Defining ESG metrics that matter for private equity portfolio companies

While the impact on private company boards, management, operations, and disclosure varies—and largely dependent on ownership—a shift is apparent in how institutional investors are directing capital and increasing expectations for private company reporting on ESG.

The confluence of trends that has elevated support for environmental and social proxy proposals by public company investors is also present in the actions and expectations of private company investors.

While the impact on private company boards, management, operations, and disclosure varies—and is largely dependent on ownership—a shift is apparent in how institutional investors are directing capital and increasing expectations for private company reporting. Yet moving from analysis to action on environmental, social, and governance (ESG) matters can require significant and sustained effort.

Private equity firms are building ESG policies that help to drive investments across their portfolios. At the same time, impact investing is now a fast-growing subset of private equity that has attracted over $502 billion globally from foundations, endowments, family offices, and sovereign wealth funds looking to be even more explicit with the social or environmental outcomes tied to their capital.

“Investors want to understand how funds are incorporating lessons learned and iterating their approach,” said Tania Carnegie, founder and leader of the Impact Ventures practice at KPMG, who recently published Enlightened capital: The role of trust in impact investing.

For private companies controlled by investors with established or burgeoning ESG oversight and disclosure regimes, the portfolio company board has a critical role to play. A measured process for evaluation and oversight of ESG factors can add real strategic value to the business beyond meeting disclosure and reporting expectations of the general partner or limited partners.

Recent work by the KPMG Board Leadership Center (BLC) can help private equity portfolio companies, their boards, and owners to establish a framework for linking ESG to strategy. As the BLC found in interviews with directors and officers of major corporations, even conscientious CEOs and boards are challenged by expectations of investors to integrate ESG considerations into the strategic plan.

Insights from The ESG journey: Lessons from the boardroom and C-suite offer private company executives and directors anecdotes and a framework for addressing ESG issues as a strategic imperative for long-term performance, including:

Level setting: How issues are framed impacts our understanding of why they matter and how we address them. By agreeing on a definition of ESG and its importance, management and boards, in conjunction with investors, can set the stage for progress. And by framing the discussion in business terms—risk, opportunity, efficiency, and financial performance—they can help short-circuit preconceptions, politics, and personal views.

Assessment: A roadmap is essential to a productive strategy. After identifying ESG risks and opportunities material to their business, companies will want to focus on the two or three that are most strategically significant. At companies competing on the basis of differentiation and strong brands, for example, boards may find their time best spent monitoring issues that impact brand value. At companies competing on price, boards may wish to focus on factors that impact cost structure. Both the Global Reporting Initiative and the Sustainability Accounting Standards Board offer frameworks for evaluating material issues and related disclosures.

Integration: Too often, ESG initiatives remain peripheral to core corporate activities and so do not contribute directly to a company’s competitive advantage. By integrating ESG programs into business strategy and the incentive programs driving it, companies can bring the same focus and discipline to them as they do other strategic initiatives. Integration efforts should include two broad areas—employee selection and behavior, and organizational processes and routines.

Stakeholder communications: Shaping the company’s key ESG messages in the context of strategy and long-term value creation can reinforce the connection between ESG and corporate performance. Although no single framework has emerged for reporting ESG information, boards and owners should understand how management decides what to disclose and how the accuracy of that information is verified—and ensure that progress updates, results, linkage to strategy, and an explanation of how ESG initiatives benefit the company and its stakeholders become part of the company’s communications.

Board oversight: Make sure there’s a “home” for ESG oversight within the board’s structure and that disclosures line up with the expectations of the general partner and limited partners. Effective oversight hinges on having the right people in the boardroom, supported with quality information.

The need to ensure that evaluations and actions related to ESG activities are linked to strategy and portfolio company performance is not lost on limited partners.

“Our members invest in private equity because it delivers strong returns. Limited partners are integrating ESG considerations into their investment strategies with the expectation that they will positively impact results, by minimizing downside or enhancing upside,” said Jennifer Choi, managing director of industry affairs at the Institutional Limited Partners Associations (ILPA) in Washington, D.C. “If there were a perception that a trade-off was taking place at a portfolio company, LPs would question the value.”

ILPA has published a template for fund-level reporting of portfolio company metrics, including ESG. The ILPA Portfolio Company Metrics Template includes the existence of an ESG policy, board-level oversight, and available resources, as well as an ESG-reporting taxonomy with itemized material ESG factors, related targets, and key performance indicators.

“The general partners getting out ahead on these disclosures understand that it’s not only good for their brand, but it’s also good for business,” said Choi.

The American Investment Council, which represents many of the largest private equity managers in the U.S., has also issued guidelines for responsible investing, developed in conjunction with the Principles for Responsible Investment. The principles are straightforward, but reinforce that portfolio companies are expected “to advance [the principles] in a way that is consistent with their fiduciary duties.”1

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Defining ESG metrics that matter
Insights from The ESG journey: Lessons from the boardroom and C-suite offer private company executives and directors anecdotes and a framework for addressing ESG issues as a strategic imperative for long-term performance

American Investment Council Web site.