sustainable finance: integrating esg into private equity

Final Report - UBS Capstone Project May 2017

ESG Integration for Private Equity -

Sustainable Finance:

Integrating ESG Into Private Equity Fund Manager Selection

Columbia University

School of International and Public Affairs

Capstone Workshop

May 8th 2017

Capstone Team Members:

Mona Alsubaei

Sam Schneider

Maria Surilas

Yifei Tang

Izzati Zabidin

Yuan Zhang

Sihan Zhang

Wei Zhao



Table of Contents

Part I: Summary of the Project & Methodology

A. Project Summary........................................................................................................2

B. Methodology & ESG Integration Framework............................................................2

C. Justification for Producing A Due-Diligence Questionnaire......................................4

Reasons for Choosing the DDQ Approach.........................................................4

Part II: Literature Review & Research Findings

A. Introduction to ESG Integration...............................................................................4

B. Understanding Why ESG Integration Matters for Private Equity............................6

C. Understanding Material ESG Factors.......................................................................8

D. Interview Findings....................................................................................................9

E. List of Interviews....................................................................................................10

Part III: ESG Integration Due-Diligence Questionnaire

A. Working With the DDQ..........................................................................................10

B. Due-Diligence Questionnaire..................................................................................11

Part IV: Due-Diligence Questionnaire Working Manual

A. DDQ Working Manual...........................................................................................13

Section 1...................................................................................................13

Section 2...................................................................................................15

Section 3...................................................................................................16

Section 4...................................................................................................18

Section 5...................................................................................................20

Part V: Outlook for Next Steps

A. Conclusions...........................................................................................................21

Part VI: Bibliography



Part I: Project Summary & Methodology

A. Project Summary

Responsible investing has become a mainstream concern within the investment industry. The

dramatic growth in the number of investors who have adopted the Principles for Responsible

Investment (UNEP, 2014) is an often cited, and telling indicator of the increased attention the

sector is paying to the integration of environmental, social and governance (ESG) factors into

investment management. Beyond that however, a variety of stakeholders, including investors, the

public, and industry groups are demanding non-financial reporting and disclosure from the

private equity industry (PWC, 2015). Investors recognize that focusing on sustainability risks

and opportunities leads to a more rigorous investment process (UBS, 2016).

With this rapidly evolving landscape in mind, our objective is to help UBS Wealth Management

assess private equity fund managers on their policies, methods, and success in integrating ESG

considerations into their different funds. We would like to provide UBS with the appropriate

tools and knowledge base to evaluate how their fund managers approach portfolio company

selection and active ownership through the lens of ESG factors and sustainability. To this ends,

we have developed a due diligence questionnaire that can be used in part, or in whole during

UBS’ regular due diligence process of fund manager selection.

B. Methodology & ESG Integration Framework

The team conducted in depth desk research to gain an understanding of the sustainable and ESG

investing industry and identify gaps. Then, we applied our analysis and findings to create a

framework for ESG and to create a due diligence questionnaire.

Our research methodology consisted of: (i) a literature review of current industry practices; (ii)

an assessment of the existing tool kits and ESG guidelines available from institutions, banks, and

international development organizations; (iii) interviews with practitioners and experts in

sustainable investing industry.

After we completed our initial research, we perceived a gap between what is available at present

and UBS needed to evaluate fund managers. Our interviews were essential in gaining more in-

depth knowledge from the practitioners in the later phase of our research. Ultimately, all of this

was critical in shaping our approach to developing a framework on the dimensions along which

to evaluate fund managers (i.e. GPs) on ESG integration. (See Table One).



Table 1: Overview of the Framework

Before finalizing our due diligence questionnaire, we created a framework to visualize our core

assumptions and pinpoint which factors we were going to use to evaluate fund managers.

As seen in Table 1, our framework is based on three basic assumptions (1) Why ESG matters (2)

Understanding material factors and (3) ESG for private equity. These are core the core principles

that make up the building blocks for the framework, and that we incorporated throughout the

different sections of the DDQ.

After establishing these basic assumptions, we identified the four most important categories and

competences with which to evaluate the fund manager. These factors are: Materiality, Active

Ownership, Communication, and Integration Infrastructure. Within each of these factors, we

developed sub questions in order to form a view on how the fund managers performs with

regards to each. These four factors make up the four main sections of our Due Diligence

Questionnaire.

Importantly, each of the four factors is be considered over the entire time horizon of a portfolio

investment. A fund manager must demonstrate commitment to each factor during the investment

process, active ownership and exit. We incorporated this timeline aspect into our DDQ by

including questions within each of the four factors to investigate the entire timeline of the

investment.

The framework above was transformed into a usable tool as a due diligence questionnaire. A

detailed manual is provided along with the DDQ to guide its usage.



C. Justification for Producing A Due-Diligence Questionnaire

Reasons for Choosing the DDQ Approach

We chose to create a Due Diligence Questionnaire (DDQ) as the tool to implement our

framework because of the following advantages:

1) A DDQ is a combination of qualitative and quantitative inputs for evaluating fund

managers. As most of the questions asked in the DDQ are open-ended, it offers LPs

sufficient qualitative information and great latitude in terms of making investment

decisions. This approach also leaves enough room for future iterations of the DDQ to

assign numerical values to each question in order to produce a quantitative scored card.

