ESG Transparency and Management in Private Equity – Definition and Solutions

In this article the following questions will be answered:

  1. What is ESG?
  2. What role does ESG play in Private Equity?
  3. What is responsible investment?
  4. What is the difference between ESG and Impact Investing?
  5. How can ESG transparency for Limited Partners be achieved?
  6. Which market standards / frameworks exist for ESG information?
  7. Why is ESG risk management necessary?
  8. How can ESG risks and opportunities be identified, managed and monitored?
  9. How can GPs ensure ESG management throughout the investment cycle?
  10. How can GPs offer their LPs better ESG transparency?
  11. How can GPs prepare for the EU regulation on “sustainability-related disclosures in the financial services sector” that comes into force March 2021?
  12. How can the data exchange of ESG KPIs with portfolio companies and other stakeholders be simplified and more automized?

What is ESG? 1

Environmental, social & governance are three central factors in measuring sustainability and ethical impact within a company.

What role does ESG play in Private Equity? 2

Private equity investing is especially suited for taking ESG factors into account due to its long-term investment horizon and often active ownership role.

What is responsible investment? 3

Being a PRI Service Provider Signatory AssetMetrix uses and incorporates where possible their definition: The PRI (Principles for Responsible Investment) defines responsible investment as a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership.

What is the difference between ESG and Impact Investing? 4

Impact investing is an investment strategy aiming to have a positive environmental or social impact i.e. investing in companies that sell products and/or solutions with the intent to have a sustainable impact. ESG focuses on the environmental, social & governance factors in a company’s operation and it can be used in addition to measure and enhance risk management.

How can ESG transparency for Limited Partners be achieved? 5

To gain full ESG transparency it is important to take both the fund managers (GPs) and the portfolio investments into account. Specialized service providers, such as AssetMetrix, have to offer a seamless and efficient setup and support Limited Partners (LPs) to collect the appropriate documents from their fund managers and derive ESG scores, ideally, from the portfolio data they already have. As a Limited Partner it is not always easy to continuously request data from GPs. For this reason, it is helpful and more efficient when the solution builds on data that is usually already available to limit the data requests to GPs to the minimum necessary.

If you are interested in finding out how technology can help solve many ESG challenges, read our article 3 ESG-related areas Technology can provide real value for.

Which market standards / frameworks exist for ESG information? 6

There are numerous players on the market. AssetMetrix has, after thorough research, chosen to focus on the United Nations’ Sustainable Development Goals (UN SDGs), the Sustainability Accounting Standards Board (SASB) and the Institutional Limited Partners Association (ILPA).

  • UN SDGs: 17 goals to be reached by 2030, scored, from 0-100, by a country’s progress. They provide a blueprint for peace and prosperity for people and the planet, now and in the future and are well known within the private capital space.
  • SASB: focuses on financially material information & defines industry-specific material issues across ESG topics. SASB has developed a framework consisting of 10 sectors split into 77 industries with 26 material issues sorted into 5 ESG dimensions.
  • ILPA: engages, empowers & connects LPs to maximize their performance. ILPA is dedicated to promoting transparency and uniformity in disclosures to LPs and has, among other, developed the LP DDQ ESG Template in cooperation with the Principles of Responsible Investment (PRI).

Why is ESG risk management necessary? 7

ESG risk management is becoming a must. Not only is there a collective responsibility to act – regulators are responding and are demanding more transparency and disclosure. The regulation on “sustainability-related disclosures in the financial services sector” published in December 2019 makes this a fact and defines “harmonized rules for financial market participants & financial advisers on transparency with regard to the integration of sustainability risks… .”

The regulation will apply from March 2021 with the exception of disclosures in regulatory reports that will apply from January 2022.

How can ESG risks and opportunities be identified, managed and monitored? 8

To identify ESG risks and opportunities it is very important to have data and documents structured and stored in a central repository. This allows for one source of truth and continuous tracking and monitoring of data. Further, it is necessary to have an efficient way to collect the data and documents needed on a regular basis. Lastly, a structured process is required to adequately identify the relevant risks.

All the above is offered in AssetMetrix’ ESG Transparency service module for Limited Partners. With minimal effort the solution provides ESG transparency on manager and portfolio level:

  • manager score based on assessment of ESG commitment and efforts
  • portfolio score based on country and industry of underlyings – without any additional data collection

How can GPs ensure ESG management throughout the investment cycle? 9

First step is to ensure a proactive and differentiated approach depending on where you are on your ESG journey. Is your focus LP reporting, ESG risk management, impact investing or all the above? Regardless of your current requirements there are a few aspects that needs to be considered: Do you have the relevant policies in place? Have you defined what KPIs to track to start building up an ESG data base? What reports do you need to produce and how will you collect the data from your portfolio companies? To properly tackle these questions and ensure a proper ESG management process a centralized and comprehensive solution is essential.

How can GPs offer their LPs better ESG transparency? 10

LPs are demanding more and more transparency with respect to ESG, both at the GP Manager level and throughout the investment cycle. To be able to cater to the investor requests a solution that offers automatic and centralized data collection is key. Showing your investors the progress you are making is only feasible if you start building a data history and continuously analyze the progress made by your portfolio companies. Further, enhancing the ESG data collected with data from recognized frameworks, such as SASB, the UN SDG or PRI can result in even more comprehensible ESG information for your annual LP reporting.

How can GPs prepare for the EU regulation on “sustainability-related disclosures in the financial services sector” that comes into force March 2021? 11

Start collecting data. There already exist certain guidelines with respect to what data points that should be captured and disclosed. However, the first challenge is how to centralize and automate the data collection from portfolio companies. With the AssetMetrix ESG Management solution capturing of data is set up and executed with sophisticated digital workflows ensuring a simple, automatic, and controlled data collection process between defined stakeholders.

For an update, please read our article Understanding the EU sustainable finance regulatory landscape.

How can the data exchange of ESG KPIs with portfolio companies and other stakeholders be simplified and more automized? 12

Having a centralized system with audit trails and customizable user access would support making the communication and data exchange between portfolio companies and GPs, as well as other stakeholders more simplified and comfortable. AssetMetrix offers sophisticated digital workflows allowing user access for several stakeholders and exchange of data in an automatic and controlled manner.

Need more information?

To learn more on how to achieve regulatory compliant ESG output, please read our article Your step-by-step guide to regulatory compliant ESG output.