Cority’s Anne Matusewicz and David Wynn recently sat down with Private Equity International to discuss data collection and reporting as a matter of regulatory compliance, and GPs need to engage with portfolio companies through a business strategy lens.
How is the regulatory landscape evolving when it comes to sustainability and what implications does this have for private equity firms in various parts of the world?
Anne Matusewicz: There is a great deal of focus on climate in the US right now. There is the pending Securities and Exchange Commission’s climate-related disclosure regulation, of course. But the climate-related reporting legislation coming out of California is more likely to affect private equity firms because 80 percent of the 10,000 companies that are going to be affected are privately held. We are therefore seeing a lot of private equity firms trying to accelerate their initial carbon footprinting exercises, if they have not already done so, as well as focusing on the more qualitative elements around climate-related risks. Climate disclosure laws are certainly acting as a catalyst to get private equity firms to track this data, with more mature companies setting reduction targets. Longer term, these companies are also thinking about how that data is going to be audited by a third party.
David Wynn: In Europe, the Sustainable Finance Disclosure Regulation and the EU taxonomy are the regulatory frameworks that are driving reporting. Again, I think climate is at the forefront. Overall, though, I would say that European private equity firms are generally in a more mature position, simply because they have been impacted by this regulation for longer than firms in the US.
What do you consider to be best practice when it comes to GPs’ engagement with portfolio companies on matters of sustainability?
DW: In this culture of compliance, you need to think about sustainability data in terms of what is required by regulators. But it is also important to approach this from a strategic planning perspective and that comes down to ensuring that sustainability initiatives are aligned with value creation and investment goals. Regulatory requirements need to be translated into a context that portfolio company management teams can understand. They need to recognise that you are engaged in a common mission to become more sustainable, and it is that value-creation lens that will really resonate.
AM: The focus must be on materiality. It is important to be aligned with the underlying portfolio company’s business strategy and value-creation plans and the data being collected should be decision-useful. In addition, firms that exemplify best practices are typically proactive around knowledge sharing and bringing portfolio companies together to discuss various ESG issues on a regular basis. Private equity firms should not only be engaging with boards but also with those individuals who are responsible for overseeing sustainability programmes on the ground. GPs need to ensure those people have the tools they need to execute on sustainability-related initiatives. Indeed, it is vital that all employees understand a company’s sustainability mission and how that is woven into its value-creation objectives.
What are LPs’ expectations when it comes to data? What challenges is this creating for GPs and how do you see this being resolved?
AM: Sustainability reporting is a common source of friction between GPs and LPs. There has been some improvement in terms of standardisation, with framework consolidation such as the International Sustainability Standards Board serving as a bright spot in the alphabet soup of sustainability frameworks and industry initiatives. But we are still hearing that GPs are receiving hundreds of data requests, with questions being framed in very specific and inconsistent ways. This can be quite challenging. Advances in technology mean it is now possible to map similar questions and pull the relevant information, which is helpful, but further standardisation is necessary. The ESG Data Convergence Initiative is a great starting point in terms of establishing a common set of metrics, and so again, we are moving in the right direction. We are starting to see GPs push back on data requests where they do not consider that data to be useful for decision-making. They are asking LPs how the absence of that data would impact understanding of the firm’s sustainability performance or investment processes as they seek to streamline the information they request from their underlying portfolio companies. The trend we see among GP clients is to whittle down the number of questions they are asking of their portfolio companies year-on year, while still ensuring any appropriate questions are added as it pertains to new regulation or emerging issues such as biodiversity.
DW: There needs to be a sense of collaboration and communication between LPs, GPs and portfolio companies, with each constituent seeking to understand the needs and challenges of others. We have facilitated such discussions, which encourage understanding of the various perspectives and promote a more collaborative conversation working toward a common goal.
Historically, access to reliable and comparable data has been one of the biggest challenges around sustainability benchmarking and reporting. To what extent have those issues now been resolved?
DW: There have certainly been some positive steps towards the standardisation of the data that is being collected. There is still some way to go, in terms of aligning global regulation and LP requests, but things are moving in the right direction. Meanwhile, we are now seeing private equity firms focusing more on data coverage and data quality. This is particularly true around environmental reporting. There are many different methods when it comes to accounting for carbon emissions, for example, and so understanding the quality of that data is critical to be able to assess year-on-year improvements and to make decisions based on that information. Furthermore, as data is increasingly audited, it is important to be able to communicate on the quality of the data in a transparent way.
AM: I would add that companies now have a better understanding around what the numbers should actually look like. There are publicly available data sets on workplace safety industry averages, for example. ESG Data Convergence Initiative benchmark data is also becoming available for member firms. This information helps businesses understand where they are and define achievable targets. I also agree with David about the focus on quality. Given the number of eyes that are going to be on these sustainability reports going forward, data validation is critical. Human error, misinterpretation of data, and reliance on estimations can result in unreliable information flowing from assets to GPs. Therefore, using tools to ensure data quality is critical if you want sustainability data to be a genuinely useful tool for the business.
What role is technology playing in driving these improvements?
DW: One role that technology is playing is around standardised calculations and methodologies to ensure consistency. Technology also facilitates the coming together of data and insights. Hard data is central to sustainability reporting and disclosure, but the insights that can be gleaned from that hard data are critical too. There is software that can allow for the management of those insights including visualisations, dashboards, benchmarking and peer comparisons. Those tools allow companies to overlay insights onto data. The architecture of technology also means data can be used for multiple purposes. You can leverage one set of calculations for multiple disclosures and then tie that into a culture of permissions and controls around the data. Data interoperability and data ecosystems are critical too, whether that relates to linking inputs with other systems to integrate data coming in, or whether it relates to outputs. Sustainability technology is now front and centre in terms of APIs [application programming interfaces], rather than being thought of as a standalone point solution as it would have been 10 or 15 years ago.
AM: The overall goal is to make data collection more streamlined, more reliable and more useful. There are certainly solutions out there that provide those benefits, allowing ESG teams, which are often small and stretched, to focus on the compelling work of supporting portfolio companies.
What do you see as the next big trend when it comes to the sustainability agenda?
DW: Sustainability is now a matter of compliance, rather than being voluntary, and I think it is inevitable that we will continue to see global regulatory alignment around sustainability reporting. Given the multi-jurisdictional nature of business today, whether through investment or supply chains, there is clear momentum in that direction and that will only prove beneficial. I also believe there will be an increased focus on data interoperability. Certainly, that is going to be a major focus for Cority in 2024 in terms of the solutions and services we offer in order to enable companies to use sustainability data for multiple purposes within the business. Finally, while the environmental, and climate side of sustainability in particular, already benefit from a strong depth of methodologies, I think we will increasingly see a proliferation of methodologies around other aspects of sustainability including social impact, equality, the implementation of nature-based principles and the circular economy.
AM: We are certainly going to see more focus on the emerging issues David has outlined. I also believe that we will see greater attention being paid to preparation for auditability, as well as action planning. Many of the targets that have been put in place are centred on 2030. With just six years to go, it is time to re-evaluate those targets, to assess what progress has been made and to consider the correct cadence that now needs to be established if the targets are to be met. It could be, for example, that certain metrics require more frequent collection and analysis, perhaps moving from an annual approach to quarterly. 2030 really is just around the corner and private equity firms and their portfolio companies need to prepare for the final stretch.
