As institutional investors display greater desire to invest in private equity funds that consider environmental, social, and governance (ESG) issues throughout their investment cycle, there has been little consensus on what information should be requested from fund managers to understand their ESG standing.

A new framework is attempting to shed some light on this issue.

More than 40 institutional investors, 20 private equity trade associations, and a number of private equity fund managers collaborated to develop the ESG Disclosure Framework for Private Equity. This document seeks to define a set of common objectives and concerns to facilitate greater consistency in ESG disclosure processes. While not the first attempt to standardize guidance on ESG disclosure, this effort is particularly unique because of its focus on private equity and extensive industry collaboration.

The working group constructed a framework of eight disclosure objectives, five specific to fund-raising and three during the fund’s life. For each objective, the framework provides questions and specific forms of communication designed to facilitate discussion around disclosure requirements.  The framework is clear that effective and relevant ESG disclosure must be defined through discussion between managers and investors in the context of specific funds.

Read about investor attitudes toward ESG issues in our ESG in Private Equity study. For more information about how the framework’s suggested forms of communication achieve its desired objectives, please contact us today at info@malksp.com.

Investors are mounting pressure on the world’s largest companies to embrace sustainability management and report on carbon emissions, according to the Carbon Disclosure Project (CDP).

But what is driving this upward trend?

With $87tr under management, an increasing number of institutional investors support CDP’s annual requests of companies’ carbon emissions. There are 2 primary reasons for this growing trend:

1) In the latest CDP survey, 70 percent of firms stated that climate impacts will threaten revenues in the near future. This raises investors’ concerns to the adaptability of companies to operate in a changing world and their ability to mitigate such risks.

2) Addressing carbon emissions is increasingly seen as an investment in long-term shareholder value. Mitigating carbon emissions is linked to lowered energy use in facilities and decreased fuel consumption in corporate vehicles – which reduces operational costs and increases the bottom line.

This upward trend is supported by the findings of our study, ESG in Private Equity 2012, in which increased investor concern about ESG issues are being met with cost savings and eco-efficiency management programs.

When facilities managers strive to maximize HVAC systems’ energy efficiency, two crucial aspects are often overlooked; the size of chiller plants and the associated air delivery system. According to Energy Star, most chillers are oversized by 50-200% and roughly 60% of building-fan systems are oversized. To combat this problem and reduce HVAC energy usage, chillers must be downsized and pumping systems must be redesigned to match occupancy and air ventilation requirements.

The immense quantity of energy required to power such inefficient systems has sparked interest in the size of buildings’ chiller plants, as this often contributes to significant costs. In the case of buildings with oversized chillers, “a common cause of energy waste is that many chilled and condenser water circulation systems are ‘throttled’ to produce the desired performance”. Essentially, if a smaller plant with a more efficient dispersal system were put in place, equivalent pressure levels could be attained using remarkably less energy.

A common rationale for oversizing chillers posits that extra capacity enables increased usage while avoiding risks inherent in overloading an undersized one. However, this hedge does not account for the increased construction cost associated with building an air delivery system designed to support the oversized chillers. This is why a review of buildings’ energy systems is so vital when planning for new construction. Not only will the effort save money in the long run, but it will also avoid overpaying upfront costs to oversize a chiller.

In terms of the system itself, there are many ways to make an HVAC run more efficiently. First, the size of the pumps has a direct effect on the available pressure so downsizing them reduces the amount of energy needed to achieve the same level of pressure. With regard to the piping, having a less complicated layout and a shorter distance of travel can fashion a more efficient system. By keeping the system simple there will be a “reduced pressure loss” in addition to “less piping [and], less welding” – which reduces the need for O&M.

Ideally these improvements would be integrated into blueprints before the construction process begins, but in the case of existing buildings the old system would have to be uprooted and another would have to take its place. Such a retrofit may deter facilities managers, because of the significant investment and long payback period. However, having a more efficient system will lower the building’s peak demand and prevent costly ratchet penalties.  Ultimately, few facilities managers, let alone CFOs, will sanction the replacement of a functioning HVAC system.  Thus, these important considerations should be communicated across the organization, so they are readily available when the existing system’s life ends and discussion of replacement options begins.

