ESG Reporting for Private Equity and PE Portfolio Companies - Last Updated: August 14, 2022

Today, most companies have committed to improving their environment, social, and governance (ESG) performance and reporting to meet growing demands from investors, regulators, and customers. While ESG is often viewed as a priority for publicly-listed companies, private companies - and private equity (PE) firms investing in them - also need to consider ESG reporting for portfolio analysis, risk assessment, and access to capital. Increasingly, annual ESG reporting and implementation is an operating imperative for private equity investors and their portfolio companies.

Since ESG programs and reporting may be newer for private equity firms and companies, here's some general guidelines on why ESG matters for the PE space and how firms should approach reporting and disclosure.

What is ESG Reporting? A Quick Definition

An ESG report is a disclosure communication designed to increase corporate transparency about an organization’s ESG performance, risks, and opportunities. ESG reports should be clear, data-driven (rather than vague, anecdotal, or solely qualitative), honest (not “greenwashing"), and tell a clear story about how a company is pursuing better social, environmental, and equitable outcomes for its employees, customers, external communities, and the planet, backed by evidence.

ESG reports are typically published by the ESG, investor relations, or corporate affairs department of a company, and creating ESG reports is a collaborative, cross-departmental effort. Private equity firms and institutional investors increasingly also need to understand the ESG profile of their portfolios, and report their own portfolio-level ESG composition and performance.

Why is ESG Reporting Important for Private Equity and PE Companies?

In most countries, ESG reports are voluntary, not mandatory. However, recent 2022 legal changes, announcements, and impending mandates in the United States, Canada, European Union (EU), United Kingdom, Singapore, Australia, and other regions are creating stricter disclosure obligations for many types or organizations to measure and report their ESG performance. For example, in the EU, between 2024 and 2028 most companies with European operations will need to publicly disclose ESG and sustainability indicators to comply with the EU Corporate Sustainability Reporting Directive (CSRD).

Moreover, many banks, investors, and large companies are increasingly asking their investments, vendors, suppliers, and partners to complete ESG and sustainability commitments, questionnaires, and disclosures. Employees, customers, and communities are also increasingly likely to advocate for larger and more impactful ESG commitments from brands.

Given the importance of access to capital and favorable lender and investor relationships in private equity, ESG data collection and reporting need to be incorporated into PE firm's portfolio strategy, analysis, and reporting, particularly when European investors and portfolio companies are involved.

Moreoever, effective ESG implementation at private equity portfolio companies can also deliver financial ROI and benefits, including:

Where Private Equity Firms and Funds Should Start with ESG

As investors, capital allocators, and company operators, private equity firms have somewhat unique ESG reporting needs. PE investments can span a broad range of industries, markets, countries, and even company stages. To properly assess ESG risk and performance across an investment portfolio, private equity needs a central, standardized methodology or framework for evaluating, benchmarking, and comparing companies across their portfolio, while also recognizing different companies within the portfolio will need specialized or sector-specific ESG KPIs in some cases.

A constructive first step in ESG reporting is to conduct an ESG readiness and resources assessment - both within the fund and across the portfolio. What analyst, data, and systems resources does the fund have now? What are the gaps and needs? Similarly, at the portfolio level, what is each company's ESG maturity level and risk profile? Are any companies in the portfolio already issuing ESG reporting?

For more on starting ESG reporting programs within an individual company, please see our guide here. Most organizations advance along an ESG readiness and maturity curve, moving from mandatory ESG compliance toward ESG excellence and sustainable innovation as a true source of alpha and risk reduction.

Taking stock of your internal readiness will help identify important resource, culture, and capability gaps, so you can proactively address them to pave the way for the next series of ESG portfolio integration steps.

It's also important for private equity investors to recognize four fundamental strategic principles about ESG investment and corporate operations:

Let's unpack and walk through each of those four points.

ESG Has Clear Financial Implications for Private Equity Investors

Even the best financial statements can't express a company’s full value and risks:

Initially, internal corporate ESG investments may look like loss-leaders. Longer-term, ESG has power to become a revenue-driver and margin-improver, not just a cost center.

