outperform those that address both material and
immaterial issues by 4 percent and outperform companies that address neither by nearly 9
percent (McKinsey 2016).
The materiality of ESG issues differs substantially between sectors and geographies (PwC,
2015). Organizations such as IFC, CDC, SASB, and GRI compiled a comprehensive
overview about sector differences with regard to ESG issues. Failure to distinguish between
sectors, geographies and investor priorities can produce an insignificant relation between
performance on sustainability issues and future financial performance.
Sector-specific - For example, resource-intensive industries such as mining have a
different exposure to environmental and social factors than the commercial real-
estate sector. Many research and financial institutions have identified major ESG
factors for different industries. For example, IFC lists E&S factors for over 60
industries (IFC). The Sustainability Accounting Standards Board (SASB) has
identified issues reasonably likely to have material impacts on companies for a
wide range of industries, and MSCI has also developed a materiality map for ESG
factors.
Geography-specific - ESG issues will be different depending on the industry
sector, the country and the markets. Every region is exposed to different ESG
factors (Mercer, 2016). More focus is given to governance than environmental or
social issues in emerging markets (PwC, 2015). Portfolio companies in the same
region may face common ESG challenges (KKR, 2010).
Investor-specific - Investors may consider certain factors more important than
others. This facet of materiality recognizes that some information is more
important to investors in making investment decisions than other information. For
example, Mercer conducted research and found that climate change, carbon
intensity, human rights, child labor, weapons, bribery and corruption are ESG
factors that are especially important to investors (Mercer).
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ESG Integration for Private Equity - Page 10
D. Interview Findings
Based on desk research, we conducted a variety of interviews with financial services
professionals and experts with experience in ESG integration. Most of the investees interviewed
represent private market investors, and many of them fund managers of the variety UBS might
consider for investment. We entered these interviews with relatively sterile research questions,
but were fortunate enough to receive answers that provided greater illustration of what ESG-
integration is like in real world application.
When asked what the most important factors are to consider in building a framework for ESG-
integration, three major themes emerged in the responses we received. First, the most common
way to evaluate an investment’s performance on ESG factors is through scorecards, though some
prefer qualitative standards while others prefer more quantitative approaches. Second, critical to
any ESG-integration framework is consideration of the impact of and changes to ESG factors
over full lifetime of an investment. Third, whether or not a GP has dedicated ESG-integration
infrastructure (i.e. personnel, budgeting) is essential for distinguishing whether a GP is
substantially or just superficially committed to ESG considerations.
In the case of Mercer, their Four Factor Framework intends to audit a GPs approach to ESG
integration without any bias about how they should being doing it. The Mercer Framework ranks
fund managers on a scale of 1 (highest) to 4 (lowest) across four ESG-integration factors: Idea
Generation, Portfolio Construction, Implementation, and Commitment. Similarly, LGT Capital
Partners uses a 1-4 scale method for evaluating four different measures: Manager Commitment,
Investment Process, Ownership, and Reporting. Both of these approaches illustrate common LP
approaches to taking largely qualitative information about ESG integration practices and
quantifying it in a way that allows for a comprehensive and flexible evaluation of GP ESG
practices.
Following from the theoretical basis we developed through our desk research, we knew
understanding the issue of materiality in ESG-integration would be important in developing our
framework. When asked about identifying materiality across a portfolio that includes
investments in different industries and regions, the responses we received from fund managers
indicated one must strike a balance between comparability and relevance when thinking about
materiality.
Three main challenges GPs face in measuring ESG factors and LPs face in evaluating GPs
integration practices were raised during our interviews: (i) the availability of data and lack of
reporting practices around ESG, (ii) the abundance of GPs who are only superficially committed
to ESG considerations (i.e. greenwash), and (iii) the mismatch that often appears with the
companies most considerate of ESG factors often not being the most exposed to them.
Looking forward, the information gathered in interviews suggests experts and practitioners
expect to see GPs developing increased amounts of human capital for ESG integration in the
near future. More broadly, those interviewed argued there remains significant room for greater
integration of ESG considerations into the conventional financial valuation process.
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ESG Integration for Private Equity - Page 11
E. List of Interviews
The following are the entities from which professional staff were identified and successfully
interviewed by the team because of their relevant knowledge and experience related to ESG-
integration, responsible investing and private equity.