With December 2012 marking the fourth year of its Green Portfolio Program, Kohlberg Kravis Roberts & Co. L.P. (KKR) released its annual results this month and the figures have indicated another exponential improvement since its inception. To achieve such results, KKR partnered with the Environmental Defense Fund (EDF) to drive operational cost savings within their portfolio companies through environmental innovation.

Last year, KKR disclosed in their report savings of $365 million and the displacement of 2.6 million tons of waste as well as carbon emissions equivalent to burning almost 91 million gallons of gasoline. Amazingly, those figures were the combined results of just 13 portfolio companies.

KKR worked with additional companies this year, 24 portfolio companies total, and as one would expect, the savings trumped last years’. On December 17^th 2012, they reported savings of $644 million and averted 1.2 million tons of greenhouse gas (GHG) emissions. KKR was also able to displace 3.4 million tons of waste and divert 13.2 million cubic meters of water. With more than a 50% increase in all areas, KKR has proven how to unlock value for its portfolio companies.

KKR’s Green Portfolio webpage breaks down the reduced environmental impact and associated cost saving for each company. Similar to how this year’s results were laid out, KKR also identifies the strategic advantage, both environmentally and financially, of adopting sustainable business practices

As stated on our blog last year, “private equity funds are an unusual type of asset management” in that they often control a large portion of privately held companies. In order to create value for their stakeholders, private equity funds must be resourceful, like KKR, to proactively reduce their environmental impact and produce a financial return in the process.

This is the first of a four-part series covering the state of sustainable supply-chain management in the IT sector. 

As global economic trends increase natural resource costs, complicate production networks, and concentrate specialized manufacturing in geographic hubs, supply chains are becoming increasingly exposed to the risk of business disruption. As stakeholders continue to raise corporate attention to issues of environmental sustainability and social responsibility, sustainable supply chain management (SSCM) strategies are becoming recognized as an effective way to address stakeholder sustainability concerns while mitigating the risk of business disruption and creating business value.

Debate over the business case for supply chain sustainability is dominated by a variety of diverging perspectives, ranging from “there absolutely is value” to “there absolutely is no value.” Malk Sustainability Partners’ study, Sustainable Supply Chain Management in Information Technology (PDF) investigated this issue as it pertains to the IT sector by interviewing supply chain and sustainability managers at top IT manufacturers and service providers as well as industry experts. The aggregated interview data conveyed, somewhat unsurprisingly, that the business value of a sustainable supply chain strategy depends on companies’ operational focus, position in the value chain, exposure to compliance risk, and business models.

Malk Sustainability Partners (MSP) engaged 29 global information technology (IT) companies and five industry experts to investigate the key drivers, important issues, and popular strategies behind this sector’s adoption of SSCM. Corporate respondents included hardware manufacturers like Hewlett Packard, Dell, Sony, Motorola, and Ericsson; component manufacturers like Intel, ST Microelectronics, SanDisk, Advanced Micro Devices, and Applied Materials; cloud software companies like Cisco Systems, IBM, and Oracle; and enterprise buyers of electronic equipment like eBay.

The results of MSP’s research revealed:

• Companies’ perspectives of the business value of SSCM strategies vary depending on their operational focus, position in the value chain, and exposure to compliance risk.
• The four primary drivers of SSCM are stakeholder pressure, regulatory pressure and compliance, risk and cost management, and corporate leadership.
• SSCM currently focuses more heavily on social issues than environmental ones; with the most prominent social issues pertaining to conflict mineral compliance and fair labor hours.
• SSCM efforts to engage suppliers vary by degree of depth. Respondents indicated this variation ranges from self-assessment questionnaires (limited depth) and second or third-party audits (intermediate depth) to collaboration through industry coalitions (most in depth).