For now, our DDQ is mostly qualitative. Our DDQ is well structured and follows a strict

logical framework, so it readily accessible for further analysis. It offers a solid foundation

on which to develop other more advanced quantitative evaluation methods.

1) A DDQ was flexible enough to incorporate our interview findings into the final product.

Our DDQ made it possible to integrate the insights we derived from our expert

interviews. We derived valuable insights from the interview process and we integrated

these into the final tool. Also, the DDQ is expected to incorporate our key concepts and

capture a comprehensive picture of fund managers' ESG integration practices

2) A DDQ is practical and easily adoptable by UBS. As DDQs are widely used and tested,

this approach should be easy to integrate into pre-exciting due diligence and investment

processes. This allowed us to concentrate more on the contents rather than the form of the

tool. Our proposed DDQ is expected to be used as a concrete tool to facilitate UBS in

identifying fund managers who perform well on ESG integration.

Part II: Literature Review & Research Findings

A. Introduction to ESG integration

As noted, responsible investment practices have gained increasing attention globally, reflecting a

new cognizance around values-based investing. Within this context, across the financial services

sector and around the world, investors have expanded the considerations they make during the

investment process, seeking a more holistic understanding of asset risk and value by taking more

than just conventional factors into account. This expanded notion of what is material in the

analysis of an investment is fundamentally tied to a desire on the part of investors to engage in

ethically responsible business practices.

However, what has propelled this evolution in investor thinking is not just idealism. It’s also

good for business. Studies have shown that investors who take into account Environmental,

Social and Governance (ESG) considerations may see market rate returns. Additionally, ESG

factors can have a major impact on risks and value opportunities associated with an investment

(KKR, 2016). From public market institutional investors to small-cap angels, investors

increasingly see the proper management of ESG factors by portfolio companies as important in

determining whether to invest. Of course, investors have long “screened” out businesses

involved in certain high-risk, vice industries, such as alcohol, tobacco, firearms and

pornography. What has changed is the breadth of ESG factors that are taken into account, and the



depth to which they are integrated into the conventional investment process.

There are several systems commonly used by investors to ingrate ESG factors into investment

decisions. ESG performance standards and due diligence tool kits, which provide a relatively

comprehensive picture of best practices in ESG-integration are available to guide investors and

portfolio managers in integrating ESG in their investments. After thorough review of these tool

kits, our team found that most of the information needed to create a robust framework to evaluate

investees on ESG competencies - in both public and private markets - already exists in these

standards, most of which were developed by international organizations such as the United

Nations (UN), International Finance Corporation (IFC), Commonwealth Development

Corporation (CDC). We found each of these tool kits provides valuable insights for the scope of

this project. However, this intelligence needed to be adapted for the specific purpose of

evaluating fund managers instead of individual projects as most of these tool kits are designed to

do. (See Table 2 for a summary of our main findings from reviewing these available tool kits).

Table 2: Analysis of Commonly Used ESG Tool Kits

Overview & Best Practices Gaps Remaining for our Framework

IFC: Environmental and Social Performance Standard and IFC Corporate Governance Questionnaire

Provides a comprehensive set of best performance

standards of E&S integration, focusing on assessing

risks and impacts.

Divides the broad categories of E&S concept into

seven different areas with detailed requirements

provided.

Emphasizes integrating ESG throughout the entire

lifecycle of an investment, is a unique opportunity for

private market investment.

Provides material E&S factors for 61 different

industries.

Targeted towards selecting projects instead of fund

managers, therefore provides guidance more than a

general framework.

Designed for projects financed by IFC or the World

Bank Group, not specificly for private markets.

Difficult to be integrated with current non-ESG due

diligence process given the completely different

methodology and template.



CDC: Toolkit on ESG for fund managers

Detailed approach for ESG integration in the

investment cycle from screening to exit specifically

for private equity.

Indicates that each investment will have different ESG

risks and opportunities and depending on its country,

sector and specific characteristics.

Emphasizes the importance of informing and

including LPs and any other stakeholders in the

process.

Indicates that all funds should have an environmental

and social management system (ESMS)

commensurate with the level of environmental and

social risks and impacts associated with current and

potential portfolio companies and that takes into

account the fund manager’s capacity and structure.

Mainly for developing countries.

Describes a limited number of sectors.

UN PRI: Limited Partners’ Responsible Investment Due Diligence Questionnaire

A good representation from an LP’s perspective to

evaluate a GP’s processes for integrating material

environmental, social and governance (ESG) factors

throughout the investment cycle.

It is referenced by a wide range of industry peers and

due diligence questionnaires.

Provides a generic starting point, instead of an

inclusive framework, for establishing the dialogue

between LP and GP.

