Private Conversations Offer Little Protection

Private equity is on the march on both sides of the Atlantic. What does it mean for ESG transparency?

UK-based supermarket group Morrisons could be a test case for how committed the private equity (PE) sector is to ESG as we head towards 2030 interim climate targets.

The grocer has agreed a £7 billion takeover offer from US private equity firm Clayton, Dubilier & Rice with another investor – US investment group Fortress – waiting in the wings to make a potentially higher bid. Morrisons has made a big play of its ESG credentials over recent times reporting on its carbon footprint since 2007. In its most recent annual report, it devotes seven pages to Environment & Supporting Communities with a full rundown of its carbon emissions as well as how it is tackling deforestation, food poverty and corporate governance.

As a FTSE listed company it is required to disclose ESG facts, figures, achievements, and commitments. From 1 January 2021, UK premium listed companies have had to include a statement in their annual financial report setting out whether their disclosures are consistent with the recommendations of the Task Force on Climate-Related Disclosures.

But in the private sector there is currently far less transparency. “A trