By Paul Davies and Michael Green

On 13 July 2017, Principles for Responsible Investment (PRI) launched guidance on incorporating environmental, social, and governance (ESG) provisions in private equity fund terms. The publication, Incorporating Responsible Investment Requirements into Private Equity Fund Terms (the Guidance), followed a year-long consultation period with PRI signatories, expert counsel, and industry associations. The Guidance aims to demystify the concept of ESG provisions, outline the terms of these provisions and work towards a consistent industry approach on this aspect of responsible investment.

The Guidance identifies current and emerging best practices, as well as possible limitations. In particular, the Guidance offers practical solutions to limited partners (LPs) and general partners (GPs) that are considering how they may integrate responsible investment into fund terms. The Guidance includes:

• The role of ESG provisions in fund terms
  • Due diligence and its implications
  • Steps for incorporating ESG provisions in fund terms
  • Current market practice and constraints

• Placement of ESG provisions
  • Private placement memorandum
  • Fund terms: limited partnership agreement or side letter

• Options for ESG provisions
  • Commitments to ESG policy or standards, and compliance with ESG-specific regulation
  • Investment restrictions, exclusions, or excuse rights
  • Investment decision-making process
  • Process for providing ESG reporting and ESG incident reporting to investors

Fiona Reynolds, Managing Director of the PRI, described the impact of this process on the private equity industry as “transformative”, highlighting that “LP and GP signatories … use the PRI as a platform to work towards an alignment of expectations and to understand best practice as it evolves.”

The Guidance is the second in a trilogy of tools intended to support limited partners and general partners with manager selection, appointment, and monitoring. PRI launched its first tool, the LP Responsible Investment Due Diligence Questionnaire, in November 2015. The third and final tool will be guidance for monitoring and reporting on ESG factors during a fund’s lifetime. PRI recently appointed ERM as its partner in developing this guidance, and the research phase has already started. ERM is due to present its initial findings at the PRI-PEI Responsible Investment Forum 2017 on 28 September 2017.

Investors and other stakeholders should continue to monitor these developments closely as the private equity industry increasingly focuses on ESG factors.

This post was prepared with the assistance of Ei Nge Htut in the London office of Latham & Watkins.