Fails to provide more detailed measurements to look

over fund managers’ ESG effort throughout the

lifecycle of investment.

s

B. Understanding Why ESG Integration Matters for Private Equity

Institutional investors are increasingly looking for ways to steer capital towards companies and

projects that provide solutions to major ESG challenges, but achieving impact at scale can be a

challenging proposition. Private equity (PE) funds are particularly well placed to catalyze ESG

opportunities because of three distinct features:

1) Active Ownership - PE fund managers are able to “actively” integrate ESG

considerations into their investments strategy as well as their restructurings of portfolio

companies.

2) Holding Period - ESG integration is especially critical for the kind of long-term active

investment found in private equity markets (avg. 4-6 years). UN PRI states that, “the

average ownership period for a private equity portfolio company is four to six years,



during which time ESG-related risks and/or opportunities may arise that were not

material at the time of investment.” (UNEP, 2011).

3) Communication - The challenge of information disclosure in private equity requires more

in-depth due diligence and consistent monitoring, rigorous communication and reporting

between portfolio companies, GPs and LPs.

PE investors cite a range of benefits to proactively addressing ESG opportunities throughout the

investment cycle (PwC, 2015). According to a survey by Mercer and LGT Capital Partners,

nearly 60% of institutional investors say ESG criteria has a positive impact on risk-adjusted

returns (Mercer and LGT, 2016). Thus ESG is gaining major traction as a tool in selecting fund

managers. Investors are beginning to restrict access to capital due to poor ESG performance and

the view that integrating ESG consideration into investment analysis is within one's fiduciary

duty is increasingly widely accepted (PwC, 2015). In other words, ESG considerations are

important for risk management.

Yet, ESG integration by fund managers is important for value creation as well. ESG

materiality improves understanding of long-term value and active management can enable

value-generating influence over strategy and mission of portfolio companies (BlackRock,

2016). In terms of exit value, strong communication and reporting practices among portfolio

companies can better facilitate exits (UBS and Calvert).

As stated above opportunities for ESG focused value creation and risk management vary by

company, sector and geography. However, some general ESG factors that have proven to be

closely correlated with value-creation include (CDC, ESG Toolkit):

Access to new markets - A company may need to adapt its products or services to

satisfy regulations, standards and customer demands.

Substantial cost savings - This can be made through the adoption of resource use

efficiency measures. (especially energy and water use) and reducing the cost of doing

business by eliminating bribes and facilitation payments.

New product design - There may be significant opportunities for companies to

develop and deliver innovative products and services that address unmet

environmental or social needs.

Value at exit - sound ESG management can improve value at exit. Increasingly,

meeting ESG requirements/standards is required both by private buyers and for initial

public offerings (IPOs) in emerging markets.

Risks from litigation as well as environmental, financial and reputational risks

(Arabesque, 2015)



C. Understanding Material ESG Factors

Materiality is at the center of all investment decision. However, Firms that consider material

ESG factors outperform those that do not (McKinsey, 2016). This is because ESG factors

have quantifiable impacts on reputational risks and broader potential consequences on

business operations. Most fundamentally, the concept of materiality recognizes that some

information is more important to investors in making investment decisions than other

information.

Firms with strong performance on material topics not only outperform firms with poor

performance on material topics, but also outperform firms with strong performance on

immaterial sustainability. Studies have showed that companies that address those material

ESG issues and ignore immaterial ones outperform those that address both material and

immaterial issues by 4 percent and outperform companies that address neither by nearly 9

percent (McKinsey 2016).

The materiality of ESG issues differs substantially between sectors and geographies (PwC,

2015). Organizations such as IFC, CDC, SASB, and GRI compiled a comprehensive

overview about sector differences with regard to ESG issues. Failure to distinguish between

sectors, geographies and investor priorities can produce an insignificant relation between

performance on sustainability issues and future financial performance.

Sector-specific - For example, resource-intensive industries such as mining have a

different exposure to environmental and social factors than the commercial real-

estate sector. Many research and financial institutions have identified major ESG

factors for different industries. For example, IFC lists E&S factors for over 60

industries (IFC). The Sustainability Accounting Standards Board (SASB) has

identified issues reasonably likely to have material impacts on companies for a

wide range of industries, and MSCI has also developed a materiality map for ESG

factors.

Geography-specific - ESG issues will be different depending on the industry

sector, the country and the markets. Every region is exposed to different ESG

factors (Mercer, 2016). More focus is given to governance than environmental or

social issues in emerging markets (PwC, 2015). Portfolio companies in the same

region may face common ESG challenges (KKR, 2010).

Investor-specific - Investors may consider certain factors more important than

others. This facet of materiality recognizes that some information is more

important to investors in making investment decisions than other information. For

example, Mercer conducted research and found that climate change, carbon

intensity, human rights, child labor, weapons, bribery and corruption are ESG

factors that are especially important to investors (Mercer).



D. Interview Findings

Based on desk research, we conducted a variety of interviews with financial services

professionals and experts with experience in ESG integration. Most of the investees interviewed

represent private market investors, and many of them fund managers of the variety UBS might

consider for investment. We entered these interviews with relatively sterile research questions,

but were fortunate enough to receive answers that provided greater illustration of what ESG-

integration is like in real world application.

