Supply chain News and trends

Private market funds may soon need to open their books to scrutiny regarding their ESG performance, and many industry players are welcoming the change.

“I’m looking forward to seeing more disclosure and transparency in the private markets,” said Bonnie Foley-Wong, Canada sustainable investment leader with Mercer (Canada) Ltd. in Toronto. “Investors are asking for that and it will certainly help in terms of whole-portfolio management.”

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Some asset managers are retreating from their public ESG commitments due to so-called ‘greenhushing’ suggests a report into ESG investing in private markets.

The report, ‘The State of Private Market ESG and Impact Investing in 2024’, was published by PitchBook, a market data provider for the private equity and venture capital markets.

It found that firms are no longer prioritising some of their ESG and impact investing programs for fear of a backlash from opponents of green and sustainable investment strategies or for fear of reputational damage amid claims of greenwashing.

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Private equity has a significant opportunity to create financial and societal value through sustainability.  PE firms that invest in improving the management and quality of companies to enable increased valuation multiples can also bring sustainability to their value creation tool box.  Unfortunately, many PE firms do not yet know how to identify, create or capture that value.  

Our research into both PE firms (GPs) and institutional investors (LPs) finds that most are focused solely on identifying major red flags during due diligence and collecting a few ESG reporting metrics once an investment is made.

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Investing using ESG principles requires access to reliable, timely, and high-quality data about companies’ ESG performance—but investors often find that data hard to come by.  

While popular in public markets for some time, demand for ESG adoption has gained significant traction in private markets. Private equity (PE), venture capital (VC), and other private market participants increasingly recognize the value of integrating ESG principles into their investment strategies. A recent study by the United Nations Principles for Responsible Investment (UNPRI) also revealed that 75 percent of PE signatories assess ESG materiality for individual companies in their portfolios. Investor pressure from LPs and the evolving ESG regulatory landscape are compelling general partners (GPs) to measure the ESG performance of their portfolio companies. Furthermore, a report surveying over 300 limited partners (LPs) and GPs shows a shift towards an "ESG or nothing" investment philosophy, with over three quarters of respondents saying that they plan to cease investing in or promoting non-ESG private markets products by the end of 2025. However, limited disclosures from private companies and the lack of a consistent ESG data collection framework across the private markets make it challenging for GPs to track progress on material ESG goals.  

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➢ Taskforce on Climate-Related Financial Disclosures (TCFD) is a market-leading standard and increasingly a regulatory requirement in some jurisdictions.
➢ The guide will provide practical tools and data sources and addresses specific considerations for private equity firms owning unlisted, often small and mid-sized companies.
➢ The document also includes findings based on interviews with key stakeholders from across private markets, as well as industry partners and academia.

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In many ways, private equity is made to be invested in environmental, social and governance (ESG) initiatives. But it takes thoughtful strategies to ensure those investments generate maximum value for both business and society.

Record levels of cash reserves — including $1.1 trillion in the U.S. and another $6.3 trillion in assets under management — combined with increased investor focus on ESG could make private equity an attractive vehicle for creating real impact.  

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Investment policies need to be tailored to company stage

The good news is that 96% of private equity signatories reported that they include asset class-specific guidelines in their responsible investment policies, although this doesn’t tell us how well these are implemented. Furthermore, only 31% of these include guidelines on how they adapt their ESG approach to different company stages and strategies such as venture and growth capital.

Investors need to tailor their policies for early-stage companies or where they do not have control positions to make clear how their responsible investment approach is relevant and viable. For instance, the start-ups that venture capital investors target can have fluid business models and limited resources, making it more difficult to identify ESG risks and opportunities and to collect ESG data.

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The KEY ESG survey of 100 general partners and portfolio companies in Europe, the U.K. and U.S. found that while 75% were required to report ESG data to limited partners, 90% of them were unsure of how do to so. Survey respondents were primarily from midmarket private equity firms, with 43 each from Europe and the U.K., and 14 from the U.S.

One of the biggest problems for general partners was the time it takes to collect ESG data, which can be as long as 12 weeks. Survey respondents said they missed reporting deadlines and risked having deals stall or fail, and 70% said they would prefer to focus on the most material information that leads to better metrics and ESG performance.

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There is strong support for net zero across the financial sector, but the number of private equity firms making public commitments remains low. This does not reflect a lack of ambition from private equity but rather confusion over application to private equity and what public commitments may require.