Abraaj Capital
Emerging Capital Partners
HarbourVest Partners
International Finance Corporation (IFC)
Mercer Wealth and Investment Management
Morgan Stanley Capital International (MSCI)
UBS Chief Investment Office
Part III: ESG Integration Due-Diligence Questionnaire (DDQ)
A. Working With the DDQ
In enhancing UBS' capacity to examine GPs’ ESG integration practices, the DDQ and
accompanying manual should present opportunities to discover areas for improvement and
engagement, and help establish a more efficient communication and disclosure channel with
GPs. The focus is to assess the level of commitment to and capacity for ESG integration before
an investment is made, though it could also be used as a tool for existing investments. The DDQ
and Manual were designed to highlight the presence of effective ESG integration, not punish its
absence.
The open-ended nature of the questions in the DDQ is intended to provide sufficient room for
fund managers to make the necessary disclosures. In order to encourage in-depth responses from
fund managers, we suggest this DDQ to be used in conjunction with a non-disclosure agreement.
We would like to again stress that this DDQ is intended to complement UBS’ existing due
diligence practices. We anticipate that the combination of these practices would provide
insightful information to be incorporated into UBS’ investment memos towards developing an
informed investment decision.
The output of the DDQ should inform UBS on:
The level of commitment of the fund managers in integrating ESG in their investment
management practices
The ESG integration areas that UBS should focus on for a particular fund manager in
order to mitigate risks and maximize returns
The types of resources that UBS could provide to fund managers in order to support
their ESG integration efforts
Apart from being a tool to understand each individual fund manager, UBS can also aggregate the
collective output of the DDQ to generate broader insights into industries and geographies. This
learning can be channeled into feedback for refining UBS’ approach to ESG integration.
Final Report - UBS Capstone Project May 2017
ESG Integration for Private Equity - Page 12
B. Due-Diligence Questionnaire
Section 1: Policy, Strategy and Philosophy
1.1 Characteristics of ESG Integration Policy
1.1.1 What are your objectives in ESG integration?
1.1.2 What is the scope of your ESG integration policy?
1.1.3 How do you ensure compliance to your policies among the management teams of your
portfolio companies?
1.2 Effectiveness of ESG integration policy
1.2.1 What processes exists for evaluating or reviewing your policy's effectiveness?
1.3 Contribution to Industry Best Practices
1.3.1 Have you committed to any international standards, industry (association) guidelines,
reporting frameworks, or initiatives that promote ESG practices?
1.3.2 Do you cooperate (or have you cooperated) with other organizations/institutions to
promote or share knowledge about sustainable investment practices?
Section 2: Materiality of ESG Factors
2.1 Determining Materiality
2.1.1 How do you determine what ESG factors present material risks or value-add
opportunities during pre-investment due diligence?
2.1.2 How do you incorporate your materiality conclusions into your investment decisions?
2.1.3 What processes do you have in place for assessing the changes in material risks &
opportunities throughout the holding period?
2.2 Sector & Geographic Materiality
2.2.1 How do you define which factors are material to the sectors in which your portfolio
companies are located? Do you categorize these factors?
2.2.2 How do you define which factors are material where your companies are located
geographically?
2.3 Improvement on Materiality Identification
2.3.1 Has your process for identifying materiality changed since previous investments, and if
so how?
2.3.2 Do you have any plans to improve your process for identifying material risks from year
to year? If so, please discuss in details.
Section 3: Active Ownership
3.1 Beliefs on ESG Management in Active Ownership
3.1.1: How important are ESG considerations to your active ownership of portfolio
companies? How did you come to this conclusion?
3.2 ESG Integration Strategy During the Holding Period
3.2.1 Through what processes or systems do you regularly monitor the ESG-related
performance of your portfolio companies?
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3.2.2 Give 2-3 examples of how you changed the way a portfolio company managed ESG
factors.
3.2.3 How do you build up and assess that adequate ESG-related competence exists at a
portfolio company?
3.3 Effects of ESG integration During Exit
3.3.1 Upon exit, have you ever managed to quantify or evaluate the benefits you’ve created
through integrating ESG considerations?
