In the first part of this discussion, participants discussed whether ESG and impact claims should be verified. In the second part of this discussion, the participants address the topic of the quality of data provided by private holdings.
This is a redacted version of a conversation in London convened and moderated by Environmental Finance and sponsored by SGS.
The participants were:
Amara Goeree - Sustainability Director Private Equity, Schroders Capital
Carol Tarr - IMM Lead, Phenix Capital Group
James Magor - Director, Sustainability, ACTIS LLP
Simon Colton - Business Development Director, Sustainable Solutions, SGS
Stanley Kwong - Principal, Sustainable Investing, KKR
Peter Cripps - Editor, Environmental Finance
Peter Cripps: Maybe I'm overgeneralising here, but you have so-far painted a picture of not much verification going on, with a few exceptions. Why is that? Is it just too much cost? What's going on?
Stanley Kwong: Because we need the data first.
I speak to private companies who we work with on gathering the data. That's the big focus.
But if the fund has a specific decarbonisation strategy, then emissions could be something we want to do a baseline check on, to make sure it's the right number.
Peter Cripps: So the data is a stumbling block, an obstacle?
Stanley Kwong: Well, you have to get data to be able to verify the data. It's a strong focus for us to do it properly.
Peter Cripps: And yet, we're always been told that private equity is easier because they own a huge chunk of company, and you just ask for the data: 'Serve it up for me, please'.
Stanley Kwong: I think that is true, but I worked in listed ESG before and it's a little bit more arm's length there.
In private equity, we can ask for it but we're also working with the company to get it. So, it's not just: 'Here's the survey, now go and do it.' We're working with the management to solve the issues of why it's hard to get this emissions data in the first place.
Peter Cripps: Helping them to get their own data?
Stanley Kwong: Exactly. We're working through these issues with them. And we definitely know it's challenging. But that's the process we have to go through.
James Magor: Also, there's a lag period. For example, you say in one year to a new investee company: 'We'd like you to share this data point', and they say, 'I'm afraid we didn't collect it last year'. You say: 'Please collect it this year so it can be reported to us next year', so you're going to have at least a 12-month lag.
But then there are also measurement challenges, like if you ask a company to report their material Scope 3 emissions. That's not an easy question to answer. There are technical challenges, plus these are often new management teams that have just come under private equity ownership, let's not underestimate the number of things being asked of them. They are under huge pressure and suddenly, you send a questionnaire with 70 KPIs, and ask for it to be returned in a month.
We shouldn't underestimate the challenge of gathering data. Assuming that because you have the governance rights to ask for information, that it will appear, that is a bit naive.
Stanley Kwong: Definitely, but even though we have that complexity, that's definitely something which we put our foot down on. It's a huge priority, and it's all the way to the top level of the company.
James Magor: There's a reasonableness test, isn't there? You apply a bit of judgement and say, is it reasonable to expect a company of this size in this market, in this stage of its growth and evolution to be able to provide that data?
And then there's probably a bucket in the middle, where the answer is "maybe". That's where, as an investor, you also have an obligation to actually put some of your resources to work to help the management team gather that particular KPI or data point.
Scope 3 emissions, is a good example of that. Do you have advisors that can help with reliable estimations to start to build up that picture?
So, the other point I was going to make was about impact and verification. I don't think we should underestimate the cost and management time for fund managers. There are smaller impact managers doing really amazing things, but obtaining independent verification can be a big drain on a small teams' time and there is a material cost for some managers.
So, I think we've got to think carefully about applying blanket "you must get external verification" requirements.
Carol Tarr: I would like to ask about tools, whether there are tools enough to do this. And two groups have gotten together for an open impact consortium to try to either create an open-source tool that everyone can use free or to come up with a database with a list of all the tools because some of them are free and some of them are better than others.
But what you don't want is a lot of the good players leaving the field because they can't afford this. At first, I was like, 'Oh boy, that's going to cut straight into my industry'. But now, I really do believe that there has to be something that we all have to sit together and make sure that these players can stay, that they can stay in the ecosystem because they're doing really good work, and they're offering really good products that, eventually, can be invested in, or built up, and can be a greater service to everyone.
