Hear ERM Global Leader of Services and Innovation Jaideep Das and Partner Michael Eisenberg discuss decarbonization and ESG best practice in Private Markets. In the conversation, they cover the challenges of incorporating best practice into the investment process, the evolving role of ESG leaders, the rise of ESG and sustainability expectations for private market companies, and ultimately how to create lasting, positive ESG impact.

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Conversation highlights

Jaideep Das (JD): Now if you think about - obviously, the ESG agenda in private markets is not something which is new. It's been evolving for sure. But clearly while the intent has been there, there are some big challenges. So what strikes you as the biggest challenges GPs face while trying to adopt such best practices?

Michael Eisenberg (ME): Sure. I think, you know, the way GPs are being evaluated now, I mean, there's a number of different components to this, but one of them is how systematic this work is being done across a particular fund or across a particular platform or across a whole firm. And so, what that has meant is, you know, there's a lot more work, there's a lot more need for internal and external resources. There's a lot more buy in, frankly, that's needed inside of these organizations to enable that work to happen. And so those increased expectations and those increased needs have, I think, pushed a lot of these practices to become more rigorous, more systematic and more incorporated into the investment process.

Now, a GP’s investment process is sacrosanct. You don't just go and change that, but it's this kind of addition or incorporation into what they're doing - from screening, to diligence, to underwriting, to portfolio company onboarding, all the way through to exit - that requires a lot of time and attention from a lot of people. And if you're going to build that at scale inside of these organizations, you need to, you know, bring in the help and both internal and external.

JD: So thinking about what, what do you see as best practice in the market in GPs and what kind of outcomes are they getting from applying those best practices?

ME: So you know the way I think LPs will oftentimes think about this - and in a way I think ERM thinks about it in the same way - is that all these things are on a maturity spectrum. So, you can't just go from, you know - you have to crawl before you walk sort of thing. So people are always kind of increasing the ambition over time and increasing the rigor over time. But some of the best practices, if you look at climate, it's going to be not just foot-printing anymore, it's going to be the target setting, it's going to be the decarbonization road maps, it's going to be putting CapEx (Capital Expenditure) numbers against what needs to be done from a decarbonization point of view, it's going to be, you know, even potentially temperature alignment of portfolios over time, that's still very nascent, but I think you'll see more of that over time.

On things like diversity, equity, inclusion, the best practices are both internally at the GPs from the most junior levels all the way to the most senior levels. How are people brought into the firm? How are people sponsored and mentored? How are people at the more senior levels being incentivized and evaluated from a 360 point of view? What's the tone at the top from the CEO - and CEOs oftentimes get very involved in the DE&I context. And then it's how is that cascaded down to the portfolio starting at the Board level and how these boards are constructed and how hiring is done in diverse slates for C-Suite level people. And then how are the GPs working with their portfolio companies to understand from a benchmarking point of view where they stand against their peers and where things can be improved.

JD: So how has that kind of role evolved and how do they also think about the anti-ESG movements going around, the green washing claims, etc.? How do private markets ESG teams, how's their role going to evolve or is evolving?

ME: Yeah, this has been one of the most exciting developments, I think. For ESG in private markets, I think historically what you had were people, perhaps more junior people, coming off an Investor Relations team or you know, taking it on as part of a compliance or a legal role. And that has fundamentally shifted and functions have shifted from where they existed before. And new people coming in, it's rare that that's the profile anymore. People are being hired from places where private equity is actually historically hired from. So consultancies, investment banks and other kinds of advisors, because this expertise does not exist in a you know, there might have been one or two people, but the kind of expertise that needs to exist for doing this kind of work did not exist inside of these firms before. Especially in the United States where, you know, this work hasn't been done meaningfully in quite as many ways as it has been in Europe. So very exciting developments, absolutely.

JD: And ESG talent in private markets is certainly in hot demand. And you know we've benefited from people like yourself and others joining from the industry, but we've also had some esteemed colleagues joined take up those private equity roles and clearly, as you said, with the view to make better impact, create more value within the portfolios. So just thinking about you know, the role of the ESG leaders and the teams have clearly evolved thinking about not just an LP engagement kind of function, it's not just compliance and thinking very interestingly about the value creation kind of opportunities. And one lens which is I guess very interesting for a number of ESG professionals is the whole impact space, because it gives an opportunity for private capital to put their investment or put their capital behind some of the most pressing sustainability challenges. How do you see the opportunities and the impact space?

ME: Sure. And I think one thing to mention is that ESG people given the demands around SFDR, given the demands from SEC exam staff and others, you're going to need, and from LPs frankly too, you're going to need to be spending time with investors and on regulatory issues and you're even seeing dedicated ESG IR (internal relations) people being hired or dedicated ESG compliance people being hired as part of these larger team builds. So that piece is important. In the impact space, this is a very exciting space for ERM and for the market more broadly. Historically, for scaled impact funds, the US has actually been a leader. So KKR, TPG - Bain in particular - are now on fund two or fund three and have established impact track records, which I think is very important for the market more broadly because you now have prior investment success to look at and to say this doesn't need to be concessionary anymore, to some of the people who might have been doubters initially about impact at scale.

JD: But also I think just beyond the pure impact funds, Michael, we're seeing even through the core funds, the mainstream funds, there's been a more propensity to invest behind companies that do address some of these challenges. And we've seen some really good examples of that, you know, beyond the pure kind of impact funds as well.

ME: Yeah, I think. I mean, you're seeing a couple things. I think the first is the discipline and process around tracking ESG KPIs and metrics and impact KPIs and metrics, that's already starting to converge, right? And if you think about it, if firms are launching impact funds and they don't have similar ESG systems for their flagship funds, the inevitable question that gets asked is why?

JD: I think we've seen the both the base and the scale of private markets ESG activity really increased in the in the last year or so. So for you, what's next? Like what's really appealing and what's sort of really exciting in the world of ESG developments in private markets?

ME: I think one of the things that we're seeing a lot when we're doing work with portfolio companies post investment, and what we're seeing during diligence, is a lot more expectations of private market companies who, you know, more often than not are B2B businesses, getting a lot of inbound from their customers, from their capital providers, in particular and from regulators as well on ESG and sustainability and impact. And I think what that means for an increasing amount of companies within private equity and infrastructure portfolios is this need to go that next step further.

JD: No doubt. And once it's embeds itself, you create lasting ESG impact - positive impact as well - and should deliver bottom line and impact as well whether it be through EBITDA enhancements or increases to the multiple. It’ll be a fascinating journey for sure. Thank you, Michael. It's great to have you.

ME: Thank you, Jaideep.