Premium on Sustainability: ESG Framework as a Driver of Investment

With a wealth of assets under management ($5.8 trillion in 2019, rising as high as $8.3 trillion by 2025), private-equity (PE) market is well-positioned to be a catalyst for constructive change and implementation of environment, social and governance (ESG) principles. 

Investors, stakeholders, regulators and international commitments are placing mounting pressure on the PE sector to be a key agent of change in the sustainable development. PE companies need to learn to carry the weight of expectation. They need time and resources to build up ESG capabilities – it’s not a sprint with short-term returns. 

Over the last couple of years, there’s been a substantial uptake in embracing sustainability in PE companies: we’re moving past thinking of “tick-a-box” exercise to value-added for the company. General partners (GPs), with their limited partners (LPs), are gradually realizing the value proposition of embedding ESG principles into their firm-wide investment strategies (and ultimately into the strategies of their portfolio companies). They will continue to demand more ESG transparency from their portfolio companies (portcos) and will continue to strategize ways to assess their partners’ performance. The reality is that many PE-backed companies struggle to get timely and accurate information on a long list of sustainability metrics – it’s usually more than an in-house team can handle. Managing even what would seem a straightforward data set, like direct greenhouse gas emissions, can be an intricate undertaking that’s best outsourced to an external rating agency. One in ten of the companies subscribed to EcoVadis rating platform calculated the total of their Scope 1 emissions. Our Carbon Action Module, launched in mid-2021, has now issued over 15,000 Carbon Maturity Scorecards (more on carbon maturity in our 2022 Report). 

GPs and LPs anticipate the need to have a flexible yet universal reporting framework for tracking the ESG performance of portcos that allows for market comparison and is aligned with existing (and ever-evolving) ESG regulatory requirements. The key is to determine what is most relevant and material to a specific portfolio. It’s better to start small and choose a handful of metrics to aggregate longitudinal data that is both quantifiable and comparable. Even with a well-defined scope, collecting and assessing ESG data across a portfolio can be a resource-intensive and time-consuming task. Data-collection processes are often manual, therefore inefficient and error-prone. 

But data quality isn’t the only issue that hampers ESG performance measurement – ESG reporting standards lack harmonization, making benchmarking difficult. You can have a wealth of raw data at your hand but no benchmark points to understand how well a company is performing against the industry standards or its peers. Without a baseline, companies struggle to set meaningful performance targets. That’s why many GPs, either at their own volition or at the encouragement of their LPs, choose to work with external rating agencies. While many rating products exist on the market, few compete with comprehensiveness and universality offered by the EcoVadis Ratings. 

EcoVadis’ assessment methodology is aligned with leading ESG standards, including Global Reporting Initiative, the United Nations Global Compact and ISO 26000, and based on 21 sustainability criteria grouped into four core themes: Environment, Labor & Human Rights, Ethics and Sustainable Procurement. Among these 21 criteria, EcoVadis selects only those that are relevant for the assessed company. In turn, the rated company receives an online questionnaire customized to their size, industry and country of operation. 

EcoVadis’ approach allows investors to obtain reliable ESG performance data on their portfolio companies and compare against their peers. The benchmarking pool consists of more than 100,000 companies (of which roughly 80 percent are private), rated across 200 industry categories and 175 countries. You can compare the overall or theme performance by industry or country. As one ESG Officer at a PE company attests, the “accuracy in EcoVadis Ratings allowed not only to perfectly place their portfolio companies within their respective market, but also provided them with unique benchmarks and points of analysis.”

In general, GPs are interested in identifying which of the portcos are well-engaged in the fundamentals of sustainability, which have sustainability risks that need to be addressed, and which are top performers. Having access to a portfolio dashboard, they can benchmark and compare portco performance, report on progress to LPs and regulators, or showcase the results to potential buyers and the broader market. Reporting aside, the assessment process invites a change discussion – it allows to identify key improvement areas and guide corrective plans aligned toward sustainable outcomes for both portcos and GPs. When the focus isn’t on short-term solutions but on long-term mentorship, integrating ESG gives competitive edge and offers business opportunities that go beyond pure financial returns.

PwC’s latest survey of ESG trends in the PE sector highlighted that most GPs now view value creation as the most important ESG driver. At the same time, more than half of LPs report they “either refused to enter an agreement with a general partner or turned down a potential investment on ESG grounds.” PE companies who incorporate ESG considerations into their strategies and operational excellence will be better positioned to win a higher share of wallet with key investors, compared to those who neglect the value derived from sustainable practices.

GPs View ESG as a Way to Create and Protect Value 

Percent of respondents who ranked each answer as one of their top three drivers of ESG activity:

Source: PWC Private Equity Responsible Investment Survey 2021

PE firms aim for return on investment when they exit, not when they invest. To have a higher valuation at exit, they need to grow and de-risk the business for the potential buyer during the holding period. ESG maturity becomes a driving factor in valuation outcomes – ultimately, the ability to demonstrate tangible sustainable performance will be a key differentiator in an increasingly competitive PE market. For more on the approach toward value creation, read our recent white paper, From Risk Management to Value Creation.

About the Author

EcoVadis is a purpose-driven company whose mission is to provide the world's most trusted business sustainability ratings. Businesses of all sizes rely on EcoVadis’ expert intelligence and evidence-based ratings to manage risk and compliance, drive decarbonization, and improve the sustainability performance of their business and value chain. Its AI-powered risk mapping, actionable scorecards, benchmarks, carbon action tools, and insights guide a resilience and improvement journey for environmental, social and ethical practices across 200 industry categories and 175 countries.

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