So how can private equity investors get started? This guide introduces iCI’s new signatory roadmap. It builds on existing recommendations and encourages iCI members to commit to aligning with a net-zero trajectory and contributing to a low carbon economy.

 

Download the full guidance document below.

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Various environmental, social and governance (ESG)-related funds from Abrdn, Morgan Stanley and UBS have recently been renamed to omit sustainability-related phrases.

In addition, according to data from Morningstar Direct cited by the FT, launches of environmental, social and governance (ESG)-related funds have been steadily declining, with only six launched in the second half of 2023 compared to an average of nearly 100 a year between 2020 and 2022.

The trend follows a ruling from the SEC in September 2023 that 80% of assets in funds must be related to the name.

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Private equity firms must accept that ESG has become a strategic imperative, says Petra Funds Group MD Charlie Chipchase. So, what can we expect in 2024?

In 2023, private equity firms continued to integrate ESG considerations into their investment processes with Limited partners (LPs) and regulators continued to prioritise the importance of transparency and reporting related to ESG factors.

So, what can General Partners expect as they look to 2024? 

 

1. Move toward outsourcing routine ESG monitoring and reporting

2. The (rising) cost of ESG

3. Increased focus on Corporate Sustainability Reporting Directive (CSRD) reporting

4. Continued politicisation of ESG, particularly in the US

5. Rise in ESG litigation and enforcement actions

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The conversation around sustainability in the private markets has intensified considerably in the past year. Even as some critics accuse the industry of greenwashing, others express concerns about whether private equity firms are prioritizing sustainability objectives over financial returns.

In hopes of shedding light on the real status of sustainability in the industry—and perhaps reconciling these two opposing points of view—we offer BCG’s first annual “Sustainability in Private Equity” report. Following up on last year’s initial analysis of early data from the ESG Data Convergence Initiative (EDCI), this year’s report offers a considerably more detailed picture of the PE industry’s current performance on social, energy, and sustainability metrics. Deep dives into decarbonization, renewable energy use, and social considerations offer insights into the importance of these key metrics as indicators of business excellence, how performance is changing over time, and how it is connected to financial outcomes.

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Investors are focusing on sustainability and private assets in the midst of energy transition opportunities while inflation concerns persist, revealed a survey. More than half of investors expressed concerns about geopolitical uncertainty and inflation, prompting them to invest in companies with localised supply chains across public and private markets, showed the Schroders Institutional Investor Study 2023. Investors identified developed market equities (32%) and private equity (23%) as the best opportunity providers over the coming years.

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As the regulatory landscape continues to evolve, integrating Environmental, Social, and Governance (ESG) considerations for new investment deals has become an increasingly imperative consideration for private equity firms. The term ESG has become a regular feature in business vocabulary. It is no longer just a matter of abstract compliance for private equity but also a strategic imperative for driving value. Transparent reporting of ESG measures is crucial to ensure fairness and accountability, and positively impacts the deal lifecycle for all. 

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By investing in earlier-stage companies and having controlling ownership, private equity has the potential to tackle ESG considerations effectively, according to Jennifer Signori, managing director, Neuberger Berman. Here, Signori discusses creating value, engaging with companies and calculating portfolios’ carbon footprints.

How does ESG create value within private equity?

Private equity investors are uniquely positioned to effect change, given they generally have controlling ownership of companies. This means private equity investors potentially have more ability to influence strategic and operational change – whether to tackle climate risks or other business challenges – than many public equity investors.

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Mainstream private-equity funds need to ramp up data gathering to demonstrate how ESG issues are integrated in their investment processes, law firm Morrison Foerster says
Survey of 100 Asia-headquartered fund general partners with over US$1 billion in assets under management shows only 29 per cent always require the inclusion of clauses in investment documents to enhance or ensure ESG compliance

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The TCFD has published guidance for asset managers but does not consider some of the specificities of PE firms managing closed-ended funds holding portfolios of unlisted SMEs, including their holding period, the significant changes in portfolio composition over the life of a fund, operational complexities (e.g., fund structures and data flows), and the requirement to disclose at various levels (e.g., firm, fund and portfolio company level).

This document provides recommendations related to these considerations: it highlights good practices for PE firms and illustrates the potential approaches that private markets firms may take to disclose information in a way that reflects their specific structure.

Read the Guidance Here

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