Dealbreaker: ESG standards

Non-adherence to ESG standards is increasingly becoming a deal-breaker in capital allocation by LPs.

According to Coller Capital’s, Global Private Equity Barometer, LPs feel confident about their ability to assess ESG standards and will stop investing with managers if they fail to adhere over the next three years.

The barometer collected the opinions of 112 investors in private equity funds worldwide. By region, the respondents were spread across North America (40%), Europe (39%) and Asia-Pacific (21%).

High demands
A high standard of ESG-related disclosure has become increasingly important to institutional investors. When asked whether they would consider to stop investing in a fund if the GP did not fulfil certain standards, 5% of respondents said they would stop right now in all cases and almost half (43%) said they would potentially do so.

“The regulatory environment has sensitised LPs to ESG as an issue,” commented David Boal, partner at Coller Capital. “Many LPs of course believe adherence to ESG standards will lead to better returns but this group was in the minority before the regulators geared up. Now many investors are welcoming the regulatory interest because they know it will ensure reporting standards are improved and maintained.”

If a GP fails to adhere to the standards in three years time, a fifth of LPs would stop investing in all cases and an increasing percentage (49%) would potentially cease their capital allocations.

Taking stock
In their ability to assess a GP’s ESG measurement systems, European LPs were the most confident, with 84% of respondents providing a positive response. North American LPs were less confident at 72%. The number decreases for Asia-Pacific LPs, with less than half (43%) affirming their ability.

“European and North American LPs have been thinking about ESG for some time,” said David Boal, partner at Coller Capital. “Particularly in Europe, the reporting regulations have been well and truly discussed for several years now. So it’s not surprising to see that European LPs feel very well apprised of this issue and well equipped. A likely reason the number is smaller for Asia Pacific LPs is that their private markets industry is at an earlier stage of development."

Additional findings

Pay off
Only a third of LP respondents are invested in a fund which acquires stakes in GP management companies. However, these have reported positive results as almost all (27%) stated their investments exceeded expectations and another 64% said investments performed in line with expectations.

“GP stakes funds are still a relatively small part of the market. And while it is likely to stay a niche market, there’s no doubt that the private markets industry will continue to grow so it’s a reasonable expectation that this strategy will develop as the market expands,” commented Boal.

Stake sales increase the insight an institutional investor has into their GP which is well received, as more than half of LPs (54%) who invested in multiple products with the same manager cited an increase in influence with the GP as a major advantage.

Macro concerns
According to the barometer, LPs are worried about private equity returns over the next two to three years given the broader macroeconomic environment and inflation.93% of LPs highlighted the macroeconomic environment as a significant concern versus 90% in 2019-2020. Inflation was pointed out by 85% of respondents. In third place was high asset prices, which dropped from 92% of LPs being concerned in 2019-2020 to 68% in 2022.

Against this backdrop, fewer LPs are set to increase their allocation to alternatives in the next 12 months. Whereas six months ago, half of respondents were positive about additional alternative allocations in 2023, only a third of LPs maintained this outlook.