Coming to an LP meeting near you

In February, the UN-supported Principles for Responsible Investment (PRI) put out a call for LPs and GPs to join a new working group. The goal? To develop a guide on environmental, social and governance (ESG) due diligence questions for LPs to ask GPs pre-investment.

The group now has 44 members hailing from all over the globe – including 27 LPs or fund of funds and 17 GPs –all prepared to take on the task of creating a detailed but practical due diligence questionnaire (DDQ) by this October. The group has met a few times to date, but already has plans for what might be included in the final product.

“We’re making sure what we come up with something that’s workable, not too onerous, but does what it says on the tin,” says Adam Black, chair of the working group’s GP members and head of sustainability at Doughty Hanson.

The industry has yet to create a standardized approach for LPs and GPs to request and disclose ESG-related information. The group is well aware, however, that coming up with a document that GPs and LPs will actually use is no easy feat, and they will need buy in from the industry at large in order to ensure that the DDQ has the lasting effect the PRI has envisioned.

Getting specific

PRI already has a workbook that contains guidance for private fund advisers wanting to better integrate ESG considerations into the dealmaking process, including a step-by-step action plan. The ESG Disclosure Framework for Private Equity was published two years ago as an industry-wide initiative to aid LP/GP communication on these integration processes.

While the framework is a good starting point for engagement, it provides “high-level guidance” and the industry is asking for more specifics, notes Natasha Buckley, manager of PRI’s private equity program.

“Using that disclosure framework, it became obvious that it was still too much of an objectives document,” agrees Tim van der Weide, working group member and responsible investment adviser at PGGM. “From the LP side, it wasn’t always clear what was expected and from the GP side, they were still getting a lot of different questionnaires.”

The working group is using the disclosure framework along with the Institutional Limited Partners Association (ILPA) due diligence questionnaire in order to come up with a standardized list of questions. The exact language will be debated over the coming months, but it’s likely there will be questions on what kind of ESG management system the GP has, what kind of reporting they do, if there is someone responsible for ESG at the firm and how the GP ensures that portfolio companies abide by ESG policy.

The PRI is also planning to include case studies in the DDQ that will specifically describe how LPs have approached ESG issues in the past and how GPs have engaged with their LPs for a successful outcome.

“We want to cover both the LP and GP perspective and have short examples supporting various sections of the document to encourage the practical application of due diligence,” notes Buckley.

The devil in the details

The goals of the document are clear, but the road to creating it and successfully implementing it may be a rocky one. One factor in play is the many different viewpoints represented in the group. While a coalition from 11 countries ensures diverse insights, van der Weide says that the different perspectives at play could make drafting a universal document tricky.

“You often find when you work in an international context, certain words for Europeans might sound very neutral but to an American it might sound like you’re prescribing something that was not intended,” he notes. “The devil is really in the details.”

While some of the members have long-established ESG programs, some are relatively new to standardizing ESG practices within their own funds. The mix has proven collaborative and proactive thus far, says Buckley, but the group’s diversity reflects the variety of approaches for which the DDQ will have to apply within the industry.

“The challenge is going to be meeting the needs and expectations of a very wide range of stakeholders, recognizing that some are fairly new to ESG and some are more sophisticated in their approach. So we have to make sure that what we come up with is a tool that’s balanced,” Black says.

Spreading the word

PRI is well aware that the best bet for industry-wide implementation is reaching out early and often as the working group drafts the DDQ. A draft for the proposal will be introduced at PEI and PRI’s Responsible Investment Forum in London on June 23. During a think tank session led by van der Weide, the group will discuss with attendees how investors are using ESG reporting guidelines and provide feedback on the draft.

As a partner to the project, the European Private Equity and Venture Capital Association is also planning to consult their responsible investment roundtable for guidance. The public consultation period will be open until early September, when the group will gather the feedback and prepare the final version.

“What we need from LPs is their buy in to this DDQ so that they will actually integrate this into their own processes,” says Buckley. “We’re also asking GPs to give feedback on the questions asked – are they reasonable? Are they feasible? Do they give the GP space to communicate their approach on ESG?”

Black notes that once the questions are standardized and published in October, the working group still faces the challenge of ensuring that GPs are reporting information truthfully and that LPs understand the information they are receiving in order to properly categorize and benchmark returns.

But the widespread introduction of the DDQ itself will help standardize ESG conversations and increase this competence, even for those who are not using the DDQ themselves.

“At some point as the understanding of the subject becomes greater and the issues become more transparent to a wider audience, people will sit up and realize they need to embrace these issues,” Black notes.

Indeed, for GPs the future of reporting may look very different if they are hoping to stay on par with their competitors. The PRI does not intend to create a standardized “tick-box” approach to reporting through this initiative – rather to ease the ESG reporting burden for GPs so that they can develop a core set of responses which can then modified to answer an investor’s supplemental questions.

“If I were a GP raising capital after October, I’d be using that document in my fundraising to ensure that I was fully prepared for the questions that might be asked,” says van der Weide.