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Due to the legal nature of the transaction, which makes the private equity fund a partial or full owner of an investee company, the private equity fund is directly exposed to, and thus also liable for, the environmental and social risks of the investee company.

Through environmental and social risk management, the private equity fund can mitigate potential environmental and social risks that would otherwise reduce an investee company’s financial viability and also identify environmental business opportunities that would enhance an investee company’s financial viability. Also, as a function of the private equity fund’s ownership position in an investee company, it will be in a unique position to advocate for sound environmental and social management of the investee company’s operations.

The private equity fund will apply the environmental and social risk management procedures to each investment as part of its overall risk management framework. The environmental and social risks of investee companies will range by industry sectors. For investments involving investee companies with high environmental and social risk, a more in-depth environmental and social analysis will be required than for those investments involving investee companies with lower environmental and social risk. A private equity fund’s Environmental and Social Management System will include the following components:

  • Environmental and social policy. The policy will state the private equity fund’s commitment to managing environmental and social risks to which it might be exposed to as a result of its shareholding position in investee companies. Typically, this will include a commitment not to finance certain types of activities, and requirements for investee companies to comply with environmental and social regulations and also international standards for certain high-risk investments.
  • Investment screening and risk categorization. The private equity fund will screen a proposed investment to determine if it will proceed with it. The private equity fund will assign a category according to low, medium or high environmental risk to determine the scope of the environmental and social due diligence that will be necessary to identify risks. This will enable the private equity fund to determine early on if a potential investee company represents environmental and social risks that are too significant to be exposed to.
  • Environmental and social due diligence. The private equity fund will conduct a environmental and social due diligence for each proposed investment but the level of detail will vary and will be based on the environmental and social risk. For low-risk investments, the extent of the environmental and social assessment will be limited to a simple review of the company’s operations to confirm that there are no concerns with the operations. For medium-risk investments, the environmental and social assessment will need to include an overview of a company’s operations, which may require a site visit, to identify potential environmental and social impacts due to the company’s industry sector. Environmental and social impacts of this scale are typically regulated under a country’s environmental and social regulatory framework and the private equity fund will need to satisfy itself that the company complies with all applicable regulatory requirements. For high-risk investments, a more in-depth assessment against environmental and social requirements will be necessary to fully understand potential environmental and social risks associated with the company’s operations. This will require a site visit and depending on the complexity of the company’s operations and industry sector, the private equity fund should retain the services of an external expert.
  • Corrective action plan. Based on the findings of the environmental and social due diligence or during subsequent monitoring of the investee company’s performance, the private equity fund will require investee companies to implement certain mitigation measures within a specified timeframe.
  • Environmental and social covenants. The private equity fund will incorporate the corrective action plan and other environmental and social requirements as clauses in the legal agreement with the investee company.
  • Monitoring environmental and social performance. The private equity fund will monitor the compliance of investee companies with its environmental and social requirements. The scope of monitoring will depend on the company’s operations and can include periodic site visits.

Although the staff of a private equity fund is generally limited in number, the ESMS will need to define their specific roles and responsibilities with respect to environmental and social risk management. An Investment Officer typically takes on the responsibilities of the ESMS Officer and has oversight for the day-to-day implementation of the ESMS.

In some cases, Investment Officers will conduct the environmental and social due diligence for low or some medium-risk investments. Generally for investments that potentially represent high environmental and social risks, a private equity fund will hire an external environmental and social specialist to conduct the environmental and social due diligence and provide the necessary recommendations for mitigation measures. The environmental and social findings and recommendations will be considered by the Investment Committee when determining to proceed with an investment. A private equity fund will need to ensure that a system is in place for record-keeping on environmental and social issues associated with each investment.


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