3.3.2 Have you ever made a decision on exit based on ESG management?
Section 4: Integration Infrastructure: Human and Financial Capital
4.1 Financial resources dedicated to ESG
4.1.1 Do you have a specific budget set aside for ESG integration?
4.1.2 Do you have separate compensation strategies for ESG outcomes than for financial
outcomes?
4.2 Human capital resources dedicated to ESG
4.2.1 Who is responsible for ESG due diligence and standards compliance and what are
his/her responsibilities?
4.2.2 Do you have any training programs related to ESG integration?
4.2.3 Do you have an evaluation system or oversight mechanism (e.g. Key Performance
Indicator) in place for ESG-integration staff?
4.2.4 Do you use any external expertise/third party to do the ESG due diligence?
Section 5: Assessing ESG Communication Procedure with LPs and Portfolio Companies
5.1 ESG Communication Procedures with LPs
5.1.1 Do you have an established ESG reporting format and channel for communicating with
LPs?
5.1.2 Do you have specific methods for communicating instances where material ESG risks
arise during the investment period to LPs ?
5.2. ESG Communication Procedures with Portfolio Companies
5.2.1 Do you have an established ESG reporting format and channel for portfolio companies?
5.2.2 Do you have specific methods for communicating instances where material ESG risks
arise during the holding period?
5.2.3 Please describe your response if portfolio companies fail to disclose ESG-related issues
to you persistently.
5.3 ESG Communication Procedures To The Public and Other Stakeholders
5.3.1 Under what conditions do you believe it is necessary for a portfolio company to
communicate or engage directly with external stakeholders on ESG factors? Examples can be
useful for this question.
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ESG Integration for Private Equity - Page 14
Part IV: Due-Diligence Questionnaire Working Manual
Section 1: Policy, Strategy and Philosophy
Different funds will have different ESG risk and opportunity exposures depending on their
investment strategy, policy and their capacities to address ESG issues. In this part, we would
like to understand how a fund manager’s approach to ESG integration is influenced by their
policy, investment strategy and philosophy. By doing so, we will be able to assess whether
their ESG-related policy aligns with an LP’s responsible investment beliefs. We would also
like to see how the policy has been improved during the progress of ESG integration, how
consistent they are and whether it has been effectively implemented.
DDQ Section 1.1: Characteristics of ESG Integration Policy
In this subsection, we would like to assess your ESG policy on a general level: by assessing
your investment strategy and specific ESG policies. If you have a policy elaborating your
approach to ESG integration, please provide as many details for the questions below as
possible, including your investment motivations, your ESG objectives and approach, your
policy scope and the compliance of your policy to any external standards. If you are unable
to answer any of the following questions, please indicate whether you you are considering or
have plans to adopt an ESG integration policy in the future and what those policies might be.
1.1.1 What are your objectives in ESG integration?
What is the objective and how is it stated in your policy?
If you don’t have an ESG integration policy, what are your general goals in
your ESG practice?
1.1.2 What is the scope of your ESG integration policy?
Does your policy cover the complete timeline of an investment (due diligence,
holding period, and exit)?
Can your policy/approaches be applied across industries and regions?
Do you specifically focus on some ESG factors, if so, which ones?
o We understand that different investment strategies and practices will
bring different ESG risks. If you have observed and focused on some
specific ESG factors, please list and explain why.
1.1.3 How do you ensure compliance to your policies among the management teams of your
portfolio companies?
How do you educate your portfolio companies on your ESG management
policy?
Who is responsible for communicating with your portfolio companies about
the policy implementation and monitoring their ESG integration?
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ESG Integration for Private Equity - Page 15
DDQ Section 1.2: Effectiveness of ESG Integration Policy
In this subsection, we would like to examine how effective your policy has been conducted
and how will you improve it in the future.
1.2.1 What processes exists for evaluating or reviewing your policy's effectiveness?
If you have a developed a monitoring system to assess the implementation status of your ESG
policy, please provide the details including the mechanism of the system, the person who uses
the system and the plan of developing the system. If not, please indicate how you currently
review your policy.
At the fund level:
Please describe the feedback about policy implementation that you receive
from portfolio managers.
o For example: Is the policy easily understood, is the policy able to be
implemented in a standard way across portfolio managers?
Please describe any internal obstacles to conducting your policy.
Given the impediments listing above, how can this policy be improved?
At the level of the portfolio company:
Please describe the feedback about the policy you receive from your portfolio
companies.
o For example: Have any benefits been observed by the portfolio
companies since your policy was first implemented?
