The ‘S’ in ESG

ESG is increasingly front of mind for LPs and GPs alike. But what isn’t clear, is what ‘social sustainability’ really means, and how businesses can incorporate it into their business practices. Cornelia Gomez, our ESG Director, shares her thoughts in an interview with SuperReturn365.

As the Head of ESG and Sustainability at PAI Partners, what does your role involve?

My primary responsibility, alongside my colleagues in PAI’s ESG Team, is to ensure that ESG becomes more deeply embedded in every stage of PAI’s investment lifecycle.

Pre-acquisition, that means keeping our investors’ restrictions top of mind during the investment screening process and carrying out a broad-based ESG due diligence to detect any red flags. Assuming the investment goes ahead, in collaboration with top management and the deal team, we carry out an in-depth external ESG review from which stems a three-year ESG roadmap. During the ownership period, we work closely with our contact points in each portfolio company, pursuing a three-tiered approach: ensuring that business is done lawfully and responsibly; identifying and avoiding key risks; and seizing ESG-related opportunities to create value.

In addition, we are the main point of contact on ESG issues between our investors, our deal teams and our portfolio companies, and it’s our job to show that PAI is anticipating and responding to key sustainability topics.

What does the ‘S’ in ESG mean for PAI Partners? How do you define its scope?

The social element of ESG can be considered somewhat of a ‘catch-all’ concept – incorporating everything that isn’t explicitly related to environmental or governance issues.

At PAI, we dedicate an entire ESG pillar to issues related to a company’s employees. These range from basic workforce metrics like the split between permanent and temporary employees, critical issues such as the accident rate, HR-specific issues like training and retention policies, as well as broader societal topics like gender diversity. These can be ‘red flag’ issues, which can prove to be very telling about the health of a company.

In addition, we decided last year to define and manage issues related to ‘external stakeholders’ – such as with suppliers, communities, charities etc. – in a separate pillar.

How easy is it to measure and track social metrics?

On the one hand, because it is such a large pillar, social metrics can be relatively easy to track. As employees are often a company’s key asset, they tend to have large amounts of HR data available to track corporate performance in this area. It is therefore possible to create a ‘social map’ of a company and define key metrics such as the turnover rate for permanent employees, absenteeism or the cost of litigation.

It’s also relatively easy to track progress compared to governance, for example: once you’ve put an anti-corruption code of conduct in place, monitoring its compliance can involve complex processes.

So it’s easier and, as mentioned above, it can be an excellent acid test to assess a company’s health. Consequently, we actively track and report on social indicators.

Some aspects are more challenging, however. For example, once you have defined key metrics, which ones do you commit to reduce? How do you monitor performance in the context of rapid corporate growth, which is an inherent characteristic of private equity-owned companies? Also, regulations can vary substantially between countries: you are legally required to track disability in France but it is illegal to ask for someone’s sexual orientation, whereas the reverse is the case in the UK.

How and where do social issues fit into the investment process?

We have the same approach at PAI to all ESG issues. That is, first, we want to be lawful, second, we want to avoid risk, and third, we want to create value. Regarding social aspects, it’s relatively straightforward to meet the first two goals: we ensure that our portfolio companies treat their employees in accordance with the law, and we manage social risks by ensuring there is proper training, that health and safety is taken seriously, etc.

But where I see a huge opportunity is in the third element, in value creation around employees. There is enormous margin to be captured by ensuring that employees are more satisfied and therefore stay longer within the company and are more productive.

Giving greater consideration to social issues will, I believe, become one of the most important trends in CSR/ESG over the coming years.

How and where do social issues fit into the investment process?

As with environmental issues, the materiality of HR and broader social issues varies company by company and sector by sector. Business services, for example, is a very ‘people-intensive’ sector. These companies may have tens of thousands of employees, and ensuring they are well treated, and that companies have the right policies in place, is absolutely crucial.

Gender diversity has become a key issue over the last few years, and it is likely to remain at the top of the social agenda. We believe that employee shareholding is also likely to become an important trend as successful companies increasingly look to share with their workforces the value they create.

Also, mental health in the workplace is gaining growing attention with a growing problem of ‘burn-out’ within the white-collar workforce. Another related trend is likely to be a greater emphasis on employee well-being and job satisfaction, especially as the millennial generation enters the workforce.

What advice would you give CFO/COOs in other PE firms looking to better manage social issues in their portfolios?

I would stress the importance of getting CFOs around the table. When ESG issues are discussed in the industry, it’s usually the same people who are gathered – the deal team, the executive committee, investor relations, human resources, communications and marketing. The one person who tends to be missing is the CFO. At PAI, we have made a step-change to ensure stronger collaboration with the Compliance and Finance teams that report to our CFO.

Everyone is convinced that ESG and sustainability is a value driver. Ultimately, we need to be able to demonstrate this by looking at the numbers, and it is the CFO who has the best grasp of those. They can provide insights in terms of the metrics that you should be looking at, and how those relate to financial value.

In addition, CFO and COOs within portfolio companies are often decision-makers in driving external growth. Raising awareness regarding the importance and relevance of social metrics – such as absenteeism rates, employee turnover, accident rates etc. – can add an additional layer of analysis when it comes to valuing target companies.

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