A significant majority, nearly 70 percent, of respondents indicated company-wide supply chain sustainability policies add value by mitigating risk and enhancing supply chain resiliency. Still, a meaningful minority of participants indicated otherwise and, in some cases, remains skeptical about the true value of these initiatives. For some, SSCM initiatives seem like obligatory investments needed to “check the box” of customer compliance. Careful review of the interview anecdotes was necessary to determine which circumstances make the value of an SSCM strategy outweigh the associated costs.

One topic that yielded particularly interesting anecdotes pertained to e-waste regulation. Governed at the state level in the U.S., the regulatory framework mandating e-waste recycling has evolved into a regulatory patchwork. Currently, more than 25 states have regulations that mandate consumer-electronics brands to recycle e-waste. States’ recycling quotas are typically determined by a weighted average of brands’ market shares. As these quotas differ by state and brand market share per state changes over time, the compliance challenge posed by this regulatory patchwork is significant. Many interview respondents cited difficulties in coordinating their companies’ programs to meet this challenge.

See original blog posting on GreenBiz.com 

Growing concern from stakeholders for the environmental and social impacts of companies has brought the reporting challenge of communicating intangible risk to the forefront of many minds.  Currently, financial reports do not explicitly address environmental, social, and governance (ESG) risks, which limits the extent to which they reflect a company’s capacity for future growth.  As investors rely on these reports to make capital allocation decisions, there appears to be an opportunity to improve that allocation through increased ESG disclosure.

While financial reports reflect companies’ prospects for short-term success, capacity for long-term resiliency depends on a combination of both financial fundamentals and exposure to ESG risks. Integrated reporting provides information about the resource intensity of companies’ product processes, which might reveal exposure to price volatility in certain commodity markets.  Additionally, it highlights efforts taken by management to address such risks, which can offer insight about corporate decision-making tactics.

Investors would benefit from integrated reporting because in order to make well-informed decisions they would need to identify and understand any imposing obstacles. As stated by the International Integrated Reporting Council (IIRC), an organization of business leaders working to define a globally accepted integrated reporting framework, “integrated reporting reflects the broad and longer-term consequences of the decisions organizations make […] in order to create and sustain value.”

Integrating intangible risks into conventional corporate reporting is a daunting task and thus calls for collaboration. This need becomes particularly apparent when considering the underlying objective, which is to standardize the report across multiple industries.  Ian Ball, the CEO of International Federation of Accountants (IFAC) and a chairman of the IIRC, confides that “financial reporting on its own [is no] longer telling us enough about a company to really understand its prospects.”  That is why the IIRC, Global Reporting Initiative (GRI), and Sustainable Accounting Standards Board (SASB) are underway to standardize integrated reporting so that all risks are effectively conveyed and stakeholders can better understand a company’s probability for long-term success.”

The SASB recently launched its goal to “standardiz[e] corporate reporting of the social and environmental performance of every publicly traded company’s operations, across 89 industries.”  Although the investment of time to create standards and benchmarks for each industry is significant, the SASB has begun the process by developing a Materiality Map.  This will help identify the sustainability issues most applicable to individual industries and establish a system for disclosure in a new model of reporting.

“Construction on the new facility is expected to begin at the end of this year and last for two years.  At full capacity, it is estimated the facility will produce 500,000 metric tons of material per year. By using plant-based materials instead of non-renewable materials, the facility will remove the equivalent of 690,000 metric tons of carbon dioxide or the equivalent of consuming more than 1.5 million barrels of oil each year, JBF says.” (Source: Environmental Leader)

As this year comes to a close, JBF Industries Ltd., in partnership with Coca-Cola, will embark on a two-year endeavor to build the largest bi-glycol production facility in the world. Bi-glycol is the main ingredient in the PlantBottle™ packaging technology developed by Coca-Cola, which is the first recyclable PET plastic bottle produced with plant matter. Since its introduction in 2009, Coca-Cola has employed this packaging solution in a number of product lines and, in the process, displaced the equivalent of 100,000 metric tons of CO₂. At full capacity, the new facility is estimated to displace 690,000 metric tons of CO₂ every year.

