What are the top ESG Considerations for the Private Equity Industry?

Rapid regulatory changes and rising awareness of investors towards their investments’ sustainability and climate change aspects have led to a surge in ESG considerations in the private equity industry. Regulatory authorities are eager to create comprehensive frameworks on ESG finance applicable to most financial institutions. Asset managers also work as suitable intermediaries to ensure channeling investments towards ESG-compliant activities. 

Private equity firms that ESG factors have a competitive edge in creating value and lucrative investment opportunities. ESG equity research can positively affect PE investments and enhance value creation opportunities. Let’s look at the top ESG considerations for the PE industry.

Latest ESG Regulations for PE Funds

According to the latest ESG guidelines and regulations, fund managers must disclose specific details about their ESG risk integration and how their product can negatively impact the investment value. Furthermore, they must prepare due diligence policies while considering adverse impacts on ESG indicators to make investment decisions. Fund managers must update their fund prospectuses, annual reports, marketing documents, and websites to ensure compliance with these latest requirements. Besides these, investors must obtain ESG data related to their prospective investment assets and base their decision on the provided disclosure.

ESG Challenges for the PE Industry

Even experienced PE managers may face challenges while obtaining ESG data about non-publicly listed and smaller companies turning into investment assets. Whereas larger companies must comply with regulations to report their ESG requirements, smaller and medium-sized companies have no such obligations or frameworks. It poses a challenge to PE managers who often rely on ESG equity research and sustainability reports to identify their potential targets. Considering this, bridging the gap becomes essential by expanding the entity’s scope for sustainability reporting. 

Collecting Relevant ESG Information about Investment Targets

Considering the challenges mentioned before, it becomes unclear for PE managers how to obtain the required ESG data while choosing their investment targets. Many times, these companies are not liable for regulatory ESG reporting requirements. Therefore, fund managers must use other methods to get the required information. These include:

  • Voluntary Disclosures: Companies looking to attract ESG-compliant investors may voluntarily disclose their ESG data according to international standards. Private equity fund managers may rely on these reports to screen potential targets and select them for investment. 
  • ESG Due Diligence: An increasing number of investors take ESG aspects into account while conducting due diligence. It includes reviewing the company’s ESG compliance related to environmental, corruption, human rights, supply chain, labor laws, and bribery. Fund managers develop their internal ESG due diligence policies apart from KPIs based on relevant ESG aspects. They closely engage with their target investment companies and obtain relevant information about their ESG aspects.
  • Third Party Reports: Rising consciousness about sustainable development and climate change encourages consultants to offer ESG equity research and due diligence services. These consultants closely engage with the target companies and obtain relevant data to ensure ESG compliance. Compared to self-conducted due diligence, third party reports bring a higher degree of assurance for data relevance.

Remember, ESG standards may vary from one sector to the other, based on their size, operations, and inclination towards E, S or G. Therefore, approach a business’s ESG aspects while considering relevant factors pertaining to the investee’s size, industry, and location.

Transactional Documentation

While creating transactional documentation, sustainable fund managers receive incentives to include extra-contractual provisions ensuring a company’s ESG profiles. It must demonstrate how the company behaved in the past and remained in line with its ESG expectations and requirements over an investment period. A target company’s poor alignment with ESG standards has a negative effect on its reputation. Additionally, the documentation must provide specific data about their ESG obligations, enabling them to fulfill their ESG-related reporting requirements. 

Private equity investors’ rising interest in ESG considerations orients assets with rapidly changing regulations, promising sustainability to stay the top priority for fund managers. 

While ensuring compliance with the latest ESG regulations, PE fund managers must take the aforementioned considerations into account to increase engagement and make informed decisions. ESG equity research results in developing the best practices to navigate the regulatory environment and shifting investors’ expectations. Since private equity touches a large part of the global economy, potential targets must follow ESG practices in their company strategies to execute with more significant impact and make informed decisions.

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