eFront: How tech can unlock private markets
eFront’s Tarek Choum …
12月 03, 2019
Increasing requirements of stock exchanges, government regulation, and voluntary initiatives are three emerging trends that attempt to provide investors with increased quality and depth of non-financial or environmental, social, and governance (ESG) information. While ESG reporting for Private Equity firm holdings may not be mandatory yet, understanding these trends and proactively developing policies and practices for ESG data collection and reporting is both pragmatic and strategic for GPs. There are many operational benefits of collecting and reporting on non-financial data of portfolio companies, but these three emerging trends illustrate the external incentives to do so.
The initial public offering (IPO) has been an important exit strategy for Private Equity funds in recent years and the increasing requirements of stock exchanges in regards to ESG are poised to affect any company going public. The adoption of either voluntary or mandatory ESG reporting has expanded beyond early adopters. The 16 partners of The Sustainable Stock Exchanges Initiative (SSE) now include exchanges such as the NYSE, NASDAQ OMX, London Stock Exchange, and the Mexican Stock Exchange. Stock exchange efforts in regards to ESG has not been limited to partner exchanges either as a recent SSE Report that reviewed non-financial reporting initiatives at 55 stock exchanges shows. 22% of 55 stock exchange initiatives reviewed require aspects of environmental and social reporting for at least some of their companies and 12% require reporting for all listed companies. 2-year commitments to promote ESG disclosure and performance were presented by partners at the October 2014 SSE Global Dialogue Forum, thus requirements on ESG reporting will continue to increase.
Legislation requiring certain companies to report non-financial information is also developing around the world. The SSE report also noted that 19 of the G20 members have at least one regulation in place requiring disclosure of some social and/or environmental aspects by companies. Companies required to report can be both private and public and usually depend on size, revenues, employees, or sector. In September 2014, the European Commission officially adopted the Directive on the disclosure of non-financial and diversity information for ‘public interest entities’. This ruling transcends the public/private divide by requiring both listed and non-listed companies with more than 500 employees and in specific industries to report on ESG. Member states have two years to adopt aligning national legislation. There is also a proposed revision to the EU’s Shareholder Rights Directive where institutional investors will be required by law to engage with the companies in their portfolios in an effort to create long-term value. Many countries have their own ESG reporting requirements for companies as well as disclosure by institutional investors.
The provision of ESG guidance and resources through international, regional, or industry-focused groups are formalizing expectations of GPs. For example, the first principle of the voluntary UN-supported Principles for Responsible Investment (PRI) is to incorporate ESG issues into investment analysis and decision-making. Guides for LPs, GPs, and the interaction between LPs and GPs have been released in the past few years. Additionally, the call for the investment community to internalize risk from climate change continues to increase. The Montreal Pledge launched September 2014 by the PRI and the United Nations Environment Programme Finance Initiative (UNEP-FI) already has 17 members and offers tools for members to calculate the carbon footprint of their portfolio. Asset owners and managers who sign The Montreal Pledge commit to measuring, disclosing, and reporting carbon emissions their investments are responsible for. Even the International Limited Partners Association (ILPA) and Private Equity Growth Capital Council (PEGCC) provide guidance on reporting non-financial data.
Private Equity firms that take a proactive approach to understand and report this type of data will establish themselves as leaders and obtain certain advantages. These benefits can range from improving the performance of their investments, to easier fund raising, to even shaping the reporting policies of the future.