There are some common trends emerging in the investment management sector in 2022, many of which can be supported by a strong due diligence strategy.
ESG Reporting: Navigating the Myriad Standards
Some key takeaways from the recent Private Equity US ESG Summit in New York.
With multiple ESG standards and reporting options, what represents best practice?
Our GP clients have seen a significant increase in report requests from investors this year and it’s causing a lot of extra work. Many European-based investors are asking for not only fund level ESG data but individual data for each portfolio company. They are building the requests to calculate metrics themselves such as financed emissions and WACI (Weighted Average Carbon Intensity).
We are even seeing LPs asking for SFDR (Sustainable Finance Disclosure Regulation) PAI (Principal Adverse Impact) metrics even for funds not covered by SFDR.
While there has been some coalescence around certain frameworks such as GRI, SASB, TCDF in recent years, there is a move towards requesting data that is most material, not relying exclusively on a specific standard. Materiality is becoming more important than internal initiatives or targets.
Data narrative matters
Harmonization is helpful but it’s important not to lose sight of the fact that data is most useful for measuring progress, at both a GP and portfolio company level.
Investors may want the same categories of data (like scope 1 emissions or gender diversity) but the way in which they request the data (the questions asked and units of measure) can vary drastically, which makes reporting more difficult. In terms of best practices, some firms think it’s important to take a more industry specific approach to capture and focus on the ESG topics most material to the underlying investments. They do also look for universal trends in LP requests. Others can be sector agnostic; their reporting goals focus on transparency.
For GPs, frameworks are an important way of understanding what data makes most sense to their portfolios.
ESG covers a large range of topics, can the sector align in coherent ways to the evidence progress?
We’ve spoken to many GPs who would like better alignment, mainly so that they can build out standard templates to send to different parties. This would reduce the need for custom responses which are incredibly complex and time consuming.
PAI and TCFD reporting are being used widely across Europe, but the US is still in the early days of ESG data collection. We know it will become more refined over the next few years.
One client told us “When it comes to emissions, I think that we will move toward becoming increasingly scrutinized and third-party reviews and limited assurance or audits will become more standard.”
Different industries need different data
For GPs, an industry specific approach for each investment is crucial. If you look at ESG factors for an energy company and a tech company, the material ESG factors will be completely different. Additionally, if you look at specific metrics across these companies – for example GHG emissions, water use, safety data, diversity data – they will have completely different profiles, and it will say nothing about how they compare to one another.
It goes without saying that if you compare any of these companies to industry peers or an industry benchmark, you will get a much better idea of their performance and progress.
For fund or portfolio level data to be useful at an aggregate level, it needs to be rather basic and considered universally material regardless of industry. This can reduce its value. Although GPs could show year-over-year changes to aggregate metrics, which could be more useful.
Most GPs want to understand ESG data in the context of the overall company strategy, market positioning, regulatory backdrop, customer profile and exit strategy. They can help LPs get a clear picture of where the differences between companies lie since they have a better understanding at the entity level. Some GPs apply ESG priorities around themes which allows them to go to portfolio companies with a consistent message.
ESG reporting is constantly evolving and as a technology provider we work with individualized metrics and can incorporate industry standards as they change. We help GPs choose between data points or standards and combine them with their own. Often firms already have a process that may not fit the framework of any standardized process regulatory, or software provider prescribed, so for us, being able to offer flexibility is essential.
Keep reading in part two on how to best leverage an array of different reports and rating standards.