When asked what the most important factors are to consider in building a framework for ESG-

integration, three major themes emerged in the responses we received. First, the most common

way to evaluate an investment’s performance on ESG factors is through scorecards, though some

prefer qualitative standards while others prefer more quantitative approaches. Second, critical to

any ESG-integration framework is consideration of the impact of and changes to ESG factors

over full lifetime of an investment. Third, whether or not a GP has dedicated ESG-integration

infrastructure (i.e. personnel, budgeting) is essential for distinguishing whether a GP is

substantially or just superficially committed to ESG considerations.

In the case of Mercer, their Four Factor Framework intends to audit a GPs approach to ESG

integration without any bias about how they should being doing it. The Mercer Framework ranks

fund managers on a scale of 1 (highest) to 4 (lowest) across four ESG-integration factors: Idea

Generation, Portfolio Construction, Implementation, and Commitment. Similarly, LGT Capital

Partners uses a 1-4 scale method for evaluating four different measures: Manager Commitment,

Investment Process, Ownership, and Reporting. Both of these approaches illustrate common LP

approaches to taking largely qualitative information about ESG integration practices and

quantifying it in a way that allows for a comprehensive and flexible evaluation of GP ESG

practices.

Following from the theoretical basis we developed through our desk research, we knew

understanding the issue of materiality in ESG-integration would be important in developing our

framework. When asked about identifying materiality across a portfolio that includes

investments in different industries and regions, the responses we received from fund managers

indicated one must strike a balance between comparability and relevance when thinking about

materiality.

Three main challenges GPs face in measuring ESG factors and LPs face in evaluating GPs

integration practices were raised during our interviews: (i) the availability of data and lack of

reporting practices around ESG, (ii) the abundance of GPs who are only superficially committed

to ESG considerations (i.e. greenwash), and (iii) the mismatch that often appears with the

companies most considerate of ESG factors often not being the most exposed to them.

Looking forward, the information gathered in interviews suggests experts and practitioners

expect to see GPs developing increased amounts of human capital for ESG integration in the

near future. More broadly, those interviewed argued there remains significant room for greater

integration of ESG considerations into the conventional financial valuation process.



E. List of Interviews

The following are the entities from which professional staff were identified and successfully

interviewed by the team because of their relevant knowledge and experience related to ESG-

integration, responsible investing and private equity.

Abraaj Capital

Emerging Capital Partners

HarbourVest Partners

International Finance Corporation (IFC)

Mercer Wealth and Investment Management

Morgan Stanley Capital International (MSCI)

UBS Chief Investment Office

Part III: ESG Integration Due-Diligence Questionnaire (DDQ)

A. Working With the DDQ

In enhancing UBS' capacity to examine GPs’ ESG integration practices, the DDQ and

accompanying manual should present opportunities to discover areas for improvement and

engagement, and help establish a more efficient communication and disclosure channel with

GPs. The focus is to assess the level of commitment to and capacity for ESG integration before

an investment is made, though it could also be used as a tool for existing investments. The DDQ

and Manual were designed to highlight the presence of effective ESG integration, not punish its

absence.

The open-ended nature of the questions in the DDQ is intended to provide sufficient room for

fund managers to make the necessary disclosures. In order to encourage in-depth responses from

fund managers, we suggest this DDQ to be used in conjunction with a non-disclosure agreement.

We would like to again stress that this DDQ is intended to complement UBS’ existing due

diligence practices. We anticipate that the combination of these practices would provide

insightful information to be incorporated into UBS’ investment memos towards developing an

informed investment decision.

The output of the DDQ should inform UBS on:

The level of commitment of the fund managers in integrating ESG in their investment

management practices

The ESG integration areas that UBS should focus on for a particular fund manager in

order to mitigate risks and maximize returns

The types of resources that UBS could provide to fund managers in order to support

their ESG integration efforts

Apart from being a tool to understand each individual fund manager, UBS can also aggregate the

collective output of the DDQ to generate broader insights into industries and geographies. This

learning can be channeled into feedback for refining UBS’ approach to ESG integration.



B. Due-Diligence Questionnaire

Section 1: Policy, Strategy and Philosophy

1.1 Characteristics of ESG Integration Policy

1.1.1 What are your objectives in ESG integration?

1.1.2 What is the scope of your ESG integration policy?

1.1.3 How do you ensure compliance to your policies among the management teams of your

portfolio companies?

1.2 Effectiveness of ESG integration policy

1.2.1 What processes exists for evaluating or reviewing your policy's effectiveness?

1.3 Contribution to Industry Best Practices

1.3.1 Have you committed to any international standards, industry (association) guidelines,

reporting frameworks, or initiatives that promote ESG practices?

1.3.2 Do you cooperate (or have you cooperated) with other organizations/institutions to

promote or share knowledge about sustainable investment practices?

Section 2: Materiality of ESG Factors

2.1 Determining Materiality

2.1.1 How do you determine what ESG factors present material risks or value-add

opportunities during pre-investment due diligence?

