The continued rise in prominence of ESG in Asia has found its way into the realm of private equity (PE), a vehicle traditionally associated with risk-taking investment for outsized rewards. Now the industry has joined other sectors in the financial ecosystem to consider sustainability and social responsibility in decision makings.

According to a report by Mayer Brown and Sedgwick Richardson, PE fund managers in Asia have been adapting to the changing regulatory landscape where regulators increase scrutiny on climate factors in their investment processes.  

Mark Uhrynuk, a partner at Mayer Brown, says regulators in Hong Kong and Singapore are spearheading this transformation in the approach expected to reshape the PE industry.  

“Many Asia-based PE managers now identify compliance with sustainability-related regulations as a primary goal. However, for certain PE managers in Asia, the tension between longer-term ESG goals (and related costs) and near-term financial objectives can impact the pace at which ESG integration occurs,” says Uhrynuk.

Alexander Burdulia, associate sustainability director at Sedgwick Richardson, observes that the number of Asian PE managers signing up to Principles for Responsible Investment (PRI) – a United Nations-supported network aimed at promoting sustainable investment – has grown by four-and-a-half times in the past four years.

But he points out discrepancies in the levels of ESG engagement in the PE space across Asian jurisdictions.

“Across Asia, we identified the greatest number of PE managers that have signed up to the UN PRI to be headquartered in Japan, Singapore, South Korea and China, with a substantial portion of those headquartered in Hong Kong,” notes Burdulia.

However, “this is not surprising as it represents those jurisdictions with more developed international financial markets, many of which have regulatory requirements or guidance on ESG and sustainability issues,” he adds, while highlighting the role played by family offices increasingly helmed by younger generations placing more significant value in ESG and social impact in their wealth solutions.

But the report highlights a relatively low level of coordination between Asian PE managers and their key limited partners (LPs) when formulating sustainability-related policies and procedures. According to the report, only a quarter of the firms reviewed indicated that they consulted with key LPs to align with their sustainability priorities in 2021.

Burdulia suggests that PE managers take a more proactive approach to engage LPs, who were found to be paying greater attention to ESG when weighing fund commitments.

“Structured stakeholder engagement on ESG and sustainability is a tangible commitment to these issues that help uncover what matters most to LPs. It allows managers to tailor policies, processes, and strategies accordingly and pre-empt LP requests in the future. In this way, failing to engage your LPs on sustainability is a missed opportunity to differentiate,” adds Burdulia.

With interest rates staying high and credit conditions squeezed by stress in the Western banking sectors, Uhrynuk admits that macroeconomic tumult could ratchet up tensions within the PE industry and thus impact ESG-related considerations and integration progress.

“The near-term economic uncertainty and related financial risks will generate pressure on many PE managers. Despite this, we expect many managers will continue to make meaningful progress on longer-term sustainability initiatives,” says Uhrynuk, who believes investment in adaptation and resilience at the portfolio company level will be propelled by regulatory tailwinds in the region and concerns for climate-related risks in the long run.

“Moreover, the need for PE managers to pay attention to supply chain resilience and human rights issues and related risks in portfolio company supply chains will not dissipate. Finally, the growing imperative to accurately monitor, measure and communicate ESG-related progress will impact the behaviour of PE managers and will continue to be a priority for LPs and other investors,” adds Uhrynuk. 

With the growing prevalence of ESG integration in the region, Burdulia believes more PE managers will fill the next chapter in their investment playbooks with fulsome sustainability strategies.

“This means going from simply considering ESG factors in the investment process to developing cohesive strategies with focus areas, goals, and targets to manage ESG factors in a way that creates positive outcomes for the environment and society, as well as financial returns. Managers who can balance a credible approach to sustainability alongside market rate returns will thrive,” explains Burdulia.

“We believe more managers in Asia will benefit from integrating sustainability into firm-level branding. A credible and clearly articulated approach to sustainability that is developed through the lens of brand can build trust and help managers stand out in a crowded marketplace that is increasingly focused on these issues,” he adds.