Sustainability Reporting in Private Equity: Progress and Challenges

Sustainability Reporting in Private Equity: Progress and Challenges

New data from the ESG Data Convergence Initiative (EDCI) indicates that privately owned companies’ environmental, social, and governance (ESG) performance continues to fluctuate relative to their peers in publicly traded markets; however, in the past year, key improvements have been made. Renewable energy adoption and utilization have both increased, and privately held companies continue to outperform their publicly traded peers regarding job creation and senior-level human capital management. These findings and trends can be found in this year’s Sustainability in Private Equity report recently released by Boston Consulting Group (BCG). Along with data trends identified using EDCI submissions, BCG also surveyed members of the EDCI – 170 general partners (GPs) and 61 limited partners (LPs) – for further insight.

Overall, the findings are encouraging for the state of ESG in private equity and suggest that private equity firms that continue to focus on building and creating resilient businesses are well-positioned for competitive advantages stemming from ESG-focused management as companies improve over time.

About the EDCI

The ESG Data Convergence Initiative (EDCI) is a collaborative effort among private equity GPs and LPs aimed at generating a substantial amount of meaningful, performance-based sustainability data from privately held companies. By standardizing sustainability and ESG metrics for private market companies, EDCI enables GPs and portfolio companies to benchmark their status and track the progress of their ESG strategies. This initiative also enhances transparency in the industry and provides LPs with more comparable portfolio information.

Highlights

According to BCG’s findings, companies owned by private equity (PE) firms that prioritize ESG and sustainability have demonstrated improvements across several key metrics, such as renewable energy use, work-related injuries, diversity, and employee engagement. These trends were observed despite private companies typically beginning with weaker ESG profiles and despite an increased focus on ESG as a result of negative political sentiment.

In the past year, both public and private companies have collectively increased renewable energy usage. Among private companies utilizing renewables, the median EDCI company boosted usage to 30% in 2023, up from 28% tin 2022. In comparison, public companies saw an increase from 29% to 32% over the same period. The gap between private and public company renewable energy adoption is also shrinking. The percentage of private companies that have increased renewable energy usage by 25 percentage points or more rose by 2 percentage points to 12% this year, compared to just 6% of public companies over the same period. In North America, the number of private companies that report using no renewable energy has decreased from 54% to 49%.

Although only 22% of private companies have a decarbonization strategy, those with such strategies are reducing emissions faster than their public peers. The EDCI benchmark data shows that the median Scope 1 and Scope 2 emissions intensity at portfolio companies owned by GPs with public commitments was more than 40% lower than at companies without such a commitment. It should be noted, however, that GPs with public, firm-wide commitments to reducing emissions tend to invest predominantly in relatively lower-emitting industries.

PE sponsored companies have also made significant strides in workplace safety and inclusion over the past year. Injury rates, as measured by incidents per 1,000 full-time employees, decreased by 22% from 2.2 in 2022 to 1.8 in 2023. Additionally, EDCI member companies reported a sharp increase in employee survey usage and completion, rising from 63% in 2021 to 74% in 2023. This trend suggests a growing recognition of the value of employee feedback in shaping workplace culture and driving positive change; such practices can lead to lower turnover rates, as companies can identify and address issues that impact employee satisfaction and engagement.

Diversity metrics continue to vary widely across privately held companies. For the third consecutive year, private companies are surpassing public companies in gender diversity at the C-suite level, but they still lag behind public peers at regarding board diversity. 77% percent of privately held companies that reported EDCI data have at least one woman in the C-suite, compared to 64% in public markets. The proportion of private companies with at least one woman on their board increased by 3 percentage points in 2023, reaching 61%, while a similar rise brought the percentage for public companies to 89%. Diversity metrics for privately held firms also vary depending on how long they have been held. Over 60% of private companies held for more than two years have women on their boards, which is 6 percentage points higher than those held for less than two years. Similarly, women hold roles at the C-suite level at almost 80% of companies held for more than two years, compared to 73% of those held for shorter periods.

Other notable data findings include:

• Sustainability teams whose heads report directly to investment professionals spend 36% of their time on sustainability reporting and regulatory compliance, compared to 44% of the time when they report to the CEO.

• Considerably fewer private companies (just 11%) have made longer-term net zero commitments, while an additional 6% have longer-term decarbonization goals in place that are not fully aligned with a net zero pathway. However, 19% of private companies plan to establish a long-term net zero path within the next two years.

• Among companies with more than $200 million in revenue, 22% have a net zero path in place.

• 40% of LPs have capital allocated specifically to climate investing.

Survey Findings

LPs are increasingly prioritizing sustainability and expecting GPs to improve sustainability outcomes. The survey reveals that LPs value better reporting and transparency, constructive engagement with GPs, and directing capital towards climate solutions. Of the LPs surveyed, 85% said they expect to increase their prioritization of sustainability-related topics over the next three years. Approximately 70% indicated that companies warrant a valuation premium when thoughtfully considering and managing an enterprise sustainability strategy. The survey results suggest there is a growing recognition of the link between sustainability and financial performance.

An overwhelming 98% of LPs say they would walk away from an investment if the manager was not adequately committed to sustainability. Predictably, the LPs surveyed place the highest importance on climate change and net zero goals. The second most critical topic is reporting and transparency, which, while not directly improving sustainability, allow LPs to monitor their investments’ commitment to and progress on sustainability issues. Other direct ESG considerations, such as diversity, equity, and inclusion (DEI) and board practices, remain important but are less prominent.

Aeterra’s Takeaways

The EDCI data set provides a proxy for how leaders in the private equity community are approaching ESG data collection and reporting and initiatives firms are leveraging. Private equity firms are increasingly driving sustainability improvements within their portfolio companies. Significant influence over management allows PE firms to prioritize initiatives that enhance ESG performance. By focusing on sustainability efforts that directly contribute to long-term value creation, such as cost reduction and risk mitigation, private equity firms are positioning themselves and their portfolio companies for a competitive advantage. Aeterra helps PE firms and their portfolio companies with the EDCI data tracking and report submission process using our proprietary Aeterra Workspace platform and affiliated advisory services. Please reach out if you are a firm interested in partnering with us.