ESG and private equity – towards a new role for lawyers?

Sustainability in private equity

A direct corollary of their implementation is that PE firms must now report both on sustainability risks and the impact at product and entity level. In effect, fund managers now stand challenged to promote transparency and combat the phenomenon of ‘greenwashing’.

In this regard, it has been said that “[PE] funds are finding that ESG issues that weren’t necessarily a factor commercially a few years ago are now front and center. And COVID-19 has only accelerated the pace of change² ”. As a matter of fact, a survey undertaken by Bain and Company³ with over 12,000 US and EU consumers revealed that 44% are very confident that “sustainability will be even more important in the wake of the pandemic.”

The figures on the growing importance of ESG are compelling and self-explanatory. Thus, a report prepared by the US SIF Foundation⁴ disclosed that for 2020, investors held USD 17.1 trillion in assets chosen according to ESG principles and, up from USD 12 trillion just two years earlier. As to ESG-specific mutual funds, in 2021, the Exchange Traded Funds reached a record USD 400 billion in Assets Under Management, representing an increase of up to 33% from the year before; these are expected to continue to grow rapidly in the forthcoming years⁵ .

Another report⁶ issued after a meeting of the Practical Law In-house Consultation Board disclosed that the “ESG is a key priority for the [Financial Conduct Authority] and the [UK] government also launched a green finance strategy which was supportive of integrating ESG factors into financial decision making⁸ .”

Yet, amidst these major changes, not much has been said on the impact of ESG on the role of PE lawyers.

What then is the changing role of PE lawyers amidst these changes? This article examines the meaning and scope of the concept of ESG, reviews industry responses and the results of surveys on its anticipated impact on PE lawyers and comes to the concluding thought that this remains a largely subjective matter given the complexity of the ESG concept. A caveat to this article is that the issue of greenwashing has been kept outside its scope but will be dealt with in another article.

Defining Environmental, Social Governance (ESG)

The concept of ESG has remained undefined despite a consensus in the PE industry that we are dealing with a concept which is “broad and amorphous, notoriously hard to define⁹” and “more complicated than GDPR implementation and Brexit [because] it touches every business area, and the transformation is not always a direct response to legislative change …/… [i]nstead there is a complex patchwork of soft and hard law and …/… many elements of the transformation are discretionary¹⁰”.

At best, ESG has been described as “ESG isn’t about doing good for good’s sake; it’s about recognising what customers really want and turning that into a strategy that creates tangible value¹¹. Consequently, “ESG criteria have now become returns in supporting more efficient governance and management practices and in reducing long-term risks.¹²”

However, what is undisputed is the importance which it has gained in the PE industry. Thus, it has been commented that ”ESG considerations – especially the environmental ones – are now a matter of credibility for funds and asset managers ESG criteria have now become returns in supporting more efficient governance and management practices and in reducing long-term risks.” A direct consequence of this is that “environmental matters are becoming a major concern for regulators which is translated in stricter regulation. It means more transparency requirements regarding environmental impact for companies and more liability related to the subsidiaries’ behaviour’.

Put within the PE perspective, Bain & Company¹³ have expressed the view that the focus of PE firms has shifted from the traditional governance risks into a “growing awareness that environmental, social and governance issues are highly interrelated and that the biggest benefits over time accrue to companies that balance efforts between all three” as opposed to the traditional focus on governance risks.

It is their firm belief that the catalyst for this change of focus are investors because globally Limited Partnerships are demanding based on the 2020 Edelman Trust Barometer Special Report¹⁴ entitled “Institutional Investors”. According to the report, 88% of Limited Partnerships globally have recourse to ESG performance indicators in making investment decisions, out of which 87% stated that they invest in companies which have reduced their near-term return on capital in order that these can be reallocated to ESG initiatives.¹⁵

LAWYERS’ ESG CHALLENGE & THE UK PERSPECTIVE

Lawyers’ New Role

There is no settled view on the changing role of PE lawyers because of ESG considerations. As Bain & Company have opined, “even the leading law firms are still figuring out where to play and how to win. One thing is already clear though – making it work takes the same level of commitment and ambition firms devote to developing any new differentiated capability.”

