USS PE RI diligence process
The first step in the process for USS occurs during the scheme’s due diligence assessments of potential GPs. Private equity is not just buyouts, where the private equity firm takes control of a company. The LP/GP structure is used for a range of asset types including, among others, debt, infrastructure and mortgages. As a result, while the process USS has developed for undertaking due diligence has some core aspects, it has to be flexible and adaptable to account for differences in the underlying assets.
USS undertakes its own traditional due diligence into GPs and once a prospective fund has passed an initial evaluation, a more detailed assessment is undertaken by the internal private equity managers. As part of that process, and before the investment decision is made, the RI due diligence is undertaken. This process is relatively simple, involving a brief questionnaire followed by either a meeting or teleconference between the GP, internal private equity staff and the USS RI team.
USS has developed its own questionnaire (see below), which is sent to all potential GPs. This questionnaire focuses on the following four areas:
1. How RI issues are considered at the due diligence stage.
2. How extra financial issues are managed in the overall management of assets.
3. Communications associated with ESG issues.
4. Views on UN-supported Principles for Responsible Investment (PRI) and other ESG frameworks.
The aim of these questions is twofold:
1. To ensure the GP is aware that USS is interested in how it manages these issues and is prepared to answer questions around them.
2. To identify areas for further discussion during the second phase of the due diligence (that is, a teleconference or meeting).
It is now unusual not to receive written responses to these questions and it is rare for USS not to receive at least basic information from potential GPs. Indeed, many funds now also provide additional information, including ESG policies and case studies as to how ESG issues have been incorporated into investment processes. USS is also seeing increased inclusion of ESG information in private placement memoranda (PPMs) – the reports that GPs provide to potential investors as part of the marketing process. While this frequently provides very limited information, it does indicate that the private equity sector is becoming both more used to seeing requests for information on ESG issues and more proactive in providing it. Inclusion of such information, in DQMs for example, demonstrates how far the sector has moved in recent years.
The second phase of the process – the follow-up call or meeting – is extremely important. During these calls or meetings, USS asks for more detailed explanations as to how extra financial issues are assessed in the due diligence process, how they are managed across portfolios and how these issues are then communicated with LPs and other stakeholders.
In order to prepare for these meetings, USS reviews previous investments made by the GP to identify where ESG issues may have arisen in a portfolio company or asset. This generates specific questions that will usually be sent to the GP in advance of the call to enable them to prepare responses and to ensure that the appropriate people are available during the call to respond to the questions. The due diligence process then drills down to how the potential GP assessed those risks in their due diligence and managed them post investment. If it is a new fund (that is, a first-time fund or new GP), USS will even look back to a potential manager’s investments at previous funds to identify appropriate detailed ESG questions.
Finally, USS – as a strong supporter of the UN-supported PRI – asks GPs for their views around the PRI as a framework for addressing these issues. USS does not require its GPs to be signatories to PRI, but does expect potential GPs to have processes in place to assess and address ESG risks and opportunities. USS does, however, encourage GPs to sign up to the PRI and a number of USS’s GPs have become signatories to the Principles. In fact, the PRI already has a disproportionate number of private equity-focused funds as signatories at about 15 percent of its membership (this is higher than the average asset allocations to the sector by pension funds).
Based on the outcomes of these calls/meetings, responses to the questionnaire and other materials provided by the GP, the RI team provides a written opinion on the level of RI activity within the fund. This opinion is then discussed with USS’s internal Private Equity team to identify any outstanding ESG risks concerns. This report includes, where relevant, the identification of issues for further engagement if USS decides to invest in the fund. This final opinion is then incorporated into a final report on the fund (a deal qualifying memorandum or DQM) and submitted to an internal Private Markets Investment Committee (PMIC), which takes the final decision on investment in a GP.
Private Equity Questionnaire for new GP's and new funds
USS’s Approach to Responsible Investment
The Universities Superannuation Scheme Ltd (USS) is one of the largest pension schemes in the UK. USS is a long term and responsible investor, and takes seriously its fiduciary obligations to its members and beneficiaries.