2.1.2 How do you incorporate your materiality conclusions into your investment decisions?

2.1.3 What processes do you have in place for assessing the changes in material risks &

opportunities throughout the holding period?

2.2 Sector & Geographic Materiality

2.2.1 How do you define which factors are material to the sectors in which your portfolio

companies are located? Do you categorize these factors?

2.2.2 How do you define which factors are material where your companies are located

geographically?

2.3 Improvement on Materiality Identification

2.3.1 Has your process for identifying materiality changed since previous investments, and if

so how?

2.3.2 Do you have any plans to improve your process for identifying material risks from year

to year? If so, please discuss in details.

Section 3: Active Ownership

3.1 Beliefs on ESG Management in Active Ownership

3.1.1: How important are ESG considerations to your active ownership of portfolio

companies? How did you come to this conclusion?

3.2 ESG Integration Strategy During the Holding Period

3.2.1 Through what processes or systems do you regularly monitor the ESG-related

performance of your portfolio companies?



3.2.2 Give 2-3 examples of how you changed the way a portfolio company managed ESG

factors.

3.2.3 How do you build up and assess that adequate ESG-related competence exists at a

portfolio company?

3.3 Effects of ESG integration During Exit

3.3.1 Upon exit, have you ever managed to quantify or evaluate the benefits you’ve created

through integrating ESG considerations?

3.3.2 Have you ever made a decision on exit based on ESG management?

Section 4: Integration Infrastructure: Human and Financial Capital

4.1 Financial resources dedicated to ESG

4.1.1 Do you have a specific budget set aside for ESG integration?

4.1.2 Do you have separate compensation strategies for ESG outcomes than for financial

outcomes?

4.2 Human capital resources dedicated to ESG

4.2.1 Who is responsible for ESG due diligence and standards compliance and what are

his/her responsibilities?

4.2.2 Do you have any training programs related to ESG integration?

4.2.3 Do you have an evaluation system or oversight mechanism (e.g. Key Performance

Indicator) in place for ESG-integration staff?

4.2.4 Do you use any external expertise/third party to do the ESG due diligence?

Section 5: Assessing ESG Communication Procedure with LPs and Portfolio Companies

5.1 ESG Communication Procedures with LPs

5.1.1 Do you have an established ESG reporting format and channel for communicating with

LPs?

5.1.2 Do you have specific methods for communicating instances where material ESG risks

arise during the investment period to LPs ?

5.2. ESG Communication Procedures with Portfolio Companies

5.2.1 Do you have an established ESG reporting format and channel for portfolio companies?


arise during the holding period?

5.2.3 Please describe your response if portfolio companies fail to disclose ESG-related issues

to you persistently.

5.3 ESG Communication Procedures To The Public and Other Stakeholders

5.3.1 Under what conditions do you believe it is necessary for a portfolio company to

communicate or engage directly with external stakeholders on ESG factors? Examples can be

useful for this question.



Part IV: Due-Diligence Questionnaire Working Manual

Section 1: Policy, Strategy and Philosophy

Different funds will have different ESG risk and opportunity exposures depending on their

investment strategy, policy and their capacities to address ESG issues. In this part, we would

like to understand how a fund manager’s approach to ESG integration is influenced by their

policy, investment strategy and philosophy. By doing so, we will be able to assess whether

their ESG-related policy aligns with an LP’s responsible investment beliefs. We would also

like to see how the policy has been improved during the progress of ESG integration, how

consistent they are and whether it has been effectively implemented.

DDQ Section 1.1: Characteristics of ESG Integration Policy

In this subsection, we would like to assess your ESG policy on a general level: by assessing

your investment strategy and specific ESG policies. If you have a policy elaborating your

approach to ESG integration, please provide as many details for the questions below as

possible, including your investment motivations, your ESG objectives and approach, your

policy scope and the compliance of your policy to any external standards. If you are unable

to answer any of the following questions, please indicate whether you you are considering or

have plans to adopt an ESG integration policy in the future and what those policies might be.

1.1.1 What are your objectives in ESG integration?

What is the objective and how is it stated in your policy?

If you don’t have an ESG integration policy, what are your general goals in

your ESG practice?

1.1.2 What is the scope of your ESG integration policy?

Does your policy cover the complete timeline of an investment (due diligence,

holding period, and exit)?

Can your policy/approaches be applied across industries and regions?

Do you specifically focus on some ESG factors, if so, which ones?

o We understand that different investment strategies and practices will

bring different ESG risks. If you have observed and focused on some

specific ESG factors, please list and explain why.

1.1.3 How do you ensure compliance to your policies among the management teams of your

portfolio companies?

How do you educate your portfolio companies on your ESG management

policy?

Who is responsible for communicating with your portfolio companies about

the policy implementation and monitoring their ESG integration?



DDQ Section 1.2: Effectiveness of ESG Integration Policy

In this subsection, we would like to examine how effective your policy has been conducted

and how will you improve it in the future.

