This article has been reprinted with permissions from Fundwise. The original article was published by Fundwise on May 12, 2021.
Understanding the exact goal of an ESG policy is one of the keys to success when creating such a document, especially for IR professionals who will be tasked with communicating the policy to LPs and to the public.
Private equity and venture capital IR professionals who are neither ESG specialists nor compliance experts often misunderstand what an ESG policy should be, how to create one and how to keep it fresh.
“An ESG policy is a fund-level policy that helps inform the investment process around how a manager prioritizes, identifies and considers the environmental, social and governance factors that may or do pose material financial risk to the underlying investments,” Trysha Daskam, head of ESG strategy at Silver, explained at a recent Fundwise roundtable. “Financial materiality and considerations in the investment process are really the hallmarks of what cause an ESG policy to be put in place.”
Daskam dug into the misconceptions she sees preventing private markets firms from producing robust ESG policies.
Misconception 1: An ESG Policy Should Be All-Encompassing
An ESG policy is a policy, not a report on corporate social responsibility practices that relate to ESG. Investment firms often mix apples and oranges and mistakenly include anything and everything related to ESG, including their firm’s vision, mission and values in their policy. This just muddies the water.
“We see managers who view their ESG policy as a comprehensive document that covers all practice areas and aspects of the firm that touch ESG,” said Daskam. “We’re really clear that this is an investment-level policy and process. Our view is that the investment team has primary responsibility for the ESG policy.”
Daskam explained that what prompts this misconception is the lack of specificity in LPs’ ESG questions. In an ESG DDQ, there may be questions about ESG at the investment level mixed with inquiries about a firm’s philanthropic initiatives. LPs conflate different issues and firms follow suit.
“As a result, managers often view these practices as the same and they do, or try to do, everything in one document,” she said. “It’s a mistake.”
Misconception 2: ESG Policies Authored By Other Firms are Useful Templates.
An ESG policy should be customized to a specific firm and its investment process, strategy, and policies. If a firm relies on a peer’s ESG policy, it will likely end up with an ESG policy that’s not applicable to its specific investment thesis.
“Your investment thesis will drive the identification of ESG factors that are or may be material to the investments you make,” said Daskam. “Using material ESG factors identified by another firm is inherently going to lead you down the wrong road. The process must be customized for your firm.”
She noted that the skeleton of another firm’s ESG policy could potentially be helpful, but only in terms of identifying the sections that other firms deemed relevant to include. “Using the contents of another firm’s ESG policy can create many risks, including the risk of policy violation if you are unable to execute on the actions described in the borrowed content.”
Misconception 3: Once an ESG Policy Exists, It’s Immutable
ESG policies should be reviewed at least once a year and Daskam suggests a higher frequency. This is because discussions around ESG are constantly evolving. Since the policy is based on a firm’s investment strategy, the policy will also evolve according to how a firm’s investment practices are changing.
“We evaluate ESG policies on a bi-annual basis,” she said. “We look at them in June. We look at them again in December. I think it’s a mistake to look at them any less than annually. ESG changes. The focus of ESG changes, and it changes quickly. Your ESG policy should grow and make space for how ESG is trending.”
She acknowledged that other policies and procedures go through annual reviews but points out that ESG considerations are changing quickly as regulators increase their focus on this area. As such keeping pace with those changes may require a shorter review cycle.
“The first iteration of your ESG policy should really capture what you’re capable of doing,” Daskam said. “Your program, your personnel and your resources will grow overtime, and future iterations of your policy will capture how you’ve been able to grow, the resources you brought in, and what new things you’re doing that you weren’t doing before.”