Benjamin David explores the transformative shift of institutional investors towards ESG investing in private markets, highlighting its rise, the demand for enhanced reporting and the potential for a sustainable future.
Institutional investors, including limited partners (LPs) and general partners (GPs), are undergoing a transformative shift in their investment philosophy as they increasingly prioritise environmental, social and governance (ESG) considerations. This emerging trend towards an ‘ESG or nothing’ approach is gaining traction across private markets, according to a report entitled ‘GPs’ Global ESG Strategies: Disclosure Standards, Data Requirements & Strategic Options’ by PwC Luxembourg. As the momentum behind ESG builds, a significant majority of institutional investors are planning to cease non-ESG private market investments by 2025.
Growing commitment to ESG
The report surveyed 300 GPs and 300 LPs, highlighting a solid commitment to ESG among institutional investors. Interestingly, 87.5% of LPs surveyed expressed their intention to increase their private market ESG investments over the next two years, with over a third targeting increases of more than 20%. This growing trend indicates institutional investors’ recognition of the potential for ESG-focused investments to deliver sustainable returns while aligning with their values and expectations.
Olivier Carré from PwC Luxembourg explains that long-term value is becoming more self-evident here. He says institutional investors can meet the evolving demands of LPs and contribute to a more sustainable and responsible investment landscape by minimising risks and positioning themselves to unlock the long-term value creation potential.
“While opportunities and challenges vary greatly from region to region and asset class to asset class, the key message remains the same: rethink the status quo and view your operations and licence to exist through an ESG lens,” he says.
“While opportunities and challenges vary greatly from region to region and asset class to asset class, the key message remains the same: rethink the status quo and view your operations and licence to exist through an ESG lens.”
Sustainability manager Charles Van Tuyckom from Morrison & Co emphasises the widespread adoption of ESG approaches and policies among industry managers. He notes, “Managers without an ESG approach and policy are extremely rare.” Van Tuyckom underscores the longstanding importance of good governance and commercial sustainability in private market investment.
He further stresses the significance of quantifying and reporting these aspects to investors in a clear and meaningful manner, stating, “Quantifying and reporting ESG aspects to investors transparently and effectively are the fundamental change we see developing, driven by investor interests and recognition of the importance of ESG risks and opportunities.” According to Van Tuyckom, the transformative trend towards ESG is driven by the increasing recognition of ESG risks and opportunities, as well as the growing interests of investors.
This aligns with the perspective of David Duffy, CEO of the Corporate Governance Institute, who suggests that ESG investing is fundamentally about “responsible investing”. Duffy points out that investors now believe their investments should create value and reflect their values. He affirms that ESG investments are not inherently riskier than those in firms that do not embrace ESG. Investors are witnessing growing evidence that they don’t have to compromise good returns for good deeds.
Unlocking value through enhanced reporting
Interestingly, institutional investors are willing to pay higher management fees for significant improvements in GPs’ ESG data reporting. The report reveals that 66.6% of LPs surveyed are willing to accept higher fees if it leads to more transparent and comprehensive ESG reporting from their fund managers. Nearly 45% of LPs stated that they would be willing to pay between 5% and 9% more in management fees should this price increase be translated into quality improvements in their GPs’ ESG data reporting practices. An additional 23% of LPs stated their willingness to absorb increases over 10%.
This is familiar to Van Tuyckom, who underscores the importance of ESG data reporting in investment management generally. He states, “Enhanced fees for ESG reporting should not be the key criterion for improving reporting, as it is not reflected in the fundraising market. Instead, the quality, reliability and transparency of ESG data reporting are crucial aspects of investment management, informing sound decisions where risks and opportunities can have a real impact.”
“Quantifying and reporting ESG aspects to investors transparently and effectively are the fundamental change we see developing, driven by investor interests and recognition of the importance of ESG risks and opportunities.”
Duffy, while emphasising the vital role of enhanced ESG reporting for investors, nonetheless expresses concern over differing ESG standards and calls for a consistent or standardised methodology for evaluating ESG performance across all firms globally. He advises firms to ensure honesty and transparency with all ESG data to align their ESG reporting with best practices and recognised frameworks. He cautions against any attempts to hide or embellish data, as scrutiny in ESG ratings and reporting is increasing, and any hint of “greenwashing” could have severe consequences for a firm’s reputation.
This concern agrees with the eighth annual ‘ESG Manual Survey’ by Russell Investments‘, which indicated that data limitations and non-standardised reporting frameworks constitute the biggest challenges for investment managers. The survey found that less than 30% of firms out of 236 can report on their respective portfolios’ carbon-related metrics. The survey findings disclosed that ESG reporting remains the most significant challenge despite increased expectations of adequate reporting, the firm said. Yoshie Phillips, head of fixed income ESG investing at Russell Investments, said ESG-related reporting continues to develop in an “unstructured fashion” due to the lack of unambiguous industry standards.
ESG challenges and reporting discrepancies
Due to perceived incompatibility, private equity (PE) has been slower in adopting ESG practices, according to the report, compared to other private market asset classes. The global PE industry lags in ESG uptake, with only 57.4% of PE LPs and 47.6% of GPs allocating over 30% of their assets to ESG products. ESG reporting holds lower strategic importance for PE LPs compared to other investors, with only 61.7% considering it crucial in GP selection.
However, 75.7% of surveyed PE GPs recognise quality ESG reporting as a competitive advantage. Discrepancies exist between LPs’ reporting requirements and GPs’ practices. LPs in Europe have higher expectations, but only 65.0% are satisfied with current reporting practices. Moreover, GPs in Europe face challenges meeting sophisticated ESG requirements and investor demands. Desired improvements include qualitative data on Taxonomy alignment (mentioned by 40% of EU LPs) and more frequent data on sustainable development goals (SDG) alignment and climate impact (mentioned by 35% of LPs).
The report notes that maintaining an open dialogue with investors is recommended to adapt reporting practices and exceed regulatory compliance. While overall satisfaction with GPs’ ESG reporting is high, GPs in Europe should be mindful of potential reputational damage and loss of business if they fail to address shortcomings. Moreover, institutional investors can enhance their portfolios and contribute to a more sustainable and resilient private market ecosystem by capitalising on this growth potential.
Building trust through EU regulation
The sentiment towards EU regulation regarding ESG is overwhelmingly positive among institutional investors. The survey findings reveal that 60.5% of EU LPs describe themselves as very satisfied with developments in EU regulation, closely followed by GPs, with an average satisfaction rate of 57.1%.
This demonstrates the positive impact of ESG regulation in providing a clear framework and standardisation, which contributes to building trust and confidence among institutional investors.
However, diverging opinions exist between LPs and GPs regarding the effectiveness of regulations in addressing greenwashing concerns. While 63.8% of LPs are satisfied, only 49.2% of GPs share this view.
According to the report, GPs may consider the regulations as an additional compliance burden rather than guidance to prevent greenwashing, as they believe they already have strong internal policies.
The report highlights conflicts between EU and national regulations and the need for alignment in ESG taxonomies to ensure the distribution of funds. Compliance requirements are burdensome, especially for smaller investors, adding complexity and cost. Despite these challenges, the EU’s sustainable finance framework is expected to harmonise, and stakeholders will drive ESG momentum.
A strategic imperative
The rise of ESG signifies a paradigm shift in the institutional investment space, where financial returns and societal impact go hand in hand.
The report substantiates the view that institutional investors can drive positive change and shape a more sustainable future by proactively embracing ESG principles, improving reporting standards and seizing growth opportunities in private markets.
“The quality, reliability and transparency of ESG data reporting are crucial aspects of investment management, informing sound decisions where risks and opportunities can have a real impact.”
Investors in Europe appear aligned – by prioritising ESG considerations, investments with values and expectations can be aligned while delivering sustainable returns. The increasing commitment to ESG reflects an understanding of its potential to unlock long-term value and contribute to a resilient investment ecosystem. However, challenges persist, such as the need for standardised methodologies and transparent reporting to combat greenwashing. Moreover, open dialogue, adaptation and continuous improvement in ESG practices are necessary.
As institutional investors reflect on the transformative power of ESG, they might be tempted to consider their role in shaping a responsible investment landscape. By embracing ESG principles, the forecast seems clear: investors can contribute to a more sustainable future while pursuing financial success.
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