1.2.1 What processes exists for evaluating or reviewing your policy's effectiveness?

If you have a developed a monitoring system to assess the implementation status of your ESG

policy, please provide the details including the mechanism of the system, the person who uses

the system and the plan of developing the system. If not, please indicate how you currently

review your policy.

At the fund level:

Please describe the feedback about policy implementation that you receive

from portfolio managers.

o For example: Is the policy easily understood, is the policy able to be

implemented in a standard way across portfolio managers?

Please describe any internal obstacles to conducting your policy.

Given the impediments listing above, how can this policy be improved?

At the level of the portfolio company:

Please describe the feedback about the policy you receive from your portfolio

companies.

o For example: Have any benefits been observed by the portfolio

companies since your policy was first implemented?

Please describe any obstacles for enforcing the policy with the portfolio

companies.

DDQ Section 1.3: Contribution to Industry Best Practices

In this subsection, we would like to know how you commit to existing regulations and whether

you have done anything to improve the responsible investment ecosystem.

1.3.1 Have you committed to any international standards, industry (association) guidelines,

reporting frameworks, or initiatives that promote ESG practices?

Are you a signatory to the PRI?

How do you incorporate the standards/guidelines/frameworks into your ESG-

related policy?

If you don’t commit to any standards, please describe in what ways you

address ESG considerations separately from regulatory requirements.

1.3.2 Do you cooperate (or have you cooperated) with other organizations/institutions to

promote or share knowledge about sustainable investment practices?

Have you initiated any activities or cooperated with any organizations to

promote sustainable investment practices? If yes, please provide the details

and the results of the initiatives.



Do you belong to any organizations/institutions with the mission of improving

responsible investment practices?

Section 2: Materiality of ESG Factors

This section is intended to provide UBS with a view on how the GP determines which ESG

factors are material for a given investment and how they determine or quantify how those

material factors will affect the risk or value of their investment.

DDQ Section 2.1: Determining Materiality

There are a wide variety of available indicators for ESG factors available through sources

such as IRIS or the GIIN, many of which will not be relevant for every investment. For this

reason it is imperative that the GP have a process in place to determine which specific

factors may affect the investment and which factors can be targeted to either reduce risk or

add value.

2.1.1 How do you determine what ESG factors present material risks or value-add

opportunities during pre-investment due diligence?

GPs are most likely to consider ESG issues as a tool for risk mitigation. However, there is an

increasing number of GPs who use ESG factors as opportunities to create the value of the

company. For example: A GP investing in a clothing factory in Bangladesh may consider

labor conditions as a material ESG factor to screen for in order to mitigate the risk of non-

compliance with local laws.

Do you have a rating (grade) system for ESG risk screening? What other frameworks

do you use?

Is there a dedicated team or person responsible for ESG risk screening?

2.1.2 How do you incorporate your materiality conclusions into your investment decisions?

Do you have a quantitative rating system, or a qualitative framework to evaluate the

different factors?

How do these factors affect your investment decision or how are they incorporated in

the decision-making process? Please describe in detail.

2.1.3 What processes do you have in place for assessing the changes in material risks &

opportunities throughout the holding period of an investment?

Throughout the holding period of an investment, ESG risks or value-added opportunities may

arise that were not relevant in the initial investment period.

Do you have a process to regularly review and monitor old and new ESG risks

throughout the holding period? Please describe in detail.

How do you plan to respond to new or emerging risks once you spot them?

DDQ Section 2.2: Sector & Geographic Materiality



ESG factors’ materiality depends on the region and sector of portfolio companies. It is

important for the GP to understand there are no universal, material ESG factors and that

disclosure of non-material ESG factors is not always relevant to investors and LPs and can

even be distracting from important ESG issues.

2.2.1 How do you define which factors are material to the sectors in which your portfolio

companies are located? How do you categorize these factors?

2.2.2 How do you define which factors are material where your companies are located

geographically?

Can you provide an example of portfolio companies in diverse regions and sectors,

and how you identify material issues?

Please describe the geographic and sector diversity of your portfolio companies.

Do you refer to any external standards (SASB, MSCI, IFC) to develop your

assessment of which factors are material in different industries and sectors?

DDQ Section 2.3: Improvement on Materiality Identification

In order to ensure compliance, we will focus on GP’s historical practices as well as beliefs

and outlook. Supporting documents may be required when discussing some of the questions.

2.3.1 Has your process for identifying materiality changed since previous investments, and if

so how?

2.3.2 Do you have any plans to improve or change your process for identifying material risks

from year to year? If so, please discuss in details.

Section 3: Active Ownership

Integrating ESG factors into the management of a portfolio investment is the idea that

through owning a company, a GP can transform management practices with material ESG

factors in mind in order to improve the value proposition of the company. In this section, we

would like to assess whether the GP is capable of influencing its portfolio companies on the

management of ESG issues in order to avoid risks to financial performance.

DDQ Section 3.1: Beliefs on ESG Management in Active Ownership

In this subsection, we would like to understand your view on ESG management during its

active ownership of portfolio companies. You may give supporting evidence by providing

empirical observations.

3.1.1: How important are ESG considerations to your active ownership of portfolio

companies? How did you come to this conclusion?

Do you believe ESG considerations can help the companies mitigate risks?

Do you believe that ESG can help portfolio companies create value?

DDQ Section 3.2 ESG Integration Strategy During the Holding Period



In this subsection, we would like to examine you interact with your portfolio companies about

ESG issues and examine your influence on portfolio companies regarding ESG management.

3.2.1 Through what processes or systems do you regularly monitor the ESG-related

performance of your portfolio companies?

How do you assess ESG-related performance of your portfolio companies during the

holding period?

3.2.2 Give 2-3 examples of how you changed the way a portfolio company managed ESG

factors.

Each example is expected to address:

o What was the general problem?

o How was that related to ESG?

o What did you respond to this problem?

o What was the result? (financial or non-financial)

Specify the initiative(s) you worked on with management to identify issues or how

you supported best practices of the company that were already underway.

Please provide historical examples from your last fund where a material ESG factor

was identified during ownership that had not been identified during due diligence.

Please include a description of any follow-up activity.

3.2.3 How do you assess that adequate ESG-related competence exists at the portfolio

company?

Describe what training, assistance or additional resources you typically provide to

your portfolio companies to help them understand the relevance of managing ESG

factors and to enable them to do so.

Do you train managers at portfolio companies in ESG factors? Do you embed your

own ESG staff within portfolio companies during your ownership?

How do you assess ESG-related expertise among the management of your portfolio

companies?

Does this training emphasize any of the individual elements of ESG - Environmental,

Social and Governance - over others?

Some GPs have a structural Technical Assistance (TA) facilities that provide support

on corporate governance issues for portfolio companies. Do you have anything of this

kind?

If you engage external expertise to assist the portfolio company in their management

of ESG factors, describe what type(s) of service is provided. Specify whether the

external specialist is typically employed by the GP or the portfolio company.



Can you connect us with the relevant personnel at 2-3 portfolio companies who would

be able to discuss your commitments to ESG integration?

DDQ Section 3.3: Effects of ESG integration During Exit

We are interested in understanding how ESG integration affects the value of a fund during

exit, and whether you have collected any data on these effects.

3.3.1 Upon exit, have you ever managed to quantify or evaluate the benefits you’ve created

through integrating ESG considerations?

Please describe what the benefits are and how you are able to measure them.

Do your systems or does your process differ based on type of exit (i.e. IPO, trade sale

or financial buyer)?

3.3.2 Have you ever made a decision on exit based on ESG management?

Has your decision about how to exit ever been influenced by ESG integration? if so

how?

Have you ever found that ESG factors limited exit options for an investment? If so,

please provide an example.

Section 4: Integration Infrastructure: Human and Financial Capital

In order for ESG factors to be able to be integrated into investment decisions, whether to

hedge risk or to create value in portfolio companies, GPs need to allocate resources dedicated

specifically to this purpose. This section aims to assess the level of dedication of GPs to ESG,

by finding out what kind of financial and human capital resources are dedicated to their ESG

practice.

DDQ Section 4.1 Financial Resources Dedicated to ESG

In this subsection, we would like to examine the costs and benefits of your budgetary plan for

ESG integration. We aim to assess how the budget is allocated between the organization and

portfolio companies and how your plan can be improved in the future.

4.1.1 Do you have a specific budget set aside for ESG integration?

Please provide the details for this budget allocation.

o How much is this budget?

o What portion of the fund’s overall budget is this?

o Please specify whether this budget allocation is associated with an individual

fund or the GPs overall operating budget.

o Accounting method: in the financial statements, Is the budget recognized as

“ESG integration”? Or do you have other ways to categorize the expenses?

o Who is responsible for managing the ESG budget?

Do you have a process to re-evaluate this budget allocation?



o How do you measure the cost-benefit of this allocation?

o Has the allocation increased, decreased or stayed the same?

o Do you have any plans to change the current amount allocated to ESG

integration? If so, why?

If not, why is there no specific budgetary allocation for ESG?

o Was there an allocation in the past?

o Is there likely to be one in the future?

4.1.2 Do you have separate compensation strategies for ESG outcomes than for financial

outcomes?

Why do you think there should be a distinct compensation strategy for ESG

outcomes?

Have you ever awarded a staff member or team based on ESG-related outcomes? If

so, please explain what these outcomes were and how the appropriate compensation

was determined.

If not, how are staff incentivized to implement ESG best practices through your

broader performance management and/or compensation process?

DDQ Section 4.2 Human Capital Resources Dedicated to ESG

Human capital is the core of the capacity of ESG integration. Therefore, in order to assess

the capacity of your ESG policy and practice, we would like to evaluate how you use, train

and distribute your ESG personnel.

4.2.1 Who is responsible for ESG due diligence and standards compliance and what are

his/her responsibilities?

Do you have a team specialized in ESG integration?

What is the person/team’s relationship with the broader investment staff? Where does

this person/team fall in the firm’s organizational chart (e.g. manager, analyst)?

What qualifications do you look for when selecting a ESG manager/staff member?

