Legal development

Ready or not ESG is coming

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    “ESG” has been a long-running buzzword in the funds industry. The growing spotlight on environmental crises has spurred investors and sponsors to reflect on their business practices and their sustainability credentials. Pitchbook’s 2020 survey (“ESG and the Private Markets, Navigating the application of ESG in the private markets”) indicated that general partners are increasingly feeling pressure from limited partners to consider sustainability within their investment decisions.

    With ESG’s growing prominence in the industry, addressing investors’ ESG demands can be a minefield for sponsors. In this article we look at some of these demands and examine the pitfalls that sponsors should avoid when negotiating ESG terms with investors.

    By Your Side [Letter]

    Investors usually first discuss their ESG needs with sponsors during their due diligence of the fund, with requests and terms later being documented in their side letters. Each investor is unique, and so ESG demands can be bespoke to reflect the investor’s profile. From a sponsor’s perspective, adhering to subtle nuances of investor demands can be an administrative headache.

    Historically, investor demands typically included requests that sponsors consider ESG factors when evaluating prospective investments; investors have also asked that sponsors ensure that their investment practices take into account or adhere to certain ESG principle frameworks, such as the United Nations’ Principles of Responsible Investing (UNPRI).

    In recent fundraisings however, some investors have sought more substantial evidence of sponsors embedding ESG principles. Examples include bespoke annual ESG risk reporting on the underlying investments and ESG-related incidents. Some investors have requested that sponsors complete ESG questionnaires. Other investors have requested that sponsors engage in good faith discussions on their compliance with investment restrictions set out in the underlying limited partnership agreement.

    The two most important things to bear in mind with these requests are consistency and future proofing. First, sponsors may wish to maintain a standard ESG approach for their investors and so avoid becoming over-burdened by tailored ESG requirements for each investor. Second, sponsors should be mindful of agreeing to standards that may change over time. ESG compliance is only going in one direction – and sponsors need to avoid agreeing to a shifting set of goalposts.

    Excuses, Excuses

    Investors such as sovereign wealth funds and development banks may have more onerous ESG terms than other institutional investors. For example, they may be restricted from investing in certain categories of industries or have a mandate to only invest in funds that can make a positive ESG impact on the companies in which they invest.

    Such requirements can be problematic for sponsors whose funds are not set up in such a restrictive way – agreeing to such investor demands may in turn vary the investment policy of the fund for all investors. To avoid such situations, sponsors should ensure that their fund documents contain a well drafted excusal provision, which allows certain investors to sit out investments that would breach their internal requirements. In return, that investor may request more transparency and prior communication on portfolio investments from the sponsor to determine whether they would need to exercise such excusal right.

    Fix Up, Look Sharp

    With the above in mind, it is important for sponsors to consider and develop their ESG policy. Sponsors should weigh up the operational demands of complying with investor ESG considerations against the impact on investor relations if they do not do so. Some investors may not be willing to back sponsors who do not show ESG capabilities (or appetite). What’s more, for certain investors, these reporting and due diligence demands are hard and fast. If they cannot be met, the investor cannot invest.

    To address this, many sponsors are building their capabilities to meet these demands. For example, sponsors have dedicated ESG task groups to identify and monitor ESG issues relating to particular regions and industries and to track the evolution of ESG policies and regulations. Some sponsors are now incorporating ESG principles into their traditional analysis of portfolio investments by leveraging ESG research into the investment process, for example by obtaining third-party reports, commissioning investment companies to produce reports or having internal teams perform research into the industry. Other sponsors use positive screening, which focuses on companies which exhibit positive ESG characteristics or which are taking steps to improve their ESG profile, either in comparison to other companies or on a country, regional, sector or industry basis.

    This practice is becoming the norm, not the exception - 71% of sponsors surveyed by Preqin in November 2020 have indicated that they require portfolio companies to report on their ESG metrics.


    The rise of ESG has brought about opportunities for sponsors and investors alike to reshape the funds landscape and the companies in which they invest. Sponsors have the power to change the business of their portfolio companies in response to growing ESG investor demands and, as the saying goes, with great power comes great responsibility.

    Sponsors, whether ready or not, are at the forefront of this movement. This is a fantastic chance for them to engage in thought leadership and to develop new opportunities and relationships with investors and portfolio companies.

    Members of the Ashurst funds practice are more than happy to advise on ESG considerations for fundraisings from sponsors’ and investors’ perspectives. More widely, Ashurst can also provide innovative and tailored advice to ensure clients comply with ongoing ESG disclosures and regulatory requirements, including through our ESG Ready digital toolkit.

    Authors: Hadrian Beckett, Peter Mallon and Catherine Gokah.

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.

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