For example, in consumer goods, from 2015 to 2019, sustainable and sustainability-marketed products accounted for 55% of total CPG market growth, despite representing around 15% of the category, according to research from NYU Stern's Center for Sustainable Business. And, given growing supply chain attention on ESG matters by large purchasers like Disney, Nike, Target, and Walmart, strong ESG performance and transparency can preserve — or open up new — customer relationships and de-risk revenue.

ESG initiatives and innovation certainly require CAPEX, and may entail longer return horizons or lower hurdle rates initially in some cases. Nonetheless, when executed thoughtfully and effectively, ESG delivers ROI, operational cost savings, and long-term competitive advantage(s).

Strong ESG Performance and Disclosure De-Risks Access to Capital

From institutional ESG investors like BlackRock and State Street to private equity and banking lenders, more capital providers are using ESG indices, scores, and ratings signals to assess the risk-return profile of their allocation decisions. Emerging evidence suggests better ESG and sustainability performance translates to a lower cost of capital for companies, plus broader liquidity access. If nothing else, strong ESG performance certainly de-risks access to capital vs. the alternative.

According to a recent study by EY, 74% of institutional investors now more likely to "divest" based on poor ESG performance, while 90% of investors say they now attach greater importance to ESG performance in their decision-making.

In total, Fortune 500 companies alone carry an estimated $2 trillion+ in financial risk from climate impacts, based on outside-in analysis and company ESG reporting. Across the global economy, ESG risks range from supply chain shocks and severe weather to energy price inflation and business model transformation. Companies and private equity investors that understand, act on, and transparently disclose their ESG and climate-related risks and opportunities stand on much stronger footing than peers who score poorly with ESG rating firms and analysts.

ESG is a Growing Source of Compliance and Investment Risk

In a growing number of countries, regions, and jurisdictions, ESG reporting and disclosure is transitioning from voluntary to a mandatory (scrutinized) process for certain material topics and indicators.

Other regions like Australia, Canada, and Singapore are also developing and refining ESG reporting requirements, and the ESG regulatory landscape continues to evolve rapidly.

Failure to keep up with ESG regulatory requirements - or worse, misstate or omit material ESG information - may incur fines, penalties, and financial risk for filers.

As disclosure standards shift toward ESG, and criteria for 'ESG investments' become stricter and more standardized, institutional investment and capital flows will follow the regulatory trends.

Many capital markets participants already view ESG performance as synonymous with management quality. And on the debt side, green and sustainability-linked bonds are one of the fastest growing debt categories, with over $1.5 trillion issued in 2022 according to S&P.

Growing alignment between capital and ESG objectives should private equity firms and portfolio CFOs to sharpen companies' ESG data, disclosures, and narratives for banks and lenders.

ESG Boundaries Differ from Traditional Entity Scope in Financial Reporting

Unlike traditional financial accounting, ESG, carbon accounting, and climate risk assessment require a broader and potentially more forward-looking lens on opportunities and risks. Climate risks may be linked to suppliers, customer preferences, or even extreme weather and natural disasters - all examples that occur externally to the reporting entity itself in different segments of its value chain.

This can be frustrating for finance leaders and investment analysts, as it broadens the scope of ESG KPIs, potential ERP and financial systems integrations, and data collection, but it is necessary to understand a firm or fund's full ESG performance and risk profile.

Setting Private Equity Portfolio ESG Metrics and KPIs

For private equity investors, Global Reporting Initiative (GRI), a leading international sustainability and ESG reporting standard, offers guidance and best practices for PE firms developing ESG reporting. GRI's recommendations include:

The United Nations Principles for Reponsible Investment (PRI) also provides helpful structure for private equity fund reporting, recommending a reporting and disclosure structure that includes:

Once on the portfolio governance and reporting structure is established, PE firms should work with their management teams to track ESG progress and KPIs within each company. These targets and indicators should be based on ESG or sustainability reporting standards, ratings methodologies, peer benchmarks, and operational feasability studies. For example, a leading global beauty brand tracks 40 top ESG KPIs across its business, with different department leads responsible for specific metrics. A smaller company will likely want a narrower focus.

