Private capital investors in emerging markets (EM) routinely engage in due diligence, including financial and legal due diligence. The growing complexity and nuanced nature of investment and regulatory environments in these markets have led practitioners to apply a more integrated and comprehensive approach to due diligence. Integrity due diligence (IDD) has become part of this approach. Carrying out effective integrity due diligence requires a unique skillset and expertise, leading many general partners (GPs) and Limited Partners (LPs) to engage with integrity due diligence specialists.
What is Integrity Due Diligence (IDD)?
Typically conducted in parallel with financial and legal due diligence, integrity due diligence (IDD) focuses on reputational risk management and investigating the integrity risk posed to investors by stakeholders involved with a specific deal, project, transaction or related enterprise. IDD is done in the context of using independent information. Unlike other types of due diligence which concentrate on legal or financial aspects, IDD focuses on reputation and more diffuse concepts which can generate very tangible risks. Depending on the breadth and depth of the investigation, IDD can be an invaluable tool for emerging market private capital practitioners.
The Role of IDD in Emerging Markets Private Capital Investment
The practice of IDD is deployed in both developed and emerging markets and across many asset classes. IDD is particularly relevant given the unique features of private equity (PE) investing in EM, specifically the fact that:
-The asset class is illiquid, it applies a long term strategy and is often characterized by minority investments and;
-EM frequently lack robust legal and regulatory systems relative to developed markets.
Private capital practitioners have a fiduciary responsibility to their investors. Reputational and integrity risks can impact the ability to create alpha, as such IDD is both forward and backward looking and focuses on identifying existing and potential risks. IDD can provide GPs with information that provides a more nuanced view of an investment, supports their risk management strategy and enhances their positioning during negotiations. Conducting their own IDD on target investments provides LPs with actionable intelligence, including the information to determine if a GP’s due diligence process aligns with their own interests and standards. LPs can also utilize IDD information to help support allocation decisions and their efforts to enter into new markets. Development Finance Institutions (DFIs) often engage in IDD when making decisions to engage around private sector depending on the breadth and depth of the proposed IDD exercise.