Regulatory drivers and stakeholder demands have put environmental, social, and governance (ESG) considerations at the top of the agenda, with PE firms adopting ESG strategies across funds, investments, due diligence, and portfolio company management. This strong focus has prompted certain stakeholders to argue that ESG factors are receiving undue attention at the expense of financial considerations, a critique sometimes referred to as “greenbashing” or the “ESG backlash”. In major markets, notably the US, certain politicians and stakeholders have expressed concerns that ideological considerations are illegitimately impacting investment and business decisions.
The scale of the backlash varies across geographies and sectors, creating challenges and opportunities for PE firms as they look to navigate an often politicised topic. In our view, a consistent and transparent approach to the integration of ESG is key.
In the US, scrutiny has focused on asset managers, financial institutions, insurance market participants, proxy advisors, and ESG raters; and we have seen a clear legislative and political split. Following a generally progressive ESG stance taken by the SEC at the federal level (including increased regulation of ESG matters for private funds), conservative states such as Florida and Texas have introduced legislation (including Florida’s House Bill 3 limiting the use of certain ESG factors in investment considerations). In addition, legal arguments have been made by US State Attorney Generals, ranking Congressional members, and others to question or limit the impact of ESG strategies — including allegations of antitrust violations, breaches of fiduciary duty, that diversity, equity, and inclusion (DEI) quotas or goals violate US civil rights laws, and that ESG factors are financially unjustified. Sponsors have been required to navigate State Attorney General subpoenas, and federal demands for information/documents.
While greenbashing has so far been less of an issue in the EU and UK (with explicitly anti-ESG legislative and regulatory developments few and far between), scrutiny of ESG strategies is growing. In contrast to the US, UK and European regulators, LPs, and other stakeholders are increasingly focused on the veracity, accuracy, and reliability of ESG claims and commitments stated publicly. Allegations of greenwashing are becoming more common as ESG-related marketing claims are studied in depth, and the regulatory environment evolves.
Both in the EU and US, we have seen that in some cases, this heightened focus results in PE firms becoming more cautious about their public ESG claims. While greenbashing may continue, it is likely that sponsors will continue to pursue assets aligned with their own investment strategies. For some sponsors this may include investments in strategies that have been disavowed by ESG focused investors.
Regardless of approach, accurate messaging is a key element in mitigating risks associated with ESG, and in particular, greenwashing. Sponsors must ensure that public statements are consistent and accurate across internal operations, investment decisions, and interactions with portfolio assets. As ever, deal teams must also be mindful of the environment and jurisdiction they operate in, and aware of potential policy changes — certain geographies or industries will be more vulnerable to an ESG backlash.
Our view is that ESG will remain a focus area for the majority of investors in the years to come, and remaining quiet on the topic is unlikely to be the optimal approach for PE firms.