Simon Colton: Regulation is driving positive change but you could also drive people out.
Carol Tarr: Right. And those are the ones you want to stay there, right? We don't want it to be prohibitive.
Stanley Kwong: We also have to be careful that we don't just leave the data collection as another tick box, because it's part of the whole value creation process.
Peter Cripps: And on the subject of data – you mentioned the CSRD, we have not mentioned the ISSB, and there's stuff going on in the US in terms of SEC reporting requirements coming down the track. Is this going to be helpful or a game-changer even for the private equity space, or is it just big listed players that will fall into the scope of this?
Amara Goeree: Some of these developments, especially the continued level of isolation between the initiatives, worries me. Stanley made an important point: we should not target ESG data collection for the sake of data collection. If we are asking for data, we need to assess if it is a good investment, use the data to assess current ESG performance and the opportunity to deliver financial and societal value through the investment.
This is a conversation that we're often having with our managers. We engage with them to increase data coverage and raise the concern on the reporting burden and resources it drains. They'll say: 'We've actually always been tracking certain non-financial KPIs that could be considered ESG KPIs, but why do we need to ask the carbon footprint of a small biotech firm that is still in development phase?'
Regulatory expectations, such as the Principal Adverse Indicators in Europe, are extremely important to consider, but let's prioritize the ESG and impact KPIs that are business-material, followed by the ESG KPIs important to most stakeholders.
As such, carbon data is a non-negotiable for example, even if it's a firm with no material carbon footprint. Thankfully, there are now a lot of tools to help you collect it.
James Magor: And there is a risk that too much of the judgment around the performance of a company just boils down to ESG data points. For example, there's a business that we exited last year called Atlas Renewable Energy in Latin America. They trained 1,500 women to participate in the renewables sector and over 1,000 of them actually got jobs following the training programme, which was a huge positive contribution to gender diversity in the renewable power sector in Latin America.
Yet, are they going to be judged instead on the tons of waste that they recycled because training opportunities for women isn't on the standard list of KPIs? You can't boil everything down to a standardised set of KPIs. There still must be room for other elements of sustainability to be ...
Peter Cripps: A narrative?
James Magor: Yes, that's exactly right, a narrative to complement the data.
Peter Cripps: Time's up, so maybe I can just ask for any final comments?
Stanley Kwong: I think, if you just take a step back, the level of conversation which we're having here, generally in the market, it's actually quite a good thing in some form. Because a few years ago, the level of discussion was not that much in depth, right? So, the conversation would probably just be we need to collect more data and everyone would say the same thing. But now it's: 'we need to collect this data' and someone will say, 'no, we should be collecting that data'.
That's actually a good conversation or debate to be having, right? Or, 'we need verification, but not just that type of verification, we need this one'.
I think at least there's a level of depth in the conversation around what which direction should be taken. So, in some ways, the market is maturing. Going forward, we need better understanding of what the regulators or supervisors expect on the types of validation on the various regulations.
James Magor: I think I'd just like to re-emphasise that we shouldn't aspire to make sustainability data like financial data. Don't lose sight of the narrative. The data should complement or validate the narrative, it mustn't completely replace the narrative.
Sustainability is broader and more complex than a balance sheet, so it's really important that we don't lose sight of that.
Carol Tarr: Like Stanley was saying the market has matured with these conversations, but there's still massive gaps that we're seeing with the social KPIs. So, in another year's time, well, we will be discussing how this or that social KPI is material. I would love to get to that level of discussion.
Amara Goeree: Our priority is on receiving and reporting business- and stakeholder-relevant ESG data in a format that can easily be processed by investors, ideally using industry standards so it's comparable. Once we have data, we can assess how substantive it is and use it for value creation.
Verification is a bonus, but that's not an engagement priority for us right now.
Simon Colton: One of the areas that we've not necessarily touched on, is the UN SDGs. We're on a working group for providing UN SDG impact assurance. And, hopefully, I can touch base with you guys and just see if that'd be something you'd be interested in.
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The first part of the discussion can be accessed here.