Environmental, Social, and Governance (ESG) Issues in Private Equity: No Longer Just an Initiative, but an Essential Strategy

By: Bruce Martin, CPEA

Institutional and portfolio investors, limited partners (LPs), and private equity firms’ investors are moving beyond an awareness of the environmental, social, and governance (ESG) programs of the portfolios and private equity firms with which they invest. While investors have been voicing concerns about sustainability and ESG issues for several decades, conditions have changed dramatically over the past several years as awareness of topics including climate, energy efficiency, labor practices, and other ESG concerns has exploded. Although many portfolio investments and private equity firms have been moving toward awareness of ESG factors, the progress has generally been slow. Investors, however, have been undeterred by this lack of progress and are expected to continue pushing for more ESG-focused investing.

Given this interest, a growing number of private equity firms are seeing that building ESG standards into their investment strategies is becoming an essential strategy for continued success. More importantly, as social and environmental issues increasingly affect business conditions, there is growing evidence that ESG programs can actually improve returns and limit risk.

The Scope of ESG Issues

ESG is a term used by investors to describe how they evaluate non-financial performance indicators. Though ESG is a broad concept with no standard definition, most can agree that it covers a wide range of issues ranging from climate, waste management, and traditional environmental risks to the social and governance topics that impact all industries including labor practices, responsible sourcing of materials, and fair employment issues.

The Growing Importance of ESG

The importance to investors on how a company manages ESG issues continues to grow. Since 2012, the number of signatories to the UN-supported Principles for Responsible Investment has grown from 1,050 to almost 2,400 funds, a group that controls a staggering $86 trillion in capital. Those funds have committed to principles that include a pledge to incorporate ESG principles into how they choose and manage investments.

According to a 2019 survey of investors by Private Equity Real Estate, 78% of LPs consider ESG factors when selecting a private equity fund to invest in, but only 19% of general partners’ (GPs’) investments strongly reflect their ESG policies.

The trends indicate that the message from investors is clear: incorporating ESG standards into investment strategies and operating principles is an essential element for future success.

Developing an ESG Approach as an Essential Strategy

Developing and sustaining an approach to ESG for a private equity firm includes several considerations:

  • Goals for how the firm intends to balance financial returns and ESG impact
  • Plans for how those goals will define its investment approach
  • Approach for how it will measure results and how it will communicate with stakeholders

ESG strategies should define specific operating changes within the firm and a timeline for implementation. The ESG approach should be applied throughout the investment value chain, from deal sourcing and due diligence to monitoring and realizing ESG goals during ownership.

Examples of a well-designed ESG approach include getting early warnings on ESG ratings for target companies, assessing companies’ track records on delivering on key ESG initiatives, or helping portfolio companies succeed by supporting them in developing sustainable procurement practices.

Measuring and tacking ESG performance can be difficult with so many variables. While many firms have developed their own methods of measuring ESG performance, there are several tools that private equity firms can use to assess and measure ESG performance.

  • The Global Impact Investing Rating System (GIIRS) uses a tool called B Impact Assessment to provide an accounting of the portfolio’s impact on workers, customers, communities, and the environment.
  • The Environmental Defense Fund’s (EDF) ESG Management Tool is a resource for private equity firms to make measuring and managing ESG performance a standard practice for value creation across their funds The ESG management tool provides a framework for private equity firms to assess and improve ESG management across their portfolio companies. For example, users of the tool can evaluate performance in areas such as access to ESG resources and integration of ESG management into the investment process and portfolio company operations.

While every firm should define its own unique ESG strategy based on its investment approach, culture, and stakeholder preferences, it is clear that no private equity firm can afford not to think about ESG.

During ownership, costs can be reduced using ESG principles by pinpointing areas where resource spending (e.g., energy, water) can be decreased and improved. For example, EHS Support is supporting clients in a variety of industries that are taking on projects that demonstrate a commitment to ESG progress, including:

  • Focusing on reducing greenhouse gases through energy efficiency
  • Implementing solar power options on their properties and facilities to reduce or eliminate their dependence on electricity from the grid
  • Creating plans for water use reduction and increasing the quality of wastewater prior to discharge
  • Focusing on efforts to manage and reduce contact and impact with stormwater
  • Increasing community outreach and education on ESG initiatives

In addition, preventive measures can be put in place so buyers can avoid ongoing ESG risks such as environmental liabilities, employee health and safety issues, social and labor issues, and supply chain compliance, to name a few. Furthermore, portfolio companies can reach a larger customer base as U.S. consumers become more interested in sustainable products and practices.

Finally, having a strong ESG program in place allows private equity firms to communicate the proactive ESG risk-mitigating processes they have implemented over their holding period, enabling them to negotiate a premium upon divestiture. This is especially beneficial when selling to a public company that may already have ESG reporting requirements in place.

