Setting the Environmental, Social & Governance (“ESG”) benchmark – The ILPA ESG Framework

The Institutional Limited Partners Association (“ILPA”) has recently released an ESG assessment framework (the “Framework”) to help limited partners (“LPs”) assess the ESG approach and integration adopted by fund managers.

ILPA has commented that the Framework is designed to help LPs evaluate and benchmark general partners’ (“GPs”) responses to due diligence efforts, inform goal-setting conversations with GPs and measure ESG integration progress over time.

A key consideration for ILPA is that the Framework was developed based on “mid/large cap buyout managers and strategies” and recognised therefore that the Framework serves as a useful starting point for LPs to evaluate managers in other private markets asset classes. Accordingly, the Framework is not intended to be a “one-size-fits-all” approach but to create a framework for structured and meaningful discussion to align interests between GPs and LPs in the market in respect of ESG matters.

In light of the above, ILPA is cognisant of the fact that smaller managers may not have the resources available to provide the level of training, analysis, reporting etc required to fall within the ‘advanced’ or even ‘intermediate’ buckets, as such ILPA notes that it is important for LPs to consider manager size and resources to adjust expectation accordingly.

THE FRAMEWORK

The Framework categorises six activities and processes across four buckets, each of which can be graded on a sliding scale from ‘not present’, ‘developing’, ‘intermediate’, to ‘advanced’ in order to identify the level of ESG engagement by the GP. The categories and questions for LPs to ask as well as the goals and evidence set out for GPs are clearly presented and summarised as follows:

  1. Policies and commitments to standards:
  • Status of current policy: LPs are to query with GP’s the status of their current ESG policy to better understand the extent of the GPs ESG policy and approach to ESG issues. Namely, LPs should look to querying the GPs approach to governance, ownership and oversight responsibilities and processes in place to identify material risk. Importantly, where there are firm-wide policies in place, GPs’ falling in the intermediate level bucket are expected to have in place sector specific ESG policies.
  • Approach to Policy Review: Where ESG policies are not present, the LP should query with the GP its plans to develop and build on its ESG policies. Even at the ‘developing’ bucket stage, GPs are expected to reference periodic reviews and development of ESG policies (at least annually) and ultimately what its plans are to keep in line with industry developments.
  • Industry Standards and Best Practices: Where GPs have not adopted industry standards, LPs should request the GPs to clarify whether they have at least committed to any industry best practices or standards and whether they have begun working towards any formal adoption. Where GPs have formally committed or adopted industry standards, GPs are encouraged to demonstrate how these standards have been integrated into processes and training.
  • Contractual Commitments: LPs are to consider whether formal ESG contractual commitments are required to be included within side letters in circumstances where the private placement memorandum (“PPM”) or limited partnership agreement (“LPA”) is light touch on ESG matters to guarantee substance in the GP’s commitment to ESG. For example, LPs may request that the GP provides the LP with annual reports on its responsible investment activities and confirms separately to the LP that is has managed its investment in accordance with its responsible investment policies.
  1. Governance
  • ESG ownership: LPs should be posing questions to GPs to ascertain who is responsible for the governance of ESG considerations. The more senior individuals are actively involved, the more there will be leadership driven accountability for ESG ownership throughout the organisation as a whole (as opposed to only being a small party of investor or compliance relations and not factor into investment committee decisions prominently enough).
  • Capacity building and training: LPs should query the level of training given by GPs to their staff. The Framework identifies ad hoc ESG training as falling within the ‘developing’ bucket where for training to fall within the ‘advanced’ bucket, GPs are expected to provide systemic regular efforts to provide training for all staff, including extending this to portfolio companies.
  1. Communications and reporting
  • Approach to communication: To obtain a comprehensive view on ESG reporting matters, the ILPA encourages LPs to query whether any ESG considerations are discussed as a matter of course at AGMs and LPAC meetings. Discussion around ESG matters is important as it ensures more regular informal updates that will keep both the GP accountable for its actions and the LP up to date on the latest developments.
  • Incident reporting: GPs are expected to have a policy in place detailing their approach to ESG incident reporting. Additionally, considering that the definition and meaning of “incident” can vary from portfolio to portfolio, LPs are encouraged to share and discuss their expectations with GPs. This discussion should include setting out the expected level and speed of communication in relation to an incident. For example, the GP can provide prior examples of how it has handled past incidents to demonstrate its incident remediation policy in action.
  • Key Performance Indicators (“KPIs“) and reporting: LPs are to consider the ESG KPI and reporting in place and the level of information provided by the GP. At a minimum, to fall within the developing bucket, GPs are expected to provide basic KPIs and ad-hoc reporting (or reporting more focused on future capacity building goals). LPs will need to consider the level of the GPs reporting and if this meets any internal compliance considerations.
  1. Investment process 
  • Due diligence: LPs are to consider to what extent ESG matters are scrutinised during due diligence. A led process that is led by the GP is considered more beneficial (as opposed to ESG solely conducted by a third party) as this increases the chances that any risks identified during the due diligence are considered during the investment committee decision-making process.
  • Post-investment management: LPs are recommended to check with GPs the level of monitoring and operation of ESG management considerations. Additionally, LPs should verify that ESG management considerations form part of a structured process, including annual reviews where risks identified during due diligence are examined and actions to address any findings are considered.
  • Exit and after sale: It is expected that GPs provide ESG related information to buyers on their request and ultimately establish an ESG focused value creation and enhanced risk management process that is reflected in investment marketing materials shared with potential buyers. To fall within the advanced bucket, GPs are expected to support buyers by providing information to continue ongoing sustainable investment initiatives at time of sale.

