Author: Tycho Sneyers
Tackling the data challenge in private and alternative markets is key to meeting sustainability requirements, says Tycho Sneyers, Managing Partner at LGT Capital Partners and Board Member at UN PRI.
Investors who are subject to the Sustainable Finance Disclosure Regulation (SFDR) have dedicated a lot of time and effort to ensure compliance, and many practitioners who are serious about ESG have generally welcomed such regulations. In practice, implementation has come with certain challenges, particularly for alternative asset classes, like private equity, or investment strategies involving multi-manager investments. Data availability is the key.
By now, the financial industry has become accustomed to the disclosure and reporting requirements of SFDR. As of January 2023, the Level 2 Regulatory Technical Standards have come into effect. Where Level 1 introduced high-level disclosure of ESG policies and procedures, Level 2 establishes more prescriptive pre-contractual and annual reporting requirements.
Privately-held portfolio companies are not covered by global data providers such as Bloomberg or MSCI. In addition, many of them are small or medium-sized and not necessarily staffed or equipped to track and report on detailed ESG metrics. On the other hand, private equity investors often have significant ownership positions and can potentially control, or at least influence, boards and management teams at their portfolio companies. By doing so, they may increase awareness of the importance of strategic sustainability thinking and accelerate ESG-related data availability and quality.
How does a private equity investor implement, and adhere to, sustainable regulations in practice? First, by setting a clear ambition level. At LGT Capital Partners (LGT CP), we aim to have all our new private equity offerings categorised at least as Article 8 under SFDR. This builds on strong and longstanding ESG practices and is substantiated in terms of the binding elements promoting ESG. According to SFDR, an Article 8 product promotes environmental or social characteristics, provided that the companies in which the investments are made follow good governance practices.
For Article 8 products, an investor must be specific about which E and S characteristics are promoted. These can relate to addressing climate change risks, monitoring carbon emissions, and, for example, addressing diversity, equity & inclusion topics. Once committed to these binding elements, an investor is required to monitor and report on these.
Reporting in Private Markets
While it is relatively straightforward to report specific E and S characteristics for portfolio companies, the application is less clear for investments into private equity funds (primaries and secondaries). For these, we at LGT CP use our ESG manager ratings combined with the tracking and reporting of environmental and social characteristics. Our ESG manager ratings are derived from the engagement with our private equity managers. This engagement typically consists of meetings and the answers to our annual ESG questionnaire.
As mentioned earlier, ESG data availability and the lack thereof are a challenge for the financial industry in general and for private equity specifically. The good news is that various initiatives aim to increase the availability of such data. The ESG Data Convergence Initiative, for example, was launched in 2021 by leading private equity managers and investors. It aims to streamline the private equity industry’s historically fragmented approach to ESG reporting by creating a consistent set of comparable ESG metrics on private companies. These metrics can in part also be used for SFDR commitments and reporting. In addition, the initiative will allow managers and portfolio companies to benchmark their current ESG performance and work toward improvements in a transparent and comparable way.
LGT CP joined the initiative in 2021 and is reporting on the key metrics in its co-investment portfolios, with a view to expand data collection for all private equity portfolios over time. This will allow us to improve our reporting on Principal Adverse Impact (PAI) indicators as well as the European ESG Template (EET), which – besides the regulatory reporting template – is developing into the market standard for product-related ESG disclosure. In the interim and until sufficient high-quality data is available, many private equity investors are working on a best-efforts basis to comply with the regulatory requirements, e.g. by using proxy data from publicly listed companies.
In conclusion, we see that the private equity industry is well positioned to support the goals of sustainable finance regulations. At the same time, a lot of work still lies ahead to enhance and accelerate data availability, both in terms of its quality and quantity.
Tycho Sneyers, is a Managing Partner at LGT Capital Partners and Board Member at UN PRI