Please describe any obstacles for enforcing the policy with the portfolio
companies.
DDQ Section 1.3: Contribution to Industry Best Practices
In this subsection, we would like to know how you commit to existing regulations and whether
you have done anything to improve the responsible investment ecosystem.
1.3.1 Have you committed to any international standards, industry (association) guidelines,
reporting frameworks, or initiatives that promote ESG practices?
Are you a signatory to the PRI?
How do you incorporate the standards/guidelines/frameworks into your ESG-
related policy?
If you don’t commit to any standards, please describe in what ways you
address ESG considerations separately from regulatory requirements.
1.3.2 Do you cooperate (or have you cooperated) with other organizations/institutions to
promote or share knowledge about sustainable investment practices?
Have you initiated any activities or cooperated with any organizations to
promote sustainable investment practices? If yes, please provide the details
and the results of the initiatives.
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Do you belong to any organizations/institutions with the mission of improving
responsible investment practices?
Section 2: Materiality of ESG Factors
This section is intended to provide UBS with a view on how the GP determines which ESG
factors are material for a given investment and how they determine or quantify how those
material factors will affect the risk or value of their investment.
DDQ Section 2.1: Determining Materiality
There are a wide variety of available indicators for ESG factors available through sources
such as IRIS or the GIIN, many of which will not be relevant for every investment. For this
reason it is imperative that the GP have a process in place to determine which specific
factors may affect the investment and which factors can be targeted to either reduce risk or
add value.
2.1.1 How do you determine what ESG factors present material risks or value-add
opportunities during pre-investment due diligence?
GPs are most likely to consider ESG issues as a tool for risk mitigation. However, there is an
increasing number of GPs who use ESG factors as opportunities to create the value of the
company. For example: A GP investing in a clothing factory in Bangladesh may consider
labor conditions as a material ESG factor to screen for in order to mitigate the risk of non-
compliance with local laws.
Do you have a rating (grade) system for ESG risk screening? What other frameworks
do you use?
Is there a dedicated team or person responsible for ESG risk screening?
2.1.2 How do you incorporate your materiality conclusions into your investment decisions?
Do you have a quantitative rating system, or a qualitative framework to evaluate the
different factors?
How do these factors affect your investment decision or how are they incorporated in
the decision-making process? Please describe in detail.
2.1.3 What processes do you have in place for assessing the changes in material risks &
opportunities throughout the holding period of an investment?
Throughout the holding period of an investment, ESG risks or value-added opportunities may
arise that were not relevant in the initial investment period.
Do you have a process to regularly review and monitor old and new ESG risks
throughout the holding period? Please describe in detail.
How do you plan to respond to new or emerging risks once you spot them?
DDQ Section 2.2: Sector & Geographic Materiality
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ESG factors’ materiality depends on the region and sector of portfolio companies. It is
important for the GP to understand there are no universal, material ESG factors and that
disclosure of non-material ESG factors is not always relevant to investors and LPs and can
even be distracting from important ESG issues.
2.2.1 How do you define which factors are material to the sectors in which your portfolio
companies are located? How do you categorize these factors?
2.2.2 How do you define which factors are material where your companies are located
geographically?
Can you provide an example of portfolio companies in diverse regions and sectors,
and how you identify material issues?
Please describe the geographic and sector diversity of your portfolio companies.
Do you refer to any external standards (SASB, MSCI, IFC) to develop your
assessment of which factors are material in different industries and sectors?
DDQ Section 2.3: Improvement on Materiality Identification
In order to ensure compliance, we will focus on GP’s historical practices as well as beliefs
and outlook. Supporting documents may be required when discussing some of the questions.
2.3.1 Has your process for identifying materiality changed since previous investments, and if
so how?
2.3.2 Do you have any plans to improve or change your process for identifying material risks
from year to year? If so, please discuss in details.
Section 3: Active Ownership
Integrating ESG factors into the management of a portfolio investment is the idea that
through owning a company, a GP can transform management practices with material ESG
factors in mind in order to improve the value proposition of the company. In this section, we
would like to assess whether the GP is capable of influencing its portfolio companies on the
management of ESG issues in order to avoid risks to financial performance.