Nevertheless, the starting point would be the outcome of a meeting of the Practical Law In-house Consultation Board to the effect that the challenge of PE lawyers’ amidst ESG is “making the indigestible, digestible¹⁶. In particular, the meeting identified the following as the challenge ahead for PE lawyers:

1. understanding the complexity of new legislations ranging from environmental law to company law and finance simultaneously with gathering data on existing structures and assist with the development of the appropriate compliance approach;
2. understanding each component of ESG notwithstanding the absence of a formal definition and developing an ESG action plan that will enable them meet with disclosure obligations;
3. developing standard contractual clauses to re-define their client relationship to guard lawyers/law firms against specific risks whilst simultaneously enabling lawyers/law firms “focus on the relevance of ESG and the desire to drive this through¹⁷”;
4. collecting and reviewing data to adequately report on ESG metrics with a view to enhancing transparency and accountability in line with regulations; and
5. developing ESG measures that are over and above the minimum regulatory compliance and adopt these as their own such that both in strategy and business they are “not just ‘doing business’ but doing business in the right way.” For instance, set up an ESG committee, designate a person who will specifically overview ESG compliance such that the direction of travel of the fund or organization will be reviewed “through an ESG lens ¹⁸”

The changing role of PE lawyers amidst ESG was addressed during the Bristol Law Society interactive webinar on “An Introduction to ESG“¹⁹ . The overwhelming view was that lawyers “play an important role as part of a multi-disciplinary group ²⁰” considering their skills “of diligence, analytical methodology, evidence-based assessment and advocacy ²¹” which are instrumental to understand, evaluate risks and advise on the strategy to be adopted to implement ESG against the backdrop of regulations developed to ensure transparency and combat the ‘greenwashing’ phenomenon as regards ESG.

Linklaters have expressed the view that lawyers will be transformed into investment bankers because of concerns that “other types of financial services firms [are] falling prey to some of the problems that have affected banks²²” as a result of which it is their belief that bank-style regulations have been extended to new spheres amongst which private equity.

As to DLA Piper²³, their view is that “legal teams are no longer just reacting to ESG issues, but proactively becoming involved in integrating material ESG risks and opportunities in business organizations, their operational policies and go-to-market strategies.”

In their view, the challenge of PE lawyers now centres around devising development strategies built around the following themes:

• sustainability strategy and integration into decision-making: lawyers will be responsible for laying down the strategic direction of travel of ESG and must ensure that sustainability forms an integral part of corporate governance;
• horizon-scanning: lawyers must be able to foresee ESG opportunities and risks that will impact the fund or company as these are at the core of sustainability. They are expected to identify the risks, including greenwashing and be aware of the evolution of regulations in order that these are incorporated into corporate management of the fund or company and that they put into place the necessary policies and protocols that will bring these into fruition.
• transparency and disclosure: lawyers have an obligation to (i) advise on and ensure that (i) reporting on sustainability (a) is transparent and identifies material issues (ii) sustainability is being implemented and the strategy to manage issues and (ii) ensure that transparency meets with the minimum reporting requirements and (iii) go above and beyond the minimum reporting requirements.
• policies and procedures: the ESG policies and procedures which lawyers draft must not only be robust but they must also be put into practice to ensure that they meet with investors’ expectations and “shape the culture and corporate decision-making process of [funds] and companies²⁴.
• grievance procedures: lawyers have an obligation to set up a grievance procedure which is adequate and the corresponding mechanism that ensures that concerns are raised and addressed as these form an integral part of the complex due diligence and risk management which lawyers are now expected to handle in the wake of the risks of litigation on ESG matters and the accompanying reputational risks and potential damage which these entail. In brief, the motto is to foresee and suggest ways to mediate in order to avoid actual litigation.
• managing indirect impacts: lawyers are expected to be directly engaged in due diligence relating to ESG matters as well as human rights issues and provide guidance on how to manage wider ESG risks and how these are likely to affect the fund or company; and
• in a time of crisis: lawyers are expected to address actual ESG crises which are likely to have a bearing on the financial position and reputation of the fund or company for instance when checks by regulators return a finding of not meeting with the minimum standards and there is a threat of litigation.

