The assessment of corporate sustainability can be divided into three areas, namely environmental, social and governance (together “ESG”).
When assessing sustainability at the corporate level, the decisive factor is whether and how companies take into account and implement environmental and social aspects as well as aspects relating to the nature of corporate governance in their (investment) decisions and in their business practices. This covers not only environmental issues but also, among other things, the way a company treats its employees and the principles of good corporate governance. The topics of environment, social affairs and corporate governance in turn each contain different criteria. Assessment criteria include the development of pollutant emissions, occupational safety and health protection for employees, equal opportunities, and measures to combat bribery and corruption.
The internal ESG policy established by HQ Equita with regard to HQ Equita Beteiligungen V GmbH & Co. KG describes how sustainability risks are to be taken into account in the relevant decision-making processes.
By evaluating ESG, we can identify companies that can benefit from future sustainability trends and create positive social value through their business model. On the other hand, we are convinced that by taking appropriate account of ESG aspects, even more substantiated investment decisions can be made and improved company valuations achieved in the long term. Additionally, we believe that, especially at the level of our portfolio companies, operational potential can be boosted and risks minimized. Accordingly, ESG-related opportunities and risks are incorporated into our investment decision-making processes. In order to further substantiate our related efforts we have set up a dedicated ESG team within HQ Equita. The composition of this team, consisting of partners, compliance and investment team, shows the high priority we assign to this topic. The task of this team is the (further) development of the ESG strategy as well as the support and supervision of the implementation by the investment team.
Our approach to ESG integration in investments in the different phases of an investment
1. Selection process
An ESG due diligence is a clear component of the review processes in the preparation of an acquisition – where appropriate, also through the involvement of specialized external consultants. If a company falls under our exclusion criteria, an investment is rejected from the outset. These essentially apply if a company is found to be engaged in illegal activities or to generate a not insignificant proportion of its sales in business areas such as gambling and comparable activities, armaments, pornography, tobacco or distilled alcohols. A further exclusion criterion could be serious corporate misconduct in the environmental, social or governance areas. The criteria include, for example, causing serious environmental damage, violating labor and human rights, or harming customers through inadequate product safety or data security.
The relevance of environmental and social aspects may vary depending on the respective industry and the company under review. If potential ESG problems are identified during the due diligence process, this in itself would not be a reason for exclusion, but would be included on the agenda for optimizations during the investment period. Depending on the specific business model of the company, HQ Equita may also conduct an additional, more comprehensive ESG review after the closing of the transaction.
2. During the term of our investment
During the term of our investment, we communicate regularly with management on ESG-relevant issues and encourage them to identify and address ESG issues. We support management in implementing the optimization potential (if applicable, as identified during due diligence) and the resulting minimization of ESG risks.
3. Divestment-phase
When preparing a divestment, appropriate measures are taken to ensure that the our portfolio company is best positioned to continuously improve its ESG performance in the long term, also beyond the term of our investment.
The EU Regulation of November 27, 2019 on sustainability-related disclosure requirements in the financial services sector (“SFDR”) requires HQ Equita to make a “comply or explain” decision as to whether it considers the principal adverse impact (“PAI”) of its investment decisions on sustainability factors in accordance with a specific regime described in the SFDR. While HQ Equita does consider sustainability risks and sustainability factors in its investment activities, it does not currently comprehensively and in detail assess the negative impacts of investment decisions based on a consistent set of sustainability factors. HQ Equita supports the PAI regime’s policy objectives to provide greater transparency to investors and the market on how financial market participants integrate consideration of the negative impacts of investment decisions on sustainability factors. The regulatory environment surrounding sustainable investments and how to evaluate sustainable investments and their negative impacts is still in flux, and clear regulatory guidance and industry consensus on how to proceed has yet to develop. Given the foregoing, the size of HQ Equita’s business, the nature of its investments, and the resources required to put in place the necessary processes to track and report on the adverse impact of investments on sustainability factors, HQ Equita has determined that it will not consider the impact of its investment decisions on sustainability factors under Article 4 of the SFDR at this time.
HQ Equita will periodically review its decision not to apply the regime described in the SFDR and, if appropriate, consider principal adverse impacts of investment decisions on sustainability factors as defined in the SFDR in the future.
Notwithstanding its decision not to apply the SFDR regime, HQ Equita has already implemented positive ESG-related initiatives and policies as part of its overall commitment to ESG matters, which are summarized above. For the avoidance of doubt: none of the information provided is intended to suggest that HQ Equita applies the PAI regime.
As part of the compensation policy, which reinforces HQ Equita’s business strategy, values and long-term interests, employees are measured, among other things, by the performance of the investee companies they manage. As stated above, members of the investment team consider ESG-related factors both when reviewing potential investments and in all stages of servicing investee companies, which are also regularly reflected in the companies’ performance. In addition, long-term incentives are established through agreements on long-term carried interest claims to create an alignment of interests between team members and investors. If the value of the portfolio companies falls (as a result of a sustainability risk or for other reasons), the value of the team members’ shares will also fall. These rules are intended to encourage employees to take sustainability risks into account when making investment decisions and not to take such risks lightly.