As markets become more volatile with the COVID-19 crisis, pressure on firms and investors to diversify and ensure resilience in their operations will further increase demand for ESG-focused (environment, social, governance) approaches in investment. In our most recent edition of Deloitte Central Europe Private Equity Confidence Survey, we asked the PE investment community in CE about their current market outlook and their perspectives of ESG as factors to consider in their investments.
These are some of the key findings of the Central European Private Equity Confidence Survey:
- Over 60% of respondents believe that the implementation of an ESG strategy can definitely lead to higher investment returns.
- Most respondents (66%) say that ESG related matters are important, but are not value levers in their own right and around a third of all respondents (30%) view them as very important and value-driving factors.
- Only 4% of all respondents regard ESG as insignificant.
- Around 60% of respondents view ESG factors as something impacting a company’s value.
From the data-driven perspective, it is quite suprising that only a third of respondents consider ESG factors to be a value driver. Research shows that companies that embrace ESG principles perform far better during periods of financial downturns and economic instability. ESG analysis has been proven to capture less quantifiable risks and opportunities that companies do not notice in their financial accounts today, and which can increase productivity and reduce costs in the future. A Meta-analysis of over 2000 empirical studies stress positive impact of ESG integration on corporate financial performance. And recent academic research shows that companies with the highest ESG ratings outperform lower-rated firms by more than 40%.
It is likely that investors and companies are yet to realize the importance of a strong ESG strategy and incorporation of ESG-related factors and risks in their financial accounting. For now, the benefits that ESG strategy and sustainability-minded approach can bring remain vastely underutilized.
Quick facts about implementing ESG strategies and reporting on ESG indicators:
POSITIVE INFLUENCE ON STOCK PRICE
Sustainability activities drive business valuation. More and more investors are paying attention to sustainability issues, as they act as a signal of the quality of their given investment.
INCREASING SOCIALLY RESPONSIBLE INVESTMENT
In 2018, global assets in the category of socially responsible investing hit nearly $30 trillion ($18 trillion in 2014). The current trend is for LPs to continue to strengthen their ESG monitoring practices and GPs need to be prepared to respond to this.
The European Union is pushing the integration of sustainability into its regulatory and financial policy frameworks to strengthen financial stability.
ENHANCING SHAREHOLDER RETURN
Addressing ESG issues can improve total shareholder return over the long term by improving margins and valuation multiples. Inclusion of ESG factors can reduce risk and build new business opportunities.
RATING ON ESG CRITERIA
Data on ESG performance is becoming increasingly available, putting companies’ actions under greater scrutiny and reinforcing investors’ attention to them.
ESG adoption reduces the risk of significant negative events and at the same time improves brand value & reputation.
Over 60% of respondents of our August 2020 survey believe that the implementation of an ESG strategy can definitely lead to higher investment returns. Meanwhile, a third of them say that there is no significant difference between the value of companies that implement such a strategy and those who do not. It is quite interesting that more than 30% of respondents do not consider an ESG strategy to be a value driver. Current research shows that companies that embrace ESG principles do operate better during periods of financial downturns and economic instability. This is especially important during the uncertainty caused by the COVID-19 pandemic. As markets become more volatile, pressure on firms and investors to diversify and ensure resilience in their operations will further increase demand for ESG-focused approaches in investment that will help ensure exposure to higher quality companies.
Recently the importance of ESG factors has significantly increased in the first four months of 2020, with over 70% of ESG funds achieving better results than similar funds managed without taking ESG considerations into account . Only 4% of all respondents view the incorporation of an ESG strategy in business operations as harmful to investment returns.
57% of respondents declared that their companies always perform ESG checks as part of due diligence before moving forward with a buy side transaction. On the other hand, 28% answered that they only consider ESG factors when they could create potential operational risks. This means that as much as 85% of companies perform ESG checks as part of due diligence, either consistently or occasionally. Even though it demonstrates great interest in ESG factors, it is worth mentioning that there are broad discrepancies in the quality of available ESG data. Therefore, on the global market, the biggest private equity funds define their own ESG policy and screening procedures in terms of ensuring a minimum baseline for each buy side transaction. Some respondents do not perform ESG checks at all, with 9% saying they are likely to start in the future, and only 6% is considering ESG checks unnecessary.
When it comes to measuring the significance of ESG in investment decisions, only 30% of all respondents view them as very important and value-driving factors. This is a surprising result, especially when looking back at two previous questions where about 60% of respondents viewed them as something impacting a company’s value. The majority of respondents (66%) say that ESG related matters are important, but are not value levers in their own right. Only 4% of all respondents regard ESG as insignificant.
Environmental regulation is quite exceptional in its pace and scale. No industry can survive unless it is at least tracks emerging solutions to the effects of climate change and trying to adapt to a new regulatory environment for its business. However, it is necessary to follow not only new laws, but also authoritative studies and recommendations, which are being transformed first into preferred behaviours and then into a mandated standard, in shorter and shorter cycles. Foresighted firms proactively monitor the impact of their activities react before someone writes a study about their problem and takes regulatory action. A number of instruments are created to do this (we attach two – to analyse the price of river and sea pollution and climate risk on the credit portfolio).
Recovery plan for Europe stands on green pillars
The European Commission has presented a Recovery plan for Europe, the main pillars of which are the Green Deal and the support of green transformation. Unprepared companies could be surprised by the adopted taxonomy of economic activities. Details of other plans were presented by the European Commission as part of Frequently Asked Questions. And the area of biodiversity funding is also surprising – the total revenues of all biodiversity related taxes were less than 1% of the total revenues of all environmental taxes. On the other hand, the Czech Republic is the second country from the OECD with the highest number of subsidies introduced, and it also ranks at the top of the list of total number of established economic instruments. Find out more >>
Sources uses in the article:
A.C. NG & Z. Rezaee. 2015. Business sustainability performance and cost of equity capital. Journal of Corporate Finance.
Kincentric/Aon. 2019 Trends in Global Employee Engagement.
Nordea. 2017. Cracking the ESG Code.
MSCI. 2019. Weighing the Evidence: ESG and Equity Returns.
UNPRI. 2017. The Next Frontier For Responsible Investment.
Friede et al. 2015. ESG and financial performance: aggregated evidence for more than 2000 studies. Journal of Sustainable Finance & investment.
Nielsen. 2015. The Sustainability Imperative.
Carnevale C & M. Mazzuca. 2013. Sustainability report and bank valuation.
Zhang, J. et al. 2018. Does Sustainability Enegagement Affect Stock Return Volatility.