REUTERS | Amit Dave

Case study: ESG and DEI in the funds industry

Whether it’s global warming or racial justice, no business can be tone deaf to how it treats others and the world around us; and the shrewdest organisations recognise that these factors are fundamental to their success. Over the last five years, international law firm Paul Hastings has examined and celebrated the efforts that their clients have undertaken to create real culture change in inclusion and diversity.

In a recent study, we examined the way in which their long-term private equity client, Pantheon, leads the funds industry in its adoption of both environmental, social and governance (ESG) and diversity, equity and inclusion (DEI) strategies, both internally and externally.

ESG: the new black?

For top private equity firms, ESG is central to what they do due to the understanding that better business practices make for better returns. Over the past 20 years, the focus on ESG has moved from being a tick box exercise to become central to many investors’ strategies. Increasingly, many fund managers look beyond ESG targets to impact investment strategies where investments are placed in funds and companies whose purpose is to create a more sustainable future.

Pantheon was an early adopter of ESG principles, driven forward by the then co-managing partner Carol Kennedy. On her retirement from Pantheon in 2012, Kennedy reflected on why she felt that ESG was more than just a trend or window dressing:

“A senior executive at an oil company told me that he didn’t think private equity could afford to take on board sustainable investing. I said we couldn’t afford not to.”

Walking the walk

The funds industry has become more aware of the dangers of operational risk, which has led to an increasing focus on DEI, and investors have been a driving force in ensuring that it is not just a talking point. Funds now understand that inclusivity needs to be a consideration in both their portfolio companies and investments, and in managers’ own operating structures.

ESG and DEI were part of Pantheon’s culture from day one, rather than being a bolt on to existing cultural norms. As Helen Steers, a partner and a member of Pantheon’s European Investment Committee and the Global Co-investment Committee, states:

“Pantheon initially had three managing partners, two men and a woman, so it was one third female from the beginning. It was also pretty much global from the start. We started in the UK in 1982 but then opened in the US in 1987 and then in Hong Kong in 1992, and the firm was founded by people who had an open outlook right from inception, and they set the tone of the culture.

Ever since then there have always been senior women and they’ve created role models that have been helpful and encouraging to younger women. We’ve also always been a diverse organisation on other metrics as well; I think because that open culture was created right at the creation of the company.”

A lived commitment to making that culture real is vital to ensuring that ESG and DEI are not transactional goals or window dressing. Many clients in the funds industry are now alert to managers who might be “greenwashing”: talking the talk of ESG but not walking the walk. Will a similar focus on DEI “greenwashing” follow?

Total brand reputation

Total brand reputation means that supply chains and the behaviours of those organisations within them are being closely monitored by clients. Can an organisation really boast about its ESG or DEI credentials if it buys from organisations that do not hold the same views? As both public sentiment and leading corporates focus on sustainability, will this change the legal profession, and could it lead to new priorities from clients?

Might law firms need to make a more concerted shift to industry verticals, rather than focusing on practice areas? Might such industry verticals be along the lines of sustainable and non-sustainable industries, so that clients who feel strongly about ESG can be sure the lawyers that work for them do not also work for arms manufacturers or tobacco companies? Perhaps this may encourage some law firms to move away from certain clients, while others rush to embrace them.

What gets measured gets managed

Industry metrics are required to track progress on ESG and DEI. For DEI, the American Bar Association in the US and the InterLaw Diversity Forum in the UK have pioneered the use of a uniform client questionnaire to produce standard data on legal suppliers’ DEI statistics, although uptake is not universal. Some legal suppliers worry about being judged on their numbers, whereas clients feel that they are needed as a starting point for mature conversations about where the challenges exist. Will we need a similar supplier questionnaire project for ESG and sustainability goals? And will clients and their legal suppliers be comfortable with both holding and being held to account?

As ESG and DEI become part of companies’ strategies, new regulations are ensuring that these strategies are embedded. For example, the EU Taxonomy Regulation is dedicated to environmental considerations, but social and governance factors will be included by the end of 2021. The Taxonomy Regulation will eventually replace voluntary schemes with a single classification system for the EU.

The EU will also adopt standardised processes through its Non-Financial Reporting Directive and Sustainable Finance Disclosure Regulation. These measures are part of a broader suite of ESG initiatives designed to channel funding to genuinely sustainable rather than greenwashed investments. They will facilitate compliance with the Paris Agreement climate targets and the EU’s commitment to adopt the United Nations 2030 Sustainable Development Goals.

An ongoing journey

The lessons from the Pantheon case study show that embracing ESG and DEI are cultural, client and performance driven. There must be a cultural willingness to embrace this, which can partly come via client pressure, but also from a strategic awareness that a prioritisation of ESG and DEI produces better returns. Private equity is an incredibly competitive industry that focuses on performance and generating great risk adjusted returns. Helen Steers at Pantheon sees this as where the argument for ESG and DEI is now really coming to the fore:

“There’s been a realisation that to generate good performance, you need a diverse group of people who will provide different views and not fall into the trap of group think.”

When all these aspects work together, it produces a virtuous circle that allows a culture to flourish where ESG and DEI can become part of day-to-day operations.

Having interviewed the participants from Pantheon, what struck me was their focus on the continuing journey to embed ESG and DEI in their culture. Arun Birla, Chair of Paul Hastings London Office, agrees:

“Pantheon is not complacent; its open and forward-thinking culture means they continue to seek improvement. It’s that forward-thinking mentality and the attitude that they can always do more that really makes their culture of inclusivity stand out in the funds industry.”

For every organisation, in law and beyond, learning from this mentality of constant vigilance on ESG and DEI is the way forward. Your culture is only ever as good as it is today; it’s not just about meeting targets but changing ways of thinking and behaviours.

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