Matt Mikulay and James Schoppe, two senior managers on Baker Tilly’s risk advisory team, recently hosted a webinar in collaboration with the Association for Corporate Growth (ACG). In the webinar, Matt and James discussed the basics of environmental, social and corporate governance (ESG), top ESG reporting trends and their impact on private equity.
Commonly referred to as corporate sustainability, ESG stands for environmental, social, and corporate governance and refers to the consideration of these three factors (alongside financial factors) in the investment decision-making process.
Environmental may apply to issues such as climate change, waste management and energy efficiency. Social can include human rights, supply chain labor standards and workplace health and safety. Governance may encompass rules and principles that define the rights, responsibilities and expectations of stakeholders throughout the company – or other companies.
In modern business, all of these elements need to be taken into consideration, along with financial factors. The days of key stakeholders being interested only in financials and profits are over, and entities must evaluate ESG risks and opportunities as part of their long-term value creation and strategy.
The pandemic has played a significant role in entities needing to revalue the risks and opportunities they are facing. In addition to COVID-19, factors such as climate change and social justice initiatives have forced investors and stakeholders to think about these factors as long-term considerations. Entities are facing increased pressure from regulators, investors and stakeholders (both internal and external) to prioritize ESG efforts. Focusing on the financial reports is no longer good enough.
As evidence of the rising popularity of ESG, we can simply look at worldwide Google trends for the term “ESG.” As seen below, it is clear ESG is on the radar of the general population more than ever – and that trend does not seem as if it’ll disappear anytime soon – which is gaining attention from corporate executives.
As far as why we are in this current ESG landscape, the primary reasons can be broken down into four areas.
While ESG reporting remains largely voluntary, entities should be aware that ESG “raters” such as MSCI, Sustainalytics, and the CDP (formerly the Carbon Disclosure Project) are actively rating companies on ESG and sustainability reporting. Additionally, the CDP, Climate Disclosures Board, Sustainability Accounting Standards Board (SASB), International Integrated Reporting Council (IIRC) and the Global Reporting Initiative (GRI) released a joint statement in September 2020 to outline their commitment to establishing global sustainability standards. This would facilitate the transition to develop a universal set of standards and consolidate the different ESG frameworks to provide increased industry-wide transparency. The end goal is to create one system of reporting with universal transparency, and eliminate certain aspects of confusion and uncertainty regarding which ESG reporting framework or set of standards entities should use.
In addition to impacting public, private and not-for-profit organizations all over the world, ESG continues to have a profound impact on the private equity space. As for why private equity investors feel so strongly about this matter, we have highlighted four key reasons:
ESG-focused strategies are not the only path for private equity firms to follow. However, there are benefits to integrating ESG elements into investing. The primary benefits, as we see them, are broken down as follows:
Private equity firms need to begin considering and responding to ESG now, if they aren’t already. Some initial steps private equity firms and their portfolio companies can begin to take include:
In all, we’re talking about proactive compliance – and operationalizing it. As depicted below, entities need to proactively and intelligently assess, implement, integrate and control their ESG-related risks and opportunities, in order to respond to changing stakeholder demands.