In many ESG areas, there are already established, industry standard KPIs and targets. In environmental sustainability measurement, measuring greenhouse gas emissions (GHG) in Scope 1, 2 & 3 emissions of carbon equivalents (CO₂e) generated is an established, material indicator. Emissions reduction targets can be set using the science-based targets methodology.

On the social side, EHS (Environmental Health and Safety), HR, CSR, and employee demographic data also have established KPIs. Common examples include:

Common ESG governance KPIs and targets should be set around issues and topics like:

Be sure select ESG metrics and targets that are material and relevant. This may require portfolio companies to complete materiality assessment projects to validate and affirm the correct KPIs and focus areas.

Formalize Portfolio ESG Governance

Long-term ESG success and investment requires governance, structure, and accountability. The optimal structure for governing your ESG efforts will depend upon your fund's structure, but ESG needs to have active visibility, accountability, and mindshare within the C-suite at each portfolio company, and within the investment team.

We've seen ESG efforts succeed where ESG is owned at the executive level by the CFO, a Chief Sustainability Officer, a head of ESG, or sometimes another C-suite leader like the Chief Communications Officer. Whoever owns ESG within a portfolio company, it needs to be a core job responsibility, and that leader needs to be senior enough to marshall resources, promote the necessary internal collaboration, provide oversight, and move critical initiatives forward.

Establish ESG Data Systems and Processes

Credible ESG programs and reporting are based on reportable, repeatable, auditable, and high-quality data. Start by creating a data inventory that includes:

Most companies and private equity investors don't focus enough on ESG data quality and collection. Think about what's most needed across your portfolio, how ESG efforts will be resourced, and who needs to collaborate with who. Interns can do research and important legwork, but make sure there's also accountability and engagement on the senior team.

Brightest automates ESG data collection from different departments, sources, and systems, including integrations, spreadsheets, and surveys

ESG reporting can be a complex process, particularly for larger enterprise businesses or across a multi-company private equity portfolio. For a lot of the same reasons why it's better to use dedicated accounting software like Quickbooks or Oracle Netsuite to produce corporate financial reports like a 10-K, manual and spreadsheet-based ESG reporting and data management is error-prone, inefficient, and has major visibility, collaboration, accuracy, and governance issues. It also just takes a lot more time.

Given that ESG disclosure requirements are being written into everything from SEC regulation to procurement contracts in 2022, this is information that needs to be accurate, consistent, structured, and easy to access - and shouldn't tie up all your time to collect and communicate.

Moreover, ESG reporting is a recurring annual obligation. It's much more efficient to use a system that's purpose-built for auditing, archiving, historical comparison, and benchmarking. Getting the right tools and systems in place early is immensely helpful for tracking performance, comparing past reports, or implementing data best practices.

Track ESG Progress, Revise Targets, and Take Action on Key Learnings, Risks, and Opportunities

Each company and private equity firm is unique, and ESG reporting and implementation will be an ongoing learning and capability-building process. While there's no one-size-fits-all approach to ESG reporting, approaching it as a long-term, continuous improvement practice is immensely beneficial. Above all, ESG is certainly not a short-term trend. Issues like climate change, public health, social well-being, and diversity will remain top-of-mind for regulators, consumers, investors, LPs, and business decision-makers for years.

While ESG reporting may feel like a burden or obligation, dozens of data and examples show strong, thoughtful, and strategic ESG performance is a competitive business and investment advantage that delivers positive ROI. Many companies start ESG work due to compliance and investor pressures, only to find that as their ESG investments, maturity, and capabilities evolve, the company realizes significant cross-company benefits and efficiencies.

Every ESG roadmap is different - and ESG truly is a long-term, strategic journey for GPs, boards, and management teams. Nonetheless, the benefits of strong ESG performance on brand reputation, employee talent, culture, operational efficiency, risk management, and access to capital are not only numerous - many are quantifiable.

Brightest offers unified a ESG reporting software platform for companies and private equity firms

Above all, we wish you all the best as you continue ahead with your ESG roadmap. If we can be helpful at all (at any step in your ESG journey), please get in touch. A central part of our mission and work here at Brightest is enabling better data-driven decision-making (and actions) to help firms achieve their full ESG potential.