In today’s investment world, there is a strong conviction that sustainability will create greater value over time. As funds struggle to pursue target businesses and boost their portfolios, the industry is significantly changing the way it works. That’s because investments are no longer being measured by conventional financial metrics alone, but through environmental, social and governance (ESG) factors supporting every transaction.
Nowadays, customers, employees and limited partners are demanding more sustainable, socially conscious corporate behaviour. Stakeholders in all industries are pushing for more sustainable investing practices, and firms are challenged with striking a balance between prioritising sustainability and generating revenue for investors. Private equity (PE) firms that can deliver as per their stakeholder’s expectations will reap the rewards in the long run. But what exactly are ESG private equity best practices and how can firms execute them more effectively? Read on to find out.
ESG in private equity: Best practices for PE firms
If your private equity firm is exploring how to approach ESG, here are some best practices to help you respond to the growing stakeholder demands and incorporate sustainability into your investments and overall operations.
1. Use an external framework to evaluate your firm and its investments
Start with clearly defining what ESG means to your PE firm. The scope of ESG issues that can affect a PE firm is exceptionally broad, and identifying where to start evaluating a portfolio through an ESG lens can be daunting. With an unbiased external framework, you will be able to take the guesswork out of ESG and it will also offer clearer reasoning to internal and external stakeholders.
Opt for an ESG framework that best suits your business goals and principles. Some popular frameworks are the Task Force on Climate-related Financial Disclosures (TCFD), UN’s Principles for Responsible Investment (PRI) and Sustainability Accounting Standards Board (SASB). Identifying a suitable framework can allow firms that are new to evaluating their investments through an ESG lens to establish an entry point into the conversation surrounding sustainable investing or help firms that may have more ESG experience address hot-button issues that are important to their stakeholders.
2. Prioritise opportunities with maximum impact
The next step is to choose some domains where you can make a significant impact. For instance, if your portfolio companies are mainly in the energy sector, you may want to focus on decreasing your company’s carbon footprint and investing in businesses that adopt similar environmental measures.
The key to informing your prioritisation is to understand what areas are the most significant for your limited partners. You should also develop a clear justification about why you have recognised specific areas having higher priority as compared to others.
3. Specify targets and determine how to measure them
When implementing an ESG strategy, you need to understand how to effectively measure progress, as ESG criteria and associated targets evolve over time. While there is no single required standard of metrics for ESG reporting, a number of organisations, including the World Economic Forum, have created reporting and disclosure frameworks that “align their mainstream reporting on performance against environmental, social and governance (ESG) indicators and track their contributions towards the SDGs on a consistent basis.” The WEF’s Stakeholder Capitalism Metrics were based on a number of existing ESG frameworks, as well as the 2030 Agenda for Sustainable Development and the United Nation’s 17 Sustainable Development Goals, and have been adopted by over 100 organisations worldwide. This metric tracking and reporting framework includes tracking ESG performance indicators related to its four pillars — Principles of Governance, Planet, People and Prosperity — and give insights into anti-corruption, sustainability and human rights efforts, among others.
Setting clear metrics and standards, and developing a solid measurement plan will help you compare year-over-year performance while laying the groundwork for an effective ESG reporting structure. Properly tracking your organisation’s overall ESG performance and progress is crucial to understanding your opportunities for improvement, as well as communicating your success to stakeholders and community members. Comprehensive ESG data can provide actionable insights to your organisation’s leaders that can help them make informed decisions about their future investment activities. Additionally, showcasing your ESG data does not only highlight your commitment to building a sustainable portfolio, but may also help identify your organisation as a leader in sustainable investing activities.
4. Establish regular reporting standards
ESG sustainability reporting for private equity firms is mostly voluntary. Nonetheless, reporting compulsions are likely to grow as standardised approaches are introduced. Your company must carefully monitor changes in ESG regulations worldwide so you are familiar with the global reporting requirements and can balance these requirements with reporting priorities from investors.
One of the major challenges for PE firms in the existing ESG landscape is developing a consistent reporting structure across all portfolio enterprises. You should have high-quality information to help manage the intricacy of organising data across several markets. Keeping tabs on progress across all investments is a significant part of getting ready for prospective compliance requirements.
5. Improve ESG visibility and transparency
Sustainability and responsible investing are rooted in transparency throughout an organisation’s investing portfolio. Quantifying and analysing the ESG status of the individual investments within your portfolio can provide you with the data needed to successfully manage your portfolio and maximise its sustainable value.
Additionally, transparency and visibility not only help organisations create clear and achievable goals for their ESG initiatives, but also build trust with stakeholders and community members alike, allowing for new sustainable investment opportunities and partnerships.
Ensure ESG compliance with
The private equity ESG landscape is quickly evolving. Companies that opt to develop and execute solid ESG strategies now, instead of waiting for reporting requirements to be instigated later, will be in a much better position to manage risk effectively.
The ESG GreenLITE solution can help PE firms manage ESG portfolio risk, resilience and reporting. It provides you with a profound and comprehensive view of your supply chain risk across key risk areas identified by the UN Global Compact.
Learn how we have helped organisations like yours. If you have any questions or concerns about ESG and private equity, feel free to reach out.