RESPONSIVENESS TO DIVERSITY, EQUITY & INCLUSION (“DEI“)

The Framework also contains a DEI supplement that provides questions for LPs to query with the GP in respect of what analysis and tracking of DEI is provided at both GP and portfolio company level. The Framework also highlights queries to GPs in respect of their recruitment policy and whether this effectively addresses DEI. At the intermediate bucket level, staff of the GPs are expected to have undergone training covering topics such as discussing systematic racism and unconscious bias.

RESPONSIVENESS TO CLIMATE RISKS AND OPPORTUNITIES

LPs are to also consider and query with the GP what processes and strategies the fund manager has put in place for conducting climate assessment at the macro level as well as deal-by-deal.

WORKSHEET – ESG ASSESSMENT FRAMEWORK

ILPA has commented that the Framework can help LPs evaluate GP responses to due diligence questionnaires and was created with the understanding that many LPs are already using ILPA’s DDQ as a point of reference. Accordingly, the Framework document includes a worksheet that LPs can download and use in tandem with the Framework to help them map GP responses to corresponding sections of the ILPA DDQ.

In respect of the ILPA buckets, LPs are encouraged to note and/or assign scores to the quality of a GP’s response in respect of each of the categories. ILPA has noted that it has intentionally forgone assigning numerical scores to each category as the relative weighting and score assigned can vary greatly by organisation, which is in line with its approach and recognition that the Framework is not a ‘one size fits all’ assessment.

NEXT STEPS

ILPA has commented that as ESG conversations continue to evolve, many best practices are still being developed and as such they expect LPs will adapt this Framework as appropriate. Accordingly, ILPA has emphasised that this Framework is meant to be representative and not be considered a comprehensive guide to best practices in the market. Therefore, LPs should use the Framework as a starting point and develop and enhance the ESG assessment Framework over time.

The Framework and FAQ document will be updated on a periodic basis and ILPA has invited all participants in the private equity industry to send any feedback or questions to esg@ilpa.org.

To review ILPA’s Framework and the worksheet, please click here.

For more information, and any guidance or advice on ESG requirements, Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.

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