In addition to enhancing Coca-Cola’s brand image, this partnership will help the company achieve their goal of using only PlantBottle™ technology by 2020. The facility itself will be located in Araraquara, Sao Paulo, Brazil and the primary input of production will be processed waste from locally sourced sugarcane. This expansion in Coca-Cola’s PlantBottle™ production reveals the company’s capacity to license the technology as a new source of revenue.  As evidence, consider Heinz’s February-decision to implement PlantBottle™ technology in their 20oz. ketchup containers. Since Coca-Cola plans to produce 500,000 metric tons of material per year, it is likely they believe more companies will follow the Heinz decision.

Such a licensing agreement, “although both CEOs declined to share financial details”, “will also help Coke further its research into renewable packaging.” Since June, Coca-Cola has been working with Gevo, Virent, and Avantium to develop a 100% renewable plastic bottle that “could ultimately cost less than the fossil fuel based incumbent.” The combination of this innovation and increased production capability from the new facility could invoke a sweeping shift towards sustainable packaging across the food and beverage industry.

Justin Vertongen is an Associate at Malk Sustainability Partners (MSP), a specialty management consultancy that guides investors and businesses to leverage resource and environmental management to maximize profitability.  Our expertise in responsible investing and business practices helps clients to enhance operational and financial performance while managing exposure to environmental risks.

Simply stated, we unlock value through sustainability™.

More information on MSP is available at www.malksp.com.

In fact, many funds, such as TPG Capital, KKR, and Blackstone, have already built systems specifically designed to drive cost savings from eco-efficiency initiatives while navigating an increasingly important set of social and governance considerations.

These are a few of the trends we’ve discovered and shared in ‘ESG in Private Equity’, a study released today by Malk Sustainability Partners (MSP). In collaboration with Environmental Defense Fund (EDF), we conducted a survey that provides a unique look into the small, yet influential universe of decision makers in the private equity sector. The report is a collection of evolving perspectives on ESG and its impact on value creation.

ESG is a term used to describe a range of investment considerations related to issues such as environmental sustainability, social equity and corporate citizenship. This report provides evidence that the private equity sector is moving rapidly through the evolutionary stages of ESG adoption.  These investors are no longer asking what is ESG or why are these issues important, but how to capitalize on them.

“Environmental management has become an important part of our value creation toolbox,” noted Pat Tiernan of TPG Capital, “energy and waste management drive cost savings while, in some cases, focusing on the environment has led to profitable new product lines.”

Respondents cited cost saving opportunities and the expectations of fund investors, referred to as limited partners (LPs), as the primary drivers for ESG management.   And LP expectations will likely continue to grow as more institutional investors become signatories of the United Nations Principles for Responsible Investment.

Interestingly, despite extensive coverage of concerns regarding recent regulations for the financial community, we were surprised to find that the new rules were the least cited factor driving funds to focus on ESG. This is a promising indicator that while government mandates will likely catalyze faster action, they are not required for this transformation to continue.

“ESG and sustainability are macro themes which will influence value going forward,” noted LP respondent Scott Chan of the Sacramento County Employee Retirement System, “We are interested in how to participate in this theme through investment vehicles, as well as how to integrate management tools for ESG-related risks.”

In addition to assessing the current state of the market, our team identified the best management practices that funds are utilizing to drive value creation through ESG, including:

• Adoption of a specific policy for managing ESG issues throughout the investment cycle;
• Recruitment of experts or consultants to plan and execute ESG related initiatives;
• Collaboration with portfolio companies to enhance ESG performance at the operational level;
• Enhanced integration of ESG considerations into the due diligence process;
• Metrics and reporting to manage ESG efforts and measure improvements; and
• Development of communications tools highlighting ESG accomplishments.

A more detailed breakdown of how funds with varying levels of ESG management maturity approach these practices is available here.

These findings are promising for the future of private equity and corporate environmental sustainability.  Private equity-owned companies represent a significant percentage of the U.S. economy, and growing fund manager focus on improved ESG performance will help a broad swath of privately owned companies profitably reduce their environmental and social impacts.

Andrew Malk and Zach Goldman are Partners at Malk Sustainability Partners (MSP), a specialty management consultancy that guides investors and businesses to leverage resource and environmental management to maximize profitability.  Our expertise in responsible investing and business practices helps clients to enhance operational and financial performance while managing exposure to environmental risks.
Simply stated, we unlock value through sustainability™.
More information on MSP is available at www.malksp.com.

