This article first appeared in The Edge Malaysia Weekly on May 16, 2022 - May 22, 2022

While most of the activities around environmental, social, and governance (ESG) reporting and investing have been in the public markets, private market investors are catching up with the trend as well.

A number of venture capitalists (VC) in Asia, for instance, are appointing ESG leads and forming ESG policies to cover their portfolio companies. 

Southeast Asia-focused VC Monk’s Hill Ventures (MHV) welcomed Susli Lie as a partner in February this year. One of Lie’s responsibilities is to build the firm’s ESG programme. Over at Gobi Partners, one of the more prominent VCs in Asia, Paul Ark was made partner and head of ESG last October.

Gobi and MHV’s initiatives could be considered to be ahead of the trend. The Principles for Responsible Investment (PRI), a United Nations-supported international network of investors and leading proponent of responsible investment globally, published survey results in January that highlighted the current state of ESG adoption among VCs.

It found that few VCs have dedicated ESG professionals to provide in-house support. ESG oversight responsibility often lies with investor relations personnel, who have no role in investment decision-making, or with junior members of investment teams.

But in Gobi’s case, Ark and the ESG committee have developed for the VC and its portfolio companies ESG strategies and frameworks, which are executed by the ESG task force. Ark also educates key stakeholders about the benefits of ESG.

“To that end, Gobi’s ESG teams have been forming partnerships, creating media content and hosting community-building and capacity-building events,” says Ark.

MHV introduced an ESG policy to cover all new investments made from mid-2021. Lie says the firm believes that non-financial considerations covered under ESG are material and can have financial implications. 

“Most start-up founders are mission-driven because they are trying to solve a problem. They are usually tackling pain points and figuring out a scalable way to sell their products and services. For the very same reasons, many of the start-ups we have invested in are already implicitly ESG-oriented,” says Lie.

MHV also measures its own greenhouse gas emissions and routinely monitors portfolio companies on gender representation. Lie believes that fundamentally, all companies have to be mindful of their consumption of materials and energy, which can impact the environment.

“I would argue that as an investor, it is important to have these conversations, even if an ESG policy isn’t in place. In my view, especially in a post-pandemic world, a strong ESG strategy is crucial for economic recovery and prepares companies to thrive in time to come,” says Lie.

In the ESG integration process, the first step that both VCs are taking is to eliminate start-ups that do not comply with their values. These could be those involved in illegal operations or those with a gender-biased workplace.

Gobi has its own “exclusionary list”, says Ark. “This involves a basic negative screening process to ensure that a potential investment isn’t engaged in egregious ‘red flag’ activities that would automatically preclude Gobi from investing, such as the utilisation of forced labour, trading of toxic materials or deforestation.”

MHV applies an ESG lens on top of its usual investment guidelines. Lie stresses that it’s not the only metric used to assess companies. It does, however, provide an overview of risks the start-ups face.

After the start-ups pass the screening stage, the VCs will identify ESG metrics used to evaluate each of them. 

“We will determine mutually agreed-upon ESG metrics that would be used to evaluate the start-up post-investment, and ESG action items for Gobi and the start-up to work on to enhance the start-up’s ESG practices,” says Ark.

MHV will identify the United Nations’ Sustainable Development Goals that are relevant to each start-up’s business and develop the ESG metrics from there. It also requires start-ups to fill in a due diligence questionnaire to establish an ESG baseline. 

“In our ESG due diligence, we emphasise establishing a baseline with our companies, understanding that there is not a right or wrong starting point, but it’s about building and thinking intentionally about ways to track and improve over time,” says Lie. 

The ESG metrics are developed for each start-up based on its unique circumstances. 

“At the moment, Gobi is working with each portfolio company to develop appropriate ESG metrics. But we are exploring global ESG frameworks and reporting standards that we would formally adopt and implement as our ESG portfolio management operation evolves,” says Ark. 

“For the time being, we utilise a more informal approach as we climb the learning curve and come to understand the strengths and shortcomings of our current process.”

Of course, some standardisation is required, says Lie. “We are trying to keep things standardised to the extent possible (for the ESG metrics) to be communicated and complied with, (so it would be) easier for us to tweak it later on.” 

For Ark, the biggest challenge for VCs in evaluating the ESG performance of start-ups is the lack of standard market practices to draw on, especially in Asia. 

“While the evaluation of ESG performance is becoming mainstream for public-listed companies and is starting to filter down to large-cap private companies, the practice of ESG assessment and evaluation in the early-stage start-up space is practically embryonic,” says Ark. 

“Reporting standards for large public and private companies need to be adapted for early-stage, resource-poor start-ups, and data needs to be sourced, aggregated, packaged and shared.”

On the other hand, Lie says the lack of ESG-related data from start-ups requires MHV to develop its own scoring methods. The VC also does site visits to observe the ESG compliance of the start-ups. 

MHV hires an ESG consultant to do the audit when it invests in deep-tech companies with operations that have a high environmental impact. 

“Generally, given that we invest in tech start-ups, our diligence will focus primarily on their tech innovations, their work culture, hiring practices, and governance,” says Lie. “The fact is, ESG awareness is low in Southeast Asia, so we’ve had to adapt a lot of the existing framework and guidelines in order to find a fit with the types of companies we invest in in the region.”

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