ABOUT THE AUTHOR Bruce Martin has more than 20 years of experience in environmental management consulting. A certified professional environmental auditor (CPEA), he brings a wealth of knowledge and leadership to EHS Support’s Business Services Group…. Read More

EH&S Due Diligence Considerations for Distressed Assets

By: Leah Krause, Amy Bauer, and Maureen S. Bayer

The ongoing economic disruptions from COVID-19 have impacted many businesses, some of which will inevitably enter the commercial and industrial real estate market. It will be essential for potential buyers to understand the risks associated with these potentially distressed operations or properties through due diligence. These risks could include:

  • Not operating in compliance with all regulations due to potential cost-cutting, which could result in regulatory enforcement actions.
  • Inflation of true profitability due to cost savings resulting from non-compliant operation.
  • No due diligence performed before buying into a company located on contaminated property.

Thorough environmental, health, and safety (EH&S) due diligence on a potential real estate purchase is recommended for all deals, but for distressed targets, it is key to ensure you are making a good investment and mitigating unknown risks leading to potential costly consequences. Unknowingly purchasing contaminated property can result in liability for that contamination and if it is migrating to a neighboring property, then the liability could be devastating to the business.

A simple strategy for dealing with a distressed asset:

  1. Understand the property. If you are considering a property purchase, conduct a Phase I environmental site assessment (ESA) or desktop review. This will help you understand and mitigate environmental risks created by the previous owners/operators.
  2. Know if the facility is compliant. Whether it be an illegal discharge to the municipal sewer or unpermitted air emissions, a highly effective way to gauge compliance and focus resources is to conduct an EH&S audit. In the interest of having a starting point, it makes sense that a high-risk operation is the first area of focus on Day 1.
  3. Develop a plan. Once you identify risks during the Phase I ESA or audit, leverage existing resources with a solid plan and identify key people to prioritize aspects of the EH&S program. This will evolve your new company beyond perpetual makeshift solutions and close EH&S program gaps to improve your risk profile and increase operational efficiency.
  4. Implement the plan. Many EH&S programs can be established and managed in-house with existing talent. It is important to focus on EH&S as an accountability for all, not merely a box on an organizational chart. You may be surprised by existing personnel who will step up if asked, or who care about the environment or safety performance, but have not been given clear direction on how to contribute.

When acquiring a distressed asset, it is important to include an evaluation of EH&S compliance during the due diligence process. EH&S compliance can be very complex – it is understanding laws, regulations, and codes and implementing those requirements at each operating commercial and industrial facility. It is safe to assume that a distressed company diverted resources from EH&S programs to keep the business afloat, which may have costly repercussions for the new owner/operator on Day 1.

Other aspects to consider which could potentially be a higher risk for distressed assets include:

  • Whether the distressed company has used any enforcement discretion or forbearance policies due to COVID-19 that provided relief if they were unable to comply with their permits or other operating conditions
  • Potential business risk issues common with older facilities, such as poorly maintained asbestos-containing material or lead-based paint, or other conditions unfolding from lack of maintenance, such as mold from water damage or poor ventilation in a vacant building.

Thorough due diligence on a potential real estate purchase is key to ensuring you are making a good investment and mitigating potential unknown risks. Find a partner that can navigate these issues and help you prepare for negotiating opportunities as the deal unfolds. In other words, with proper understanding of risks, and a better understanding of how these risks affect the real value of properties, the proactive company may position themselves to enhance their portfolio, even at discounted prices, while protecting their risk profile.

For more information, see the “Demonstrating Value Through Proactive EH&S Due Diligence of Distressed Portfolios” White Paper by Amy Bauer.

About the Authors

Leah Krause, CPEA  With 20 years of experience across various sectors of the environmental field, Leah brings real-world knowledge to the workplace, enhancing her ability to prepare accurate compliance documents, permit applications, and environmental assessments… Read more.

Amy Bauer, CPEA  Amy brings over 20 years of experience conducting and managing environmental site assessments, regulatory compliance audits and support, and environmental investigations for clients… Read more.

Maureen S. Bayer  With over 15 years of experience in the environmental field and as an environmental attorney, Maureen serves as an invaluable asset to the EHS Support team by providing our clients with sound guidance they can trust…Read more.

The Show Must Go On: EH&S Compliance During the Pandemic

By: Beth Hesse, CPEA

In EHS Support’s March 27, 2020 Client Alert, we identified the United States Environmental Protection Agency’s (EPA) temporary policy regarding its enforcement of environmental legal obligations during the COVID-19 pandemic. This temporary policy applied to the EPA’s Enforcement and Compliance Assurance Program with a separate policy issued for activities performed under the Superfund and Resource Conservation and Recovery Act (RCRA) Corrective Action enforcement instruments. Under this temporary policy, EPA could grant enforcement discretion for noncompliance if regulated entities complied with the steps outlined in the temporary policy.