In fulfilling these obligations, USS takes account of short and long term value drivers in its investment process. Environmental, social and governance (ESG) factors are considered in conjunction with financial information. In particular, we believe investee companies’ corporate governance, reputation management, environmental risk exposure, and human resource management should be evaluated as part of an assessment of a company’s competitive positioning and long term profitability. The scheme also seeks to actively encourage responsible corporate behaviour, which is based upon the belief that:
i) management of such issues is good for long term corporate performance, and
ii) better management of these issues will protect and enhance the value of the Scheme's investments.
Our approach aims to ensure long term value delivery for our pension fund beneficiaries.
Implications for Managers
USS expects that its fund managers, both internal and external, will take account of potentially material corporate governance, social and environmental considerations in the selection, retention and realisation of scheme investments. In addition, where the manager owns the assets or company, USS expects the manager to ensure that the above issues are managed to reduce risks, identify opportunities and to protect the reputation of USS.
Questions for Managers
• Please describe how your due diligence process incorporates an assessment of environmental, social and governance risks in the assets you are examining.
• Please identify the main environmental, social and corporate governance risks both your firm and investee portfolio assets face, and explain how these risks are managed. Please provide examples.
USS is facing increasing demand from members, trustees and investment staff for transparency and disclosure of ESG information. USS is supportive of greater transparency to both LPs and other stakeholders by private equity firms and investee companies. The scheme expects its GPs and their portfolio companies to work towards best practice reporting, and industry standards where applicable, such as the Walker Guidelines (http://www.walker-gmg.co.uk/) in the UK.
• Please explain your policy on reporting and disclosure pertaining to your own operations and those of investee companies, and provide supporting material.
USS is a signatory to the UN Principles of Responsible Investment (http://www.unpri.org). These commit signatories (currently representing some US$60+ trillion in assets) to six aspirational Principles that help guide responsible investment strategy in all asset classes. Building on the UN PRI, the American Investment Council (AIC - see www.investmentcouncil.org) published its own Responsible Investment Guidelines in February 2009, and Invest Europe’s Professional Standards Handbook also provides guidance on the integration of ESG into investment decision making and portfolio management.
• Please outline your views on the UN PRI, AIC Guidelines, Invest Europe professional standards and other industry best practice codes. Please outline where you are signatories to such initiatives and provide examples of your commitments.
For further information please contact RI@uss.co.uk.
RI monitoring for private markets
Post investment, USS Investment Management’s in-house staff undertake monitoring of the GPs to which the scheme has allocated capital. The scheme undertakes monitoring to seek assurance that ESG issues are being managed by its GPs and to encourage improvements in ESG performance. The information collected during monitoring also helps inform USS’s future allocations to a private equity manager as data collected are used in the due diligence process for new funds (as outlined above).
The process of RI monitoring begins with research into the portfolio companies or other assets in which a GP has invested. The research identifies relevant ESG risks or opportunities that can be interrogated further with the GP and seeks to understand how they have engaged with portfolio companies on these issues. A member of the RI team meets with representative members of the GP and questions the processes, actions and outcomes associated with the management of ESG issues within the portfolio. USS carries out these assessments within the context of the LP / GP relationship, where the GP has ultimate responsibility for investment decisions and its portfolios. As a result, USS is not involved in managing issues at a portfolio or asset level.
USS aims to assess their GPs on ESG issues on a regular and ongoing basis (typically every three years). This is irrespective of the type of private equity fund in which USS is investing (for example, debt funds or buyouts). It may also be the case that due diligence is undertaken on new funds offered by the private equity manager during this time. USS would assess how RI has been incorporated in any previous investments: this process also acts as a post investment review.
To aid with due diligence and ongoing assessments, USS has developed an internal databank of questions on ESG topics to ensure that the effectiveness of meetings with GPs is maximized covering the broad range of ESG issues.
Re Public Markets Passive funds
Note on Passive Investment Strategies: For our passive equity portfolio, USS expects the fund manager to adhere to principles of good stewardship and to take an active approach to voting and engagement: the scheme monitors the manager to ensure that this is the case. USS does not consider this to be integration and has not looked at monitoring for ESG integration at its passive equity fund manager. However, it could be argued that the monitoring of ESG risk, active decision making on voting, and engagement on ESG matters within a portfolio would be considered "ESG integration" by some.