DDQ Section 3.1: Beliefs on ESG Management in Active Ownership
In this subsection, we would like to understand your view on ESG management during its
active ownership of portfolio companies. You may give supporting evidence by providing
empirical observations.
3.1.1: How important are ESG considerations to your active ownership of portfolio
companies? How did you come to this conclusion?
Do you believe ESG considerations can help the companies mitigate risks?
Do you believe that ESG can help portfolio companies create value?
DDQ Section 3.2 ESG Integration Strategy During the Holding Period
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ESG Integration for Private Equity - Page 18
In this subsection, we would like to examine you interact with your portfolio companies about
ESG issues and examine your influence on portfolio companies regarding ESG management.
3.2.1 Through what processes or systems do you regularly monitor the ESG-related
performance of your portfolio companies?
How do you assess ESG-related performance of your portfolio companies during the
holding period?
3.2.2 Give 2-3 examples of how you changed the way a portfolio company managed ESG
factors.
Each example is expected to address:
o What was the general problem?
o How was that related to ESG?
o What did you respond to this problem?
o What was the result? (financial or non-financial)
Specify the initiative(s) you worked on with management to identify issues or how
you supported best practices of the company that were already underway.
Please provide historical examples from your last fund where a material ESG factor
was identified during ownership that had not been identified during due diligence.
Please include a description of any follow-up activity.
3.2.3 How do you assess that adequate ESG-related competence exists at the portfolio
company?
Describe what training, assistance or additional resources you typically provide to
your portfolio companies to help them understand the relevance of managing ESG
factors and to enable them to do so.
Do you train managers at portfolio companies in ESG factors? Do you embed your
own ESG staff within portfolio companies during your ownership?
How do you assess ESG-related expertise among the management of your portfolio
companies?
Does this training emphasize any of the individual elements of ESG - Environmental,
Social and Governance - over others?
Some GPs have a structural Technical Assistance (TA) facilities that provide support
on corporate governance issues for portfolio companies. Do you have anything of this
kind?
If you engage external expertise to assist the portfolio company in their management
of ESG factors, describe what type(s) of service is provided. Specify whether the
external specialist is typically employed by the GP or the portfolio company.
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ESG Integration for Private Equity - Page 19
Can you connect us with the relevant personnel at 2-3 portfolio companies who would
be able to discuss your commitments to ESG integration?
DDQ Section 3.3: Effects of ESG integration During Exit
We are interested in understanding how ESG integration affects the value of a fund during
exit, and whether you have collected any data on these effects.
3.3.1 Upon exit, have you ever managed to quantify or evaluate the benefits you’ve created
through integrating ESG considerations?
Please describe what the benefits are and how you are able to measure them.
Do your systems or does your process differ based on type of exit (i.e. IPO, trade sale
or financial buyer)?
3.3.2 Have you ever made a decision on exit based on ESG management?
Has your decision about how to exit ever been influenced by ESG integration? if so
how?
Have you ever found that ESG factors limited exit options for an investment? If so,
please provide an example.
Section 4: Integration Infrastructure: Human and Financial Capital
In order for ESG factors to be able to be integrated into investment decisions, whether to
hedge risk or to create value in portfolio companies, GPs need to allocate resources dedicated
specifically to this purpose. This section aims to assess the level of dedication of GPs to ESG,
by finding out what kind of financial and human capital resources are dedicated to their ESG
practice.
DDQ Section 4.1 Financial Resources Dedicated to ESG
In this subsection, we would like to examine the costs and benefits of your budgetary plan for
ESG integration. We aim to assess how the budget is allocated between the organization and
portfolio companies and how your plan can be improved in the future.
4.1.1 Do you have a specific budget set aside for ESG integration?
Please provide the details for this budget allocation.
o How much is this budget?
o What portion of the fund’s overall budget is this?
o Please specify whether this budget allocation is associated with an individual
fund or the GPs overall operating budget.
o Accounting method: in the financial statements, Is the budget recognized as
“ESG integration”? Or do you have other ways to categorize the expenses?
o Who is responsible for managing the ESG budget?
Do you have a process to re-evaluate this budget allocation?
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ESG Integration for Private Equity - Page 20
o How do you measure the cost-benefit of this allocation?
o Has the allocation increased, decreased or stayed the same?
o Do you have any plans to change the current amount allocated to ESG
integration? If so, why?
