The backlash of private equity against ESG

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Call it Newton’s Law of Business Ownership. As listed companies come under increasing pressure from investors to act on everything from executive compensation to carbon emissions, a backlash against these constraints appears to be fueling a wave of buyouts by private equity firms.

The first half of 2021 has been a boom period for the sector with more than $ 500 billion in transactions, the highest level since the record began four decades ago.

The main reasons are well known: a glut of cash in the coffers of buyout companies; ultra low interest rates that make borrowing easier than ever; and opportunities offered by digital innovation. There have even been pockets of perceived cheapness in otherwise exuberant public markets, with the relatively undervalued post-Brexit UK being a redemption hotspot.

Done well, private equity has a crucial role to play in modernizing economies, helping companies restructure effectively away from the short-term glare of public markets. Buyout companies rightly pounce on listed companies that they deem undervalued or inflated. In doing so, they maintain the effectiveness of capitalism and act as a positive reactionary force.

But is private equity also reactionary in the conservative backlash sense of the term – facilitating a rebellion against some of the progressive constraints on the existence of state-owned enterprises, in particular the growing demands to meet standards on environmental, social and social issues. of governance? The evidence is mounting.

More freedom in governance has long been seen as a plus for private companies. As the governance of listed companies has become stricter, the advantage of private company status has increased. Private equity executives appreciate the reduction in bureaucracy and the ability to make more money without critical scrutiny from shareholders of public companies. Fortress’s £ 9.5bn buyout of Morrisons this month came with a strong hint that management’s ‘incentive structures’ would be tightened, just weeks after the listed UK supermarket suffered a downturn. revolt of shareholders over wages.

The governance latitude enjoyed by private companies extends to private equity firms themselves. In particular, it is a notoriously male dominated industry.

Social issues, S of ESG, are also poles apart from most traditional investment funds. Many listed companies are increasingly touting “stakeholder value”, expressing concern for a company’s people, customers and territory. Private equity remains a safe space for the intransigent. With good reason in some cases: the management of state-owned enterprises may have been reluctant to make difficult decisions about closing stores, factories or offices, and carrying out job cuts.

But it is in the environmental realm that much of the private equity industry is playing its most blatantly reactionary role. When oil majors seek to sell stranded production assets, private equity is among the most ready bidders.

Some private equity insiders insist the industry is not as unstructured as such deals might suggest. They cite examples of buyout investors spurring radical change: The buyout arm of Goldman Sachs backed Orsted’s wind farm strategy as it moved away from oil and gas. A recent analysis by the consultancy firm Bain admitted that there was “skepticism” about ESG investing in the private equity industry. But he announced notable triumphs, such as the overhaul of the Polish convenience store chain Zabka, owned by CVC, which resulted in substantial reductions in plastic waste and CO2 emissions, and increased sales of food to consumers. herbal.

The fact remains that ESG is a marginal subject in the private equity industry. This in turn risks undermining any drive to mainstream ESG into global affairs. First, the constant shift to private ownership and the distance from public procurement neutralizes progress made in ESG standards for public companies. Second, private equity is under little pressure to change. The buyout companies say their “limited partner” end investors, such as right-thinking pension funds and endowments, demand a greater focus on ESG. However, these LPs have little real clout, given the yield-hungry money wall that demands access to the best private equity funds.

ESG dynamics among listed companies may well continue to stimulate reactionary instincts in the private sector, at least until ESG criteria can generate superior returns on investment. For now, at least, that remains to be proven.

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