This temporary policy expired August 31, 2020, meaning that EPA has returned to business as usual; the agency will levy civil and criminal enforcement penalties in response to non-compliance. During a September 2020 air quality compliance workshop hosted by the North Carolina Department of Environmental Quality’s (NCDEQ) Division of Air Quality, it was reported that the number of on-site compliance inspections conducted by NCDEQ between March 2020 and June 2020 dropped significantly from 139 on-site inspections in March to 42 total on-site inspections between April and June. However, in July 2020, NCDEQ rebounded to 128 inspections. Regulatory compliance and enforcement activities are returning to “pre-COVID-19” rates, especially in states where COVID-19 restrictions are being eased, like North Carolina.

Similarly, our clients’ portfolio companies have returned to work. Though many of these companies are operating at reduced capacities based on state and local restrictions, as operations pickup, facility personnel are confronted with ongoing environmental, health, and safety (EH&S) concerns, in addition to managing COVID-19 protocols. At its core, these two interests share similar and complementary objectives – protecting the environment and the health and safety of people. Though managing COVID-19 risks has demanded a shift in focus, neglecting EH&S compliance can lead to significant business risks as well as impacts to people and the environment.

EHS Support expects to see the same EH&S compliance issues as we go back to visiting sites. As before the pandemic, these compliance issues occur for several reasons. For example, issues are not identified by facility personnel due to a lack of expertise or training. But after several months of business disruption because of the pandemic, some facilities had personnel retire or get furloughed without a clear delegation of EH&S responsibilities, possibly exacerbating unknown violations. If done without careful consideration, cost-cutting measures could also have unintended consequences on EH&S compliance.

In our April 9, 2019 Client Alert, we suggested that a focused approach to EH&S compliance helps prevent runaway expenses, violations, and loss of a positive corporate reputation. It is also preferred over applying makeshift solutions that may lead to more problems. During the last 6 months, compliance schedules have continued to age – permits may have expired, notifications or annual submittals (e.g., EPCRA Tier 2, Toxic Release Inventory [TRI], or Toxic Substances Control Act [TSCA] reporting) have come due, and training obligations continue to be required. With the TSCA deadline approaching in November 2020, companies will want to get back on track or face the music. For example, as reported by EHS Daily Insider in May 2020, significant fines were assessed for violations of the TSCA, including an ammonia supplier in Georgia that was fined $22,500 for failing to submit a chemical data reporting (CDR) report for a chemical by the required date.

What is the current compliance status of your facility’s EH&S programs? If you are not sure, consider conducting an internal audit or program-specific compliance evaluation. Compliance evaluations can be as simple as asking an employee to closely review their regulatory obligations on a continuous basis, or a more objective approach would be to hire a third-party auditor. Did you know that audits can be done virtually, still giving your company a snapshot of compliance without adding additional exposure to on-site personnel?

When contemplating EH&S compliance, it is critical to have a clear strategy. At a very basic level, the steps are simple:

  • Understand the facility/operations
  • Identify potentially regulated aspects (e.g., wastewater discharges, waste generation, air emissions, fork-lift operations, fall protection, confined spaces, electrical safety)
  • Develop a plan of action
  • Fully implement the plan

While EH&S compliance can be complex when you consider the various laws, regulations, and codes that potentially apply to a facility, site personnel can make the most of the resources they have. Rather than become overwhelmed, try to break potential risks into tiers or areas of focus. Is there an operational area where you might be more proficient than another? Does your state offer small business compliance support? Are you able to bring in a consultant to get you started? The last 6 months have shown businesses how to leverage technology to facilitate site inspections and training, enhance site safety protocols, and implement operational efficiencies out of necessity.

The business landscape has changed, but EH&S compliance obligations continue to be in effect. These uncharted times call for balancing ever-evolving responsibilities related to COVID-19 with the ongoing EH&S compliance obligations. By developing and implementing a plan that effectively contemplates both, you can help proactively manage those risks. The show must go on.

EHS Support is a full service environmental, health, and safety consulting firm for a wide variety of industries. We offer site assessments, investigation and cleanup, environmental due diligence, and EH&S regulatory compliance guidance to our clients.

ABOUT THE AUTHOR Beth Hesse is a Certified Professional Environmental Auditor with over a decade of experience in multi-party project coordination, environmental due diligence (including Phase I and Phase II assessments), and environmental compliance (including hazardous waste management, stormwater, spill prevention, air quality, and wastewater aspects)… Read More