Environmental, social and governance (ESG) issues have become increasingly important to private equity and venture capital fund managers and their investors over the last few years. And as well as the various pressures to ensure responsible investment, there is some evidence that ESG policies may have a positive effect on returns. Managers starting the fund raising process are therefore subject to numerous due diligence requests, and the Principles for Responsible Investment (PRI), an investor initiative in partnership with the United Nations, have recently released the "Limited Partners' Responsible Investment Due Diligence Questionnaire" (DDQ) to assist investors and encourage more standardised due diligence.
As well as assisting those investors who may not have a formal ESG policy, or who have not previously submitted questions at the due diligence stage about ESG, standardised questions could also help managers by cutting down on the time and cost required to answer different questions on the same subject. In fact, the creation of the DDQ was partly in response to requests from managers who have signed up to the PRI for more consistency across the industry. The PRI have been keen to point out that the DDQ should not be used as a checklist and is by no means exhaustive, but more a tool to establish a dialogue between investors and managers, and that investors may well want to tailor the questions or indeed add some of their own.
The DDQ covers four areas: the ESG policy of the fund and the influence of ESG factors, management of ESG related risks and value creation, contribution to ESG management at portfolio company level, and communication with LPs on ESG related matters. There are 21 questions in total, but it is also accompanied by a guidance document which provides useful background to the questions posed as well as case studies and examples of how some LPs and GPs work in relation to ESG. The guidance document also includes further "developed questioning" that LPs may want to put to GPs, which expand on the initial questions and many ask for examples of past situations where an ESG issue has arisen or descriptions of procedures that are in place to identify and manage ESG incidents. There are also links to publicly available resources to assist LPs, such as the CDC toolkit for ESG.
There is no doubt that ESG will continue to be an important issue for managers and their investors, and resources such as the DDQ and the CDC toolkit that encourage greater consistency in approach across the industry should be welcomed. As with any attempt to standardise, whether it be reporting, due diligence questionnaires or other issues, it is important to remember that a "one-size fits all" approach may not always be suitable. And the PRI have made it clear that this is not the intention, with the aim being to promote discussions between all parties and that consideration needs to be given to the diverse nature of private equity as an asset class when approaching issues such as ESG.