If not, why is there no specific budgetary allocation for ESG?
o Was there an allocation in the past?
o Is there likely to be one in the future?
4.1.2 Do you have separate compensation strategies for ESG outcomes than for financial
outcomes?
Why do you think there should be a distinct compensation strategy for ESG
outcomes?
Have you ever awarded a staff member or team based on ESG-related outcomes? If
so, please explain what these outcomes were and how the appropriate compensation
was determined.
If not, how are staff incentivized to implement ESG best practices through your
broader performance management and/or compensation process?
DDQ Section 4.2 Human Capital Resources Dedicated to ESG
Human capital is the core of the capacity of ESG integration. Therefore, in order to assess
the capacity of your ESG policy and practice, we would like to evaluate how you use, train
and distribute your ESG personnel.
4.2.1 Who is responsible for ESG due diligence and standards compliance and what are
his/her responsibilities?
Do you have a team specialized in ESG integration?
What is the person/team’s relationship with the broader investment staff? Where does
this person/team fall in the firm’s organizational chart (e.g. manager, analyst)?
What qualifications do you look for when selecting a ESG manager/staff member?
4.2.2 Do you have any training programs related to ESG integration?
Please provide details about the program. Is it mandatory for all personnel or only
certain team members? What does the training entail?
4.2.3 Do you have an evaluation system or oversight mechanism (e.g. Key Performance
Indicator) in place for ESG-integration staff?
Is this part of your broader investment staff performance evaluation/oversight
processes? Does it have any impact on investment selection or management
decisions?
Does this ESG-focused evaluation/oversight system impact decisions around staff
compensation, advancement, etc?
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ESG Integration for Private Equity - Page 21
What are the priorities of this performance evaluation/oversight method? What does it
reward?
4.2.4 Do you use any external expertise/third party to do ESG due diligence?
If so, which third party do you use and in what capacity?
o Is this third party employed by the GP or portfolio company?
Section 5: Assessing ESG Communication Procedure with LPs and Portfolio Companies
In this section, our goal is to get an understanding of the level of transparency on ESG issues
practiced by the fund. We want to explore what processes and channels the fund has in place
for communicating to and receiving communication from three important parties: the
portfolio companies themselves, the LPs that have invested with the fund, as well as the
general public and other external stakeholders.
This section is organized by communication partner, however most questions can be asked in
parallel.
DDQ Section 5.1 ESG Communication Procedures with LPs
For GPs, a best ESG practice requires a proactive, frequent and transparent ESG-related
disclosure to LPs in order to take the timely and appropriate actions if there are any
potential ESG risks. Therefore, we would like to examine whether you can assure the LPs of
the ESG reporting throughout the whole investment period and when material ESG incidents
happens.
5.1.1 Do you have an established ESG reporting format and channel for communicating with
LPs?
Are you required to regularly update LPs on ESG issues that may arise during the
holding period?
What is the channel of regular communication, eg. capital calls, investment memos,
portfolio company reports, Limited Partner Advisory Committee meetings etc.
5.1.2 Do you have specific methods for communicating instances where material ESG risks
arise during the investment period to LPs ?
Are there any special disclosure mechanisms that enable you to disclose ESG issues
outside of regular, periodic disclosures?
Please provide specific examples of past incidents could be included to further
illustrate the methods.
DDQ Section 5.2. ESG Communication Procedures with Portfolio Companies
To better monitor the ESG integration of portfolio companies and ensure they are operating
consistently with GP’s ESG-related policy and practice, it’s important to require ESG
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ESG Integration for Private Equity - Page 22
reporting and disclosure in a frequent manner from your portfolio companies. Therefore, we
would like to assess whether you can effectively interact with your portfolio companies in
regards to ESG integration in order to facilitate their ESG management.
5.2.1 Do you have an established ESG reporting format and channel for portfolio companies?
Do you require your portfolio companies to regularly update you on ESG issues that
may arise during the holding period?
What is the channel of regular communication, for example: reports or board
meetings?
5.2.2 Do you have specific methods for communicating instances where material ESG risks
arise during the holding period?
What types of material ESG incidents for which the portfolio companies should
provide disclosure?
In what format this disclosure could take?
5.2.3 Please describe your response if portfolio companies fail to disclose ESG-related issues
to you persistently.