The pressures on lawyers is clearly highlighted in by PWC²⁵ who have asserted in their Global PE Responsible Investment Survey that 37% of their “respondents …/… have turned down an investment opportunity because of ESG concerns²⁶” and that less than PE firms have in place plans for emerging technologies and data ethics. Furthermore, Thomson Reuters²⁷ has summarised the challenge awaiting lawyers with the implementation of ESG itself in relation to three themes namely (i) ESG ratings and ESG data are not regulated thereby triggering lack of transparency (which the FSA has identified as crucial), conflicting data and loss of confidence from investors (ii) the formidable costs associated with data collection, preparing ESG reports, assessing performance, producing files and creating what they have termed as ‘new sustainability-based products²⁸’ and (iii) the absence of a definition of the ESG concept and considering the complexity of ESG components themselves. Robert van Breeman²⁹ has expressed the view that there is no one size fits all formula for lawyers’ internal ‘reconstruction’ for ESG. However, some pointers have been suggested and are worthy of note namely “(i) market positioning (ii) size (iii) types of clients, matters and sectors/industries (iv) financial structure and (v) governance model³⁰.”

The World Economic Forum³¹ has expressed the view that what it calls the data challenge is much wider than meeting with reporting requirements and that “the foundations of a strong ESG program are built on data ³²…/… [because] an organisation that is able to fully integrate ESG into corporate strategy, with a symbiotic relationship between day-to-day business and ESG goals, will find itself in a much stronger position than its peers”. It in fact advocates that reporting is actually a subset of data because it is data which makes decision making possible as it is “data which is integral to how an organisation collaborates, tracks and reports on ESG ³³.”

CONCLUSION

The concluding thought is that there is no single identifiable biggest challenge awaiting PE lawyers, especially in the realm of implementation of ESG with funds:

1. first because of the lack of an agreed and authoritative definition of ESG;
2. secondly because of the absence of an ‘ESG Scorecard’ setting out an agreed set of criteria to assess whether an institution is ESG compliant and deal with the twin issue of ‘greenwashing’;
3. thirdly, the question of data to be used for assessing ESG compliance. In the sphere of Private Equity, Apperio³⁴ have expressed the view that “data security is a case in point because the issue can be classified in several ways…/… today it has clear implications across the [ESG] categories – especially around employee and customer privacy ³⁵”
4. fourth, data privacy management because business is increasingly being done digitally since the COVID-19 pandemic and if we consider existing data protection laws and the twin issue of cybersecurity which calls for protection against ransomware attacks and hacking³⁶; and
5. finally, the governance level challenge, both at the level of clients and lawyers/law firms themselves because their new roles with ESG means that they too must review their internal processes, implement their own ESG strategy, recruit the right talent and/or train their personnel and revamp their environmental policies metrics in order that they remain competitive but also to be ESG compliant themselves. As Robert van Breeman has put it, lawyers new role amidst ESG is two-fold namely (i) “guide their clients through the ESG transformation³⁷” and (ii) “as independent actors in their own right ³⁸’.

In brief, lawyers/law firms need to reinvent themselves to meet the challenges of ESG as ESG is here to stay³⁹. In my view, this actually represents an opportunity⁴⁰ for growth. As Robert van Beemen and Sophie Chammard have explained, “as the regulatory rules of the game continue to evolve towards sustainability, lawyers have become instrumental in facilitating their clients; journey. Initially law firms were required to engage in ESG due to client needs. They are now climbing the ladder of the different stages of CSR. ⁴¹”