Top private equity players create new ESG reporting standards

As the latest indication of the increasing importance of ESG considerations to financial sponsors, this October we saw two notable announcements from groups of private equity funds and investors:

• ESG Data Convergence Project: The launch of the ESG Data Convergence Project, the first set of standardised ESG reporting metrics for the private equity industry. Co-led by Carlyle and the California Public Employees’ Retirement System (CALPERS), one of the world’s largest pension funds, with the involvement of 14 participating LPs and GPs, the project is an agreement between participants to standardise the measurement and reporting of six ESG metrics.
• Novata: The creation of a central database, called Novata, for gathering data and reporting on private companies’ ESG performance, backed by the Ford Foundation, the Omidyar Network, GP Hamilton Lane, S&P Global, Clearlake Capital Group, and Kohlberg & Co, with the advice of a number of other private equity funds.

The objective of the ESG Data Convergence Project, according to a Carlyle statement, is “to create a critical mass of material, performance-based, comparable ESG data from portfolio companies”. The statement goes on to say that: “This will allow GPs and portfolio companies to benchmark their current position and accelerate progress towards ESG improvements, which the group believes drives better financial outcomes. This will also enable greater transparency and provide more comparable portfolio information for LPs”.  An additional goal is to track whether ESG information contributes to the financial performance of fund managers.

For the time being, the six ESG metrics reported are: Scope 1 and Scope 2 greenhouse gas emissions, renewable energy, board diversity, work-related injuries, new net hires, and employee engagement. Further data will be collected to be able to normalise and segment the data, with GPs submitting all information using a standardised template. The data will be shared directly with LPs, but also with Boston Consulting Group who will aggregate the data on an anonymised basis and produce benchmarks.

Novata is not intended to compete with these efforts, but is a for-profit tool that aims to streamline the process of storing ESG data in whatever form a private company or private-market investor chooses, and share it with investors and others. GPs will be able to compare the ESG performance of their portfolio companies not just with each other but with industry peers.

As with other industry-backed initiatives, the success of the ESG Data Convergence Project will depend on wide industry participation. If joined by a number of other LPs and GPs with significant assets under management, and provided the data collected is consistent and reliable, the project has scope to significantly increase the amount of good ESG data available in the private markets, influence LP oversight of GPs, and ultimately GP accountability.

Anne Simpson of CALPERS notes that: ”Markets can be forceful and powerful, but not if they are ill-informed. At the moment, we simply don’t have the data in a standardised, consistent, verified format integrated into the financials, which is what you need to make good investment decisions. We’re…groping in the dark. We’ve got to have global standards of climate risk reporting so that the financial markets can play their part – and also so that regulators can do what they need to do” (see here).

CALPERS particularly note the disparity in reporting obligations between the public markets and the private markets (which is more pronounced in the USA); once a public company makes a disposal and the assets are part of the private markets, “then it is really a case of out of sight, it’s easy to be out of mind”. 

Private equity assets are already a major part of the markets and global economy and these initiatives by LPs and GPs represent real progress. However, voluntary initiatives within the private equity industry cannot replace the need to standardise ESG reporting across the board for both sizeable public and private companies, whatever their geographical composition, such that over time any investor, whether in the public or private markets, could easily view and compare ESG performance between companies, in the same way they can compare the financials for companies that are required to disclose their annual accounts. Additional ESG disclosures are already required in the European Union under the Sustainable Finance Disclosure Regulation (SFRD) and Taxonomy Regulation, and the global nature of many portfolio companies managed by GPs means that they collect some kind of detailed ESG data for the whole organisation, not just Europe. 

To address the issue of standardisation across the world, IFRS has created the International Sustainability Standards Board (ISSB), which has been tasked with developing a “comprehensive global baseline of high-quality sustainability disclosure standards to meet investors’ information needs” (see here). This will be the sustainability reporting equivalent of the International Financial Reporting Standards, and at COP26 last week, IFRS announced the publication of a set of disclosure standard prototypes which will form the basis of a consultation in 2022. These standards will be voluntary, as are the current various ESG disclosure frameworks and guidance (e.g. TCFD, SASB, GRI, etc), but there are good indicators that the forthcoming ISSB standards could be made mandatory in various jurisdictions. For example, the UK Government has already said that it intends to adopt ISSB standards for use in the UK as part of a new integrated Sustainability Disclosure Requirements (SDR) regime (see here).

If the IFRS’ ISSB standards are more widely adopted, this could have two key effects:

• One, streamlining upstream reporting in the private equity industry, such that portfolio companies can report to their LPs in a standardised way, and these LPs can in turn report to their GPs in the same way. As companies change hands between funds on the secondary market, they would not need to alter the way they report to meet either LP or GP requirements (which currently vary between funds).
• Two, as ESG due diligence becomes a standardised part of any downstream due diligence process, sets of common metrics and benchmarks will help streamline the diligence, and eventually drive the formulation of detailed post-closing covenants aimed at improving a company’s ESG performance to meet a financial sponsor’s investment criteria, and eventually the criteria for any exit, whether to meet public standards required for an IPO, or another investor’s criteria for a sale.