As the world responds to the global financial crisis and economic downturn, a growing number of people are urging that we use this as an opportunity to address the next wave of threats facing our global community. The future will be different for us all, no matter our industry. Yet one common denominator is emerging, namely the concept of responsible values. This is an issue to which private equity institutions can and should add their voice.
We should see it as a good thing that this crisis is forcing us all to redefine certain corporate values, placing new norms and responsibilities at the core of business agenda with renewed vigour. This is an opportunity to be seized. Otherwise, other devastating shocks will sweep over the world, dispensing destruction on perhaps an even greater scale than we have seen over the past year. This global financial crisis was not without warning. There were a few who saw the writing on the wall but were ignored. Short-term thinking and greed prevailed with little regard for the unsustainable and harmful nature of the systems and human failures at play. Technology and globalisation have interconnected our societies and economies like never before, offering highways for rapid contagion. Systemic risks will persist as our world integrates further and our planet undergoes "global shrinkage".
So what of oft-mentioned issues such as access to clean water, climate change, energy-resource depletion, urban expansion, food scarcity and poverty? Are we going to ignore well-documented and researched warnings? Or, are we corporates going to use today's crisis to place at the centre of our production system and economic activity the notion of responsible values that can live alongside profit generation and stakeholder value-creation? Private equity has an important contribution to make in shaping this new world. Private equity investors are long-term value creators, with their success based on trust, good governance, proper accounting and reliable valuation methodologies; criteria that have been sorely missing over the past few years. Private equity firms can also have a multiplier effect in that their holdings and investments span numerous businesses, touching thousands of employees and stakeholders.
Globally, it is estimated that private equity companies manage more than US$2 trillion (Dh7.34tn) of assets. This is a powerful vehicle through which it can make a difference in several ways. Improved transparency is a fundamental starting point. To be part of the solution that rebuilds confidence, private equity must significantly enhance its own transparency. This can include voluntary submission to regulation, quarterly reporting along, say, European Venture Capital Association guidelines and increased non-financial reporting, that is, explaining how private equity works and how it creates real value.
By insisting on good governance, transparency and accountability, private equity can immediately raise standards at hundreds of influential, privately held companies worldwide. The consultancy firm McKinsey says companies moving from worst to best in terms of corporate governance can, on average, expect their valuation to rise 10 per cent to 12 per cent. This comes from stronger management, improved performance and the reputational benefit associated with being well-run and well-governed.
Secondly, companies need to practise the good old-fashioned model of steady growth, based on the provision of real goods and services, real demand and real revenue. To be part of the solution, private equity can focus on low-leverage models that concentrate on enhancing the operations at their portfolio companies and providing growth capital to help address market demand for an important good or service.
Lastly, firms need to recognise the importance of a wider range of environmental and social risks, as well as opportunities, when considering investment. As the world moves towards a low-carbon, sustainability-orientated marketplace, these factors will become ever more critical. In February, the US industry association the Private Equity Council (PEC), announced that its members had adopted a set of comprehensive responsible-investment guidelines to apply in making their investments and during their period of ownership. The guidelines cover environmental, health, safety, labour, governance and social issues, and emerged out of dialogue between PEC members and some of the world's biggest institutional investors. The dialogue also took place under the umbrella of the UN-backed Principles for Responsible Investment. These principles should be rigorously applied, measured and enhanced to address the growing range of global challenges.
Of all the roles private equity can play, the most important and perhaps the one that has the most impact is to invest some of its funds in meeting some of the world's most pressing challenges. These can also be exciting business opportunities. For instance, the relatively low quality of schools and associated educational systems in parts of the Middle East, in North Africa and South Asia, combined with huge population growth, create not only an urgent need but a phenomenal business opportunity for private schooling for all income levels. The provision of health care in this region is not only an urgent need and a growing challenge, but also a huge business opportunity.
Underpinning all that it does, private equity needs to be more closely connected with the society in which it operates. This means being engaged in critical, multi-stakeholder discussions, supporting non-profit organisations and entrepreneurs, and looking to create durable solutions for the underprivileged. The challenge for private equity worldwide is that companies increasingly understand that responsible competitiveness is emerging as a core business strategy. Globally, the industry has perhaps lagged the rest. Private equity can be an enormous force for rebuilding confidence and reshaping business and markets for strong responsible values. The advance and progress of our global society depends on each one of us doing our bit. Ignoring the writing on the wall and the opportunity this global crisis presents will only be done at our peril.
Fred Sicre is the executive director of Abraaj Capital