How young people can lead the way towards sustainable finance in private equity

by Valeria Merkel (Partner) and Laetitia Hamon (Senior Manager), KPMG Luxembourg

Socially responsible investing and sustainable finance have become defining topics in present-day economics and business, as has “ESG” (shorthand for environmental, social, and governance— the metrics used in determining the sustainability of an investment). Most market players, however, especially those in private equity, find them difficult to grasp. Unsurprisingly, at the last PE conference I attended the answer to the question What does ESG mean to you? was pretty short: “Well, we are compliant”.

Compliance with laws and regulations is a strong incentive, so on 24 May 2018 the European Commission issued a legislative package called the “Action Plan for financing sustainable growth”. This plan aims to introduce a compliance and risk management framework into a field currently based on  voluntary investor action.

Sustainability risk management: a shift in approach

In the past, sustainable finance was approached as a way of limiting, reducing and mitigating the impact of a business on the environment, which is probably one of the reasons why the financial sector did not immediately take it up. Indeed, some would have argued that sustainability had no direct value but for certain communication and marketing benefits.

At some point, however, this mind-set and approach changed completely. Companies and investors now understand that environmental and social risks from disruptive global megatrends will affect their businesses: climate change, for example, brings physical, liability, and transitional risks which should be carefully addressed.

All of this is particularly relevant for private equity players, since a more comprehensive risk management approach will necessitate more accurate company valuations during the due diligence and exit stages.

Millennials are more likely to invest with purpose 

Together with this paradigm shift comes a generation, now with investors and rising managers, that is challenging how the PE sector operates.
Millennials often approach investing (and leading a company) with expectations and priorities unlike those of preceding generations. They seem to have grown up far more aware of global issues like climate change, environmental damage, or human rights breaches. They have shown a tendency, perhaps as a result, to seek out investment decisions matching their values—thus they might put sustainability and transparency in the same league of importance as profits.

PE has an important role to play in the EU calls for financing sustainable growth

With the EU Action Plan there comes the momentum for PE to play a fundamental role in financing the transition to a low-carbon economy, for example by financing SMEs and start-ups that offer sustainable solutions and products. PE actors—particularly its younger leaders— who understand the market opportunities arising from this transition, and who value companies on their “true value”, will become industry leaders.

Valeria Merkel, Partner, KPMG

Laetitia Hamon, Senior Manager, KPMG

THREE QUESTIONS TO HELP LPS AND GPS ASSESS THEIR READINESS

  • Are you comfortable with your knowledge of best practices in this area?
  • Have you studied the impacts of the EU Action Plan’s regulatory changes on your investors and portfolio companies?
  • Does your current set of information (including corporate disclosures and risk metrics) provide GPs with enough information to perform sustainability risk assessments in respect of portfolio companies?