It is easy to assume that management of triple bottom line issues, often described in finance as environmental, social, and governance (‘ESG’) matters would be of little interest to such financiers.  However, GPs around the world are beginning to adopt ESG in a context they are familiar with: value creation.

Active value creation is now fundamental to providers of private capital.  A recent survey by tax and assurance consultancy McGladrey, for example, found that 70% of firms now implement a ‘100 day plan’ to realize operational cost savings and other strategic benefits shortly after acquiring a company.  Once the domain of only the most active funds, 100 day plans and other approaches to operational improvement are now commonplace.

An increasing number of funds now see ESG management and environmental management in particular as a means of creating value.  In a recent study our group conducted in collaboration with the Environmental Defense Fund (‘EDF’), 69% of responding GPs noted that environmental issues are material to investments from a cost savings perspective and 77% cited materiality from a risk management perspective.  In short, funds are increasingly confirming the perception that they can profit by focusing on sustainability.

How can funds profit from ESG management?  In our experience, GPs are doing so by:

• Leveraging eco-efficiency efforts as a method of driving operational ‘cost-outs’
  Funds are engaging management of their portfolio companies to focus on savings which can be realized by increasing the energy efficiency of operating areas such as facilities, manufacturing processes and logistics while identifying other cost saving opportunities in areas such as packaging or waste management.  For instance, private equity fund TPG collaborated with portfolio company Caesars Entertainment on energy and waste management initiatives which resulted in $17 million in annual run-rate savings across 110 projects and a 33% reduction in trash at 2 properties.Another interesting example of eco-efficiency is KKR’s Green Portfolio Program.  This initiative, which began within a small subset of the fund’s portfolio as a collaborative effort with EDF, has expanded across 13 companies between 2008 and 2011 and resulted in $365 million of avoided costs.  At the same time, Green Portfolio initiatives have avoided over 800,000 metric tons of greenhouse gas emissions, 2 million tons of solid waste, and 300 million liters of water use.

  Such efficiency initiatives are an extension of the private equity sector’s focus on reducing operating costs within portfolio companies and can often generate attractive returns.  In our experience, GPs typically expect green cost-out initiatives to have a simple payback of less than three years and a meaningful impact on a company’s EBITDA.

• Integrating ESG considerations into portfolio management & investor relations
  While reducing portfolio company operating expenses through eco-efficiency initiatives is the primary focus of ESG initiatives at many funds, particularly in the United States, GPs are also striving to integrate these considerations throughout the investment cycle and into relations with the institutional investors which are limited partners (LPs) in private equity funds.These efforts are driven, in large part, by the increasing expectations of LPs that GPs more proactively manage ESG issues.  A representative of one major UK-based institutional investor recently shared four overarching questions which he asks when evaluating a private equity fund manager:
  1. How do you as a GP look at ESG issues in your own due diligence?
  2. How do you look at these issues when you’re managing an asset?
  3. How do you communicate to LPs and other stakeholders?
  4. What are your views on ESG-related protocols including the United Nations Principles for Responsible Investment?

  These inquiries, and similar questions which large LPs are increasingly asking fund managers, are driving GPs to look more closely at environmental, social, and governance issues throughout the investment cycle.  Amongst other benefits, doing so helps them to please their investors and supports fundraising efforts.

The Economist recently argued that the public company is in danger of extinction (the number of public companies in the U.S. has fallen by 38% since 1997) and it is expected that private capital will play an expanding role in the global economy.  Private equity funds could therefore play a prominent and expanding role in the business world.  At the same time, commodity-related risks (such as price volatility) are making the mandate for efficiency in business stronger than ever.

Given this growing role, increasing visibility, and the business case for smarter resource use, many private equity fund managers are beginning to manage environmental, social, and governance matters in a more systematic, value-oriented way.  At Malk Sustainability Partners we look forward to seeing this trend continue, and to accelerating it wherever we can.