4.2.2 Do you have any training programs related to ESG integration?

Please provide details about the program. Is it mandatory for all personnel or only

certain team members? What does the training entail?

4.2.3 Do you have an evaluation system or oversight mechanism (e.g. Key Performance

Indicator) in place for ESG-integration staff?

Is this part of your broader investment staff performance evaluation/oversight

processes? Does it have any impact on investment selection or management

decisions?

Does this ESG-focused evaluation/oversight system impact decisions around staff

compensation, advancement, etc?



What are the priorities of this performance evaluation/oversight method? What does it

reward?

4.2.4 Do you use any external expertise/third party to do ESG due diligence?

If so, which third party do you use and in what capacity?

o Is this third party employed by the GP or portfolio company?

Section 5: Assessing ESG Communication Procedure with LPs and Portfolio Companies

In this section, our goal is to get an understanding of the level of transparency on ESG issues

practiced by the fund. We want to explore what processes and channels the fund has in place

for communicating to and receiving communication from three important parties: the

portfolio companies themselves, the LPs that have invested with the fund, as well as the

general public and other external stakeholders.

This section is organized by communication partner, however most questions can be asked in

parallel.

DDQ Section 5.1 ESG Communication Procedures with LPs

For GPs, a best ESG practice requires a proactive, frequent and transparent ESG-related

disclosure to LPs in order to take the timely and appropriate actions if there are any

potential ESG risks. Therefore, we would like to examine whether you can assure the LPs of

the ESG reporting throughout the whole investment period and when material ESG incidents

happens.

5.1.1 Do you have an established ESG reporting format and channel for communicating with

LPs?

Are you required to regularly update LPs on ESG issues that may arise during the

holding period?

What is the channel of regular communication, eg. capital calls, investment memos,

portfolio company reports, Limited Partner Advisory Committee meetings etc.


arise during the investment period to LPs ?

Are there any special disclosure mechanisms that enable you to disclose ESG issues

outside of regular, periodic disclosures?

Please provide specific examples of past incidents could be included to further

illustrate the methods.

DDQ Section 5.2. ESG Communication Procedures with Portfolio Companies

To better monitor the ESG integration of portfolio companies and ensure they are operating

consistently with GP’s ESG-related policy and practice, it’s important to require ESG



reporting and disclosure in a frequent manner from your portfolio companies. Therefore, we

would like to assess whether you can effectively interact with your portfolio companies in

regards to ESG integration in order to facilitate their ESG management.

5.2.1 Do you have an established ESG reporting format and channel for portfolio companies?

Do you require your portfolio companies to regularly update you on ESG issues that

may arise during the holding period?

What is the channel of regular communication, for example: reports or board

meetings?


arise during the holding period?

What types of material ESG incidents for which the portfolio companies should

provide disclosure?

In what format this disclosure could take?

5.2.3 Please describe your response if portfolio companies fail to disclose ESG-related issues

to you persistently.

What is your approach if non-compliance happens? Eg. The steps taken to remedy or

mitigate the effect of the relevant non-compliance, and to ensure that there is no

further non-compliance in the future.

Are there any affirmative/negative covenants in the investment agreement regarding

ESG communication?

DDQ Section 5.3 ESG Communication Procedures To The Public and Other

Stakeholders

In this subsection, we would like to know your contribution of disclosing ESG practices

beyond current regulation or compliance which you are subjected to.

5.3.1 Under what conditions do you believe it is necessary for a portfolio company to

communicate or engage directly with external stakeholders on ESG factors? Examples can be

useful for this question.

This question aims to assess how the company views the importance of communicating ESG

matters to external stakeholders. This is important as it shapes the perception on the company

of external stakeholders and the public, which could directly impact the operations of the

company.



Part V: Outlook for Next Steps

A. Conclusions

We believe incorporating the DDQ we have developed into UBS’ due diligence processes would

allow for a salient precursory understanding on the ESG integration practices of fund managers.

Nonetheless, we suggest the following next steps to optimize the insightfulness of the DDQ:

Developing a scorecard for fund managers’ responses - In the future, UBS could work

towards developing a scoring scheme for the responses collected. There are two key

components to this exercise; (i) Assigning a weight to each question relative to other

questions within the questionnaire, and (ii) Rating the generated responses based on a

predetermined scheme of ‘good vs. bad answers’. The resulting score can be included as

a metric in UBS’ investment memos.

Automating the implementation of the DDQ - This includes automating the processes of

rolling out the questionnaire as well as storing the generated responses. The automated

aggregation of answers could provide more value by automatically highlighting the

potential areas of concern and opportunity for each fund manager. We believe that this

would be valuable in guiding onward analysis by UBS.

Incorporate ways to validate responses - As an extension to the automated

implementation and aggregation, UBS could work towards incorporating validating

measures within the DDQ. Although we do not envision this to eliminate the need for

manual review of the responses by the UBS investment team, we believe this would

reduce the need for extensive cross-validation exercises. We believe that there could

various ways of implementing this, but further work needs to be done to investigate the

most efficient method.



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sustainable finance: integrating esg into private equity

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