There has been considerable speculation about the effect of Donald Trump's presidency on U.S. environmental policies regulating greenhouse gas emissions, clean air, contamination and impacts to water and other natural resources. Despite the incoming administration's pledge to scale back environmental rules and regulations, we expect the private equity industry's commitment toward developing meaningful environmental, social and governance programs to continue gaining momentum.
ESG issues have emerged as a key consideration affecting both institutional investors' capital commitments and investment firms' capital deployment. A concept that originated when socially conscious European-based investors began requiring private equity firms to consider ESG issues prior to making an investment now knows few borders. An increasing number of U.S. pension funds and other institutional investors now require private fund managers to not only have formalized ESG policies, but also to consider ESG when weighing the risks and opportunities associated with a potential target company's operations.
Despite changes to existing environmental laws and regulations that likely will be discussed in the White House and on Capitol Hill, it's important to remember existing ESG programs never were inspired by federal law and there's no indication institutional investors will retreat. European-based limited partners are not expected to relax their ESG requirements simply because the U.S. rolls back environmental requirements; leading U.S. pension funds are expected to continue to require a rigorous analysis of ESG issues prior to investment. If anything, interest in ESG issues has only expanded among the investor class, as evidenced by the growing interest by high net-worth investors.
ESG considerations have become so ingrained into the acquisition process, a growing number of investment firms are assessing ESG issues despite not being required to do so by their institutional investors. Increasingly, ESG programs are being viewed in terms of the benefits they can deliver and a growing number of investment firms have proactively adopted programs on their own.
An increasing number of investment firms have embraced ESG as an important tool to help drive value and mitigate risks. By working with portfolio companies to reduce emissions and their use of fuel, water and other resources, substantial cost savings are being realized. ESG also has been recognized for its usefulness in protecting value. Increasingly, these programs have been found to deliver a more thoughtful approach to heading off political, reputational and headline risk that could affect a business' relationships with its key stakeholders, including customers and labor organizations, as well as various advocacy groups.
Just as the market appears to have spoken, offering what is essentially a carrot (value and reputational benefits) and a stick (institutional investor requirements) approach to encouraging ESG program adoption, there are some other parties that are expected to keep the ESG train on its tracks: individual states and advocacy groups.
Even if important federal environmental regulations are eliminated, or federal agencies do not rigorously enforce environmental laws, states are expected to fill the void. States such as California and New York are expected to push for stricter environmental laws, including laws designed to reduce greenhouse gas emissions. Factoring in the impact of state environmental actions when evaluating opportunities is likely to increase the stakes in some transactions, as state enforcement of environmental laws becomes more aggressive.
Finally, environmental advocacy groups and other non-governmental organizations also likely will try to fill the void left by the federal government's more limited enforcement of environmental laws. With a press release in one hand and a lawsuit in the other, these advocacy organizations might seek to bring challenges if federal regulators do not.
Because of these various market forces, ESG programs are here to stay, irrespective of the new administration's environmental policies. For institutional investors and investment firms, the better question to ask might actually be: How quickly will momentum build toward the development of even more mature ESG programs?