Private Equity’s ESG Balancing Act

 

Author: Paul Johns, Chief Marketing Officer, Ethixbase

 

As supply chains continue to reel after the multiple blows dealt by the pandemic, the Russia-Ukraine war and the mounting crises spurred by climate change, private equity firms are on the search for ways to seize the opportunities created by the destabilization. Despite the upheaval of the past few years, PE firms are pouring more money into logistics as they seek deals in the disrupted sector. In 2021 alone, private equity invested $50.6 billion–triple the amount invested in 2020 and 34 percent higher than the previous annual record in 2019. Whether it’s suppliers themselves, or other companies adjacent to logistics and manufacturing, PE wants in. 

The opportunity in supply chain investments is immense, but private equity firms face a two-fold challenge as they dive into a sector that is relatively new to them: A growing focus on Environmental, Social and Governance, and the ESG pitfalls common throughout any supply chain. 

Following the money to ESG value creation

ESG has completely saturated the business sphere and continues to polarize leaders the world over. Vocal opponents of ESG have gone so far as to create explicitly anti-ESG investment firms like Strive Asset Management, which has been seeded by noted billionaire Peter Thiel. ESG opposition has even been codified into law, with Florida completely barring its $186 billion pension fund from considering ESG at all in its investment decisions.

Despite a spike in resistance, the fact is that actually following the money leads to ESG as a critical factor in the success of PE investments. PwC’s 2021 survey on ESG in private equity claims that PE firms focusing on ESG-based strategy will be leaders in the developing sustainable economy, and sheds some light on the matter with a few critical statistics: 

  • 65 percent of respondents have developed a responsible investing or ESG policy. 
  • 72 percent always screen target companies for ESG risks and opportunities.
  • 66 percent rank value creation as one of the top three ESG investing drivers.

SG is inching closer to being firmly ensconced within private equity’s wheelhouse, but this industry-wide focus makes diversifying into supply chain opportunities riskier and more challenging.  

Evaluating fundamental tensions

Any businesses that touch manufacturing and supply must handle the threat of third-party risk. From oversized emissions to skirting labor laws and exhibiting poor governance, third-party risks have the potential to cause an investment to go sour. Private equity firms just aren’t used to the level of scrutiny required to ensure the convoluted risks of supply chain companies stay under control. 

PE firms that want to maintain their ESG lens on investing must shore up the tools they use for ESG evaluation to handle the extra risk associated with investing in suppliers and companies providing supply chain-related services.  

Reaching for standardization

One of the problems facing ESG-focused private equity firms is a general lack of standardization in benchmarking. There are currently multiple frameworks companies can choose from, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB). Under these and other standards, PE firms looking to invest in supply chain companies should be looking at issues including:

  • Labor practices 
  • Climate impact and emissions remediation
  • Scarcity of natural resources
  • Political contributions
  • Board composition
  • Diversity, Equity and Inclusion

And of course, PE must look at the supply chain management at each organization.

The point of ESG reporting is to produce data that is both accurate and verifiable, but a significant part of the challenge is determining which data to harvest, analyze and disclose in the first place. PE firms can choose and stick to one standard, but that may limit them to targets in certain geographical areas and create greater exposure to risk. As standardization continues to develop, diversifying collection of ESG metrics will be a key advantage in taking safer advantage of supply chain disruption.

The foremost tool for full visibility

For private equity to create value and improve supply chains through an ESG lens, full visibility is the standard to secure. With continued uncertainty about regulatory moves and shifting standards, the smart play is to cover all ESG bases from the start with a supply chain benchmarking tool like ethiXbase360. 

Use of detailed benchmarking tools makes companies less risky and more attractive to PE firms by providing proof of sustainable practices. As benchmarking moves toward uniformity, ethiXbase360’s comprehensive reporting will keep supply chain companies and the PE firms that target them at an acceptable balance between ESG value creation and risk.     

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