- Financial sponsors’ effort to overhaul environmental, social, and governance (ESG) reporting is transforming the industry’s data, and the market is taking notice.
- Improved reporting frameworks are creating new opportunities to capitalize on ESG assessments, for top-rated companies and historic underperformers alike.
2022 was a challenging year for the ESG community. As the influence of ESG ratings grew, so did public scrutiny, with many criticizing the industry’s data as inconsistent and ill-defined.
Across the political spectrum, there is growing consensus around the need to focus on financial materiality in investment decision-making, but some skepticism that ESG assessments are substantive enough to be a core focus.
Some of this criticism was well founded. ESG ratings – like many financial assessments – were frustratingly subjective. Different methodologies engendered variable results. As recently as 2021, despite the sector’s growing influence, no standardized framework for measuring and reporting ESG data existed.
New Reporting Frameworks
Leading LPs and GPs in the financial sponsors space have confronted this challenge head-on. In 2021, CalPERS and Carlyle led an effort to create a mechanism for comparative reporting, benefiting stakeholders across markets. This project, known as the ESG Data Convergence Initiative (EDCI), is uniting private companies around a meaningful, standardized set of ESG metrics.
Participating companies report data across six categories, using a globally accepted and objective submission template. The EDCI ensures this data’s viability for a large network of financial sponsors and investment managers. Today, more than 275 leading financial sponsors, representing more than $25T in global assets, are committed to the EDCI.
Financial Sponsors like Carlyle and CalPERS are pushing their portfolio companies to obtain and report this data, but they are far from alone. In the private equity (PE) community, over 80 of the top-100 PE firms have a partner dedicated to ESG on their investment committee. Whether firms are selling sponsor to sponsor, working with family offices, or taking a business public, ESG plays an important role in enhancing the value of portfolio companies.
Similar efforts are underway in public markets. The EU recently introduced mandatory disclosure requirements for all large and listed companies on their risks and opportunities arising from social and environmental issues, and on the impacts of their activities on people and the environment.
While the SEC does not yet require extensive ESG disclosure, it is expected to follow the EU’s lead and already mandates climate disclosures encompassing emissions from upstream and downstream activities.
A 'Transition' Mindset Emerges
For years, ESG evaluations lacked nuance. With fragile data, companies were viewed as ‘green or brown’: strong on ESG or weak on ESG, there was no middle ground. As the quality of ESG reporting improves, so has the quality of ESG analysis. Today, financial sponsors and investment managers have adopted a mindset that values ‘transition.’ Companies are not judged on their history, but on their commitment to progress.
The market is patient, but it wants to see data, analytics, and intentionality. Even historic underperformers can represent great investment opportunities, if they can showcase their efforts to track meaningful metrics and make improvements. Markets are rewarding companies that advance ESG strategies, something priced in and reflected in their multiples.
In the coming years, companies should develop inclusive, analytical frameworks for understanding sustainability, human capital, and corporate culture. Those that fail to demonstrate a commitment to ESG risk significant consequences from their investors, their employees, and the SEC.
Ignoring ESG Invites Risks
The EDCI’s database of meaningful, performance-based assessments is gaining traction amongst LPs and GPs. As these metrics continue to gain wide spread adoption, companies who do not engage with this process may struggle to raise capital and attract top talent.
Jefferies delivers customized ESG guidance to clients, offering unique access to public and private sector ESG thought leaders for investors and corporate boards. The firm’s specialized expertise, followed by actionable and timely strategic insights, can ensure your company capitalizes on the market’s swiftly evolving assessment of ESG.