Institutional investors should update their environmental, social and governance (ESG) standards to limit investment in private equity firms that make use of the controversial leveraged buy-out (LBO) strategy, according to social policy network Catalyst.
According to the group, the LBO model, which was harnessed extensively during the private equity boom of the early 2000s and is still used widely today, has negative social impacts and is widely associated with practices like tax avoidance, retrenching workers, extracting high fees and destabilizing companies.
But while superannuation funds and institutional investors in Australia account for around 60% of private equity funding, existing ESG standards do not screen out firms involved in this controversial practice.
Catalyst has called on large investors to review their ESG frameworks to put greater scrutiny on private equity firms' investments strategies.
"A starting point for institutional investors who are concerned about the ethical implications of their existing PE investment may be to engage with these PE firms, as proposed by the United Nations-supported Principles for Responsible Investment. This essentially involves subjecting PE investment to the same standards for transparency and accountability that ethical investors would apply to their share portfolio," Catalyst's latest report said.
"Institutional investors can also consider developing their own criteria for ESG which goes beyond that provided in the standard ESG tools, in order to capture some of the extractive practices that have been associated with the PE industry."
Some investors, such as the Norwegian government pension fund, choose not to invest in PE firms given their lack of transparency about what they invest in, the negative effects of the LBO model, and their high management fees which cut into investor returns, Catalyst explained.
In 2011, a number of significant PE investors including the Victorian Funds Management Corporation and UniSuper decided to stop making new commitments to PE in favour of other asset classes, in the wake of the 2010 Super System Review (Cooper Review).
A large number of PE funds have signed up to the UN-supported PRI and have complied with reporting and other implementation requirements. However, Catalyst says the UN-supported PRI is vague in its definition of responsible investment, and its principles do not make clear the obligations imposed upon signatories.
It believes the responsibility lies with large investors to tighten their ESG frameworks to promote reform in the PE industry.
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