General partners see the benefits of improved ESG practices for reputation and investment opportunities, but often fall short of putting mechanisms in place that will drive actual change
HONG KONG (November 14, 2022) – Morrison Foerster, a leading global law firm, today announced the results of its inaugural Asia Funds ESG Report, which highlights the disconnect between increasing ESG awareness and embedding ESG into deals and operations. The new report, Navigating the ESG Maze, in conjunction with AVCJ, shows that the ESG framework provides opportunities for fund managers, including: implementing ESG policies at target companies to raise company valuations; engaging ESG professionals to assist with enterprise risk assessments related to climate, Diversity, Equity & Inclusion (DE&I), and governance; and staying ahead of greenwashing claims by conducting ESG audits of their investments and marketing efforts.
“Certainly, fund managers are re-evaluating their approach to ESG and almost all have at least started on their ESG journey. Every respondent on our survey says they take ESG criteria into account when making investment decisions, with more than two-thirds describing it as a deciding factor,” said Marcia Ellis, global chair of Morrison Foerster’s Private Equity Group. “However, Asia GPs are generally behind other areas of the world on ESG adoption and practice, and while significant progress has been made in the past few years, there is still a long way to go.”
“Our findings reveal that many fund managers are still at an early stage of their ESG journey and this provides an opportunity for fund managers in Asia to get it right from the start,” added Susan Mac Cormac, global chair of Morrison Foerster’s ESG Group. “Many GPs are making the mistake of only treating ESG as a compliance issue – whereas the real benefits in embedding ESG considerations are in driving value, managing enterprise risk, and reporting.”
Widespread Awareness of ESG in Asia Impacts Investment Choices and Valuations
As an example of the global reach of ESG, every respondent reported factoring ESG criteria into their decisions about potential investments. General partners (GPs) see the benefits of improved ESG practices for reputation and investment opportunities, with a large majority (69%) reporting that ESG can be a deciding factor when making investment decisions. The opportunity for ESG to increase a target company’s valuation is a strategy used across the region, with 82% of respondents indicating that they have invested in companies with negative or neutral ESG credentials with this strategy in mind. A large majority (83%) agree that positive ESG metrics increase a target’s valuation, and 91% of GPs have found that positive ESG metrics help smooth exit processes.
Potential Greenwashing Risks Loom
In Europe and the United States, regulators are evaluating how greenwashing should be tackled as the number of sustainability and ESG funds have multiplied in recent years. While ESG regulations in Asia have not developed to the same degree, the report indicates that GPs in the region may be at risk of greenwashing accusations. Almost none of the fund managers have had greenwashing claims raised about their company or their funds, but 60% of respondents say they promote some investment activities as “green.” Additionally, enthusiasm for ESG seems to be limited to fund managers’ investment criteria for target companies and not their own organizations, as only 22% of funds have a dedicated ESG professional and just 14% link investment team compensation to ESG goals.
The “S” in ESG Needs More Concrete Action
While the environmental aspect of ESG captures most of the discussion, the social component has quickly come to the fore. Over the last decade, risks, both operational and reputational, and regulations have dramatically increased around human rights and equality. This is reflected in the high percentage (88%) of fund managers who reported that communicating the importance of DE&I issues internally is the top action they have taken to promote improved DE&I in their organizations. Embedding ESG considerations into a fund or company’s policies and operations helps not just to comply with existing laws and regulations, but also to identify company-wide risks and opportunities to drive value. However, only 50% of fund managers say they are committed to diverse representation in leadership, and only 33% have made a financial commitment in this area.
Fund Managers Not Yet Viewing ESG Due Diligence as a Necessary Risk Mitigation Strategy
In regions with more developed ESG programs, fund managers see ESG due diligence as a necessary risk mitigation strategy. However, in Asia, less than half of respondents (46%) conduct ESG due diligence on every deal, with a further 46% doing so on most deals. Additionally, it is increasingly common in the US for fund managers to include ESG provisions in investment documentation. But this has not taken hold in Asia, where less than one-third (29%) of respondents always require the inclusion of ESG compliance clauses in investment documents. These clauses set out clear expectations and targets on key ESG issues and also address potential accusations of greenwashing, an area where regulators are increasingly active.
To download the full report, view interviews with Asia fund managers about their views on the current and future status of ESG-led investing, or listen to the companion podcast ESG Journey, visit: www.mofo.com/asia-funds-esg-report.
As part of MoFo’s Asia Funds ESG Report, fund managers can take a five-minute ESG online quiz to identify where they are along in their ESG journey for their funds and investments. The online quiz is anonymous and provides fund managers with a short report to benchmark themselves against data from this report. Visit the survey.
In the third quarter of 2022, on behalf of Morrison Foerster, AVCJ surveyed 100 Asia-headquartered Fund GPs with USD1 billion+ assets under management to gain their insights on how ESG considerations are impacting their investments and the market. The respondents came from private equity funds, credit and special situations funds, sovereign wealth funds, insurance asset managers, and pension funds. By geography, 35% of respondents were based in China/Hong Kong, 25% in Japan, 15% in India, 15% in Southeast Asia, and 10% in other Asian jurisdictions, including Taiwan and South Korea. All responses are anonymous, and results are presented in aggregate.
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