What is your approach if non-compliance happens? Eg. The steps taken to remedy or
mitigate the effect of the relevant non-compliance, and to ensure that there is no
further non-compliance in the future.
Are there any affirmative/negative covenants in the investment agreement regarding
ESG communication?
DDQ Section 5.3 ESG Communication Procedures To The Public and Other
Stakeholders
In this subsection, we would like to know your contribution of disclosing ESG practices
beyond current regulation or compliance which you are subjected to.
5.3.1 Under what conditions do you believe it is necessary for a portfolio company to
communicate or engage directly with external stakeholders on ESG factors? Examples can be
useful for this question.
This question aims to assess how the company views the importance of communicating ESG
matters to external stakeholders. This is important as it shapes the perception on the company
of external stakeholders and the public, which could directly impact the operations of the
company.
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ESG Integration for Private Equity - Page 23
Part V: Outlook for Next Steps
A. Conclusions
We believe incorporating the DDQ we have developed into UBS’ due diligence processes would
allow for a salient precursory understanding on the ESG integration practices of fund managers.
Nonetheless, we suggest the following next steps to optimize the insightfulness of the DDQ:
Developing a scorecard for fund managers’ responses - In the future, UBS could work
towards developing a scoring scheme for the responses collected. There are two key
components to this exercise; (i) Assigning a weight to each question relative to other
questions within the questionnaire, and (ii) Rating the generated responses based on a
predetermined scheme of ‘good vs. bad answers’. The resulting score can be included as
a metric in UBS’ investment memos.
Automating the implementation of the DDQ - This includes automating the processes of
rolling out the questionnaire as well as storing the generated responses. The automated
aggregation of answers could provide more value by automatically highlighting the
potential areas of concern and opportunity for each fund manager. We believe that this
would be valuable in guiding onward analysis by UBS.
Incorporate ways to validate responses - As an extension to the automated
implementation and aggregation, UBS could work towards incorporating validating
measures within the DDQ. Although we do not envision this to eliminate the need for
manual review of the responses by the UBS investment team, we believe this would
reduce the need for extensive cross-validation exercises. We believe that there could
various ways of implementing this, but further work needs to be done to investigate the
most efficient method.
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ESG Integration for Private Equity - Page 24
Part VI: Bibliography
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Mercer, and LGT Capital Partners. “Global Insights on ESG and Alternative Investment” March
2016. Accessed at: https://www.uk.mercer.com/newsroom/global-insights-on-esg-in-alternative-
investing-report.html
Linda-Elling Lee, and Matt Moscardi. MSCI Issue Brief. “Six ESG Trends to Watch in 2017.”
January 2017. Accesse at: https://www.msci.com/documents/10199/cbc27309-8157-4589-9cc0-
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Price Water-House Coopers. “ESG considerations for private equity firms.” 2015. Accessed at:
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UBS, CIO Wealth Management Research. “Doing well by doing good.” May 2016.
UBS, “To Integrate or to Exclude? Approaches to Sustainable Investing.” July 2015.
CDC. “ESG Toolkit for Fund Managers.” Accessed at: http://toolkit.cdcgroup.com/
KKR. “Creating Sustainable Finance.” 2010 ESG Report.
KKR. "Private Equity ESG Policy". Update. July 25, 2016.
Principles for Responsible Investment. “The Limited Partners Responsible Investment Due
Diligence Questionnaire: And How to Use it.” November 2015: Accessed at:
https://www.unpri.org/news/pri-launches-private-equity-due-diligence-question
UNEP. Principles for Responsible Investment. “Integrating ESG into Private Equity: A Guide
for General Partners.” 2016.
UNEP. Principles for Responsible Investment. "Responsible investment in private equity: A
guide for limited partners". Second Edition. June 2011.
BlackRock. “Exploring ESG: A Practitioner’s Perspective.” June 2016. Accessed at:
https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-exploring-esg-a-
practitioners-perspective-june-2016.pdf
Barclays: Impact Series 1, “Sustainable Investing and Bond Returns: Research Study Into the
Impact of ESG on Credit Portfolio Performance. 2016. Accessed at:
https://www.investmentbank.barclays.com/content/dam/barclaysmicrosites/ibpublic/documents/o
ur-insights/esg/barclays-sustainable-investing-and-bond-returns-3.6mb.pdf
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