Managing ESG is becoming an integral part of private equity investment processes. Still, many private equity investors face the same challenge – data, writes Heleen van Poecke, founder and CEO, KEY ESG.
As with other asset classes, having the correct data continues to be a significant stumbling block that firms face in improving ESG performance. Often, data is not readily available at the portfolio company level, and so private equity firms will have to build the data collection, reporting and disclosure processes across their portfolio to be able to deliver on their ESG promise. Speaking to over 100 industry participants in a recent survey, across GPs and Portfolio Companies, we found several common challenges that the industry faces on its way to ESG performance.
Data-driven?The plethora of data requests from LPs, regulators, and other key stakeholders is both the single biggest demand for ESG resources within private equity and the biggest challenge GPs face. Often, a GP must contend with over ten ESG questionnaires from their LPs that can vary in the data they request, which can eat into the bandwidth used to manage and improve ESG performance.
At the other end of the scale are inconsistent measurements across a portfolio and a lack of ESG “literacy” within portfolio companies. When GPs send Excel spreadsheets to their portfolio companies, they often struggle with the quality of the data. Calculations are not consistently applied or there is no audit trail, making it difficult to back up the ESG metrics calculated from the provided data. Moreover, portfolio company teams might not be familiar with ESG and need education on certain topics to be able to deliver the right answers to GP questions.
This feeds into another commonality between most funds and portfolio companies – they have limited resources to keep up with the growing demand of ESG disclosure. ESG data needs to be pulled from operations, HR, compliance and legal and finance. With so many data points coming from different parts of the organisation, simply sending out emails to all the portfolio companies and keeping track of what they have and have not submitted can be very time-consuming. ESG specialists are in high demand and even when GPs turn to in-house ESG talent, they often see themselves competing with other GPs for candidates.
Looking geographically, particularly in comparing Europe and the US, ESG regulations continue to change, and different jurisdictions have different regulations regarding ESG disclosure. Although there might be less regulation in the US concerning ESG, US GPs find they still need to deal with the EU Sustainable Financial Disclosure Regulation (SFDR) because it covers their European LPs. It can be hard to keep track of the regulatory requirements and the changing standards in terms of measuring and disclosing ESG.
Moving from “Box Ticking” to ESG as an advantageTraditionally, ESG reporting and management have been seen as a “check the box” part of diligence and portfolio management. As ESG gains strategic and commercial prominence, some GPs are struggling to get their investment teams to embrace ESG. This can be from a lack of training on ESG within investment teams but also from the lack of ESG know-how within their portfolio companies.
I recommend GPs make ESG management part of strategy and portfolio management, included in a 100-day post-acquisition plan, with measurable targets set and progress tracked over time.
When asking portfolio company teams to supply data, it helps to explain what ESG metric those data points connect to and why they are relevant. When portfolio teams understand what they provide data for, they can translate that into initiatives to instigate improvement.
Another way to ensure ESG management gets the attention it deserves is to create proper incentives. Some of the leading GPS have not only included ESG targets in their investment team’s performance targets but also made it part of management incentive plans. For these GPs, ESG is a staple agenda item for each board meeting.
To gain a true comparative advantage, being able to understand ESG at a micro-level and ensuring the accessibility of raw data is critical. With granular data, GPs and portfolio companies will better understand the ESG risk and opportunities in front of them. It also provides useful insights into the levers management teams might have to drive improvement. Ultimately, the goals of ESG disclosure and regulation have to be to improve the management of Environmental, Social and Governance factors. Without high-quality data, managers cannot effectively steer towards ESG excellence. Setting up the right processes and systems to capture the right information will be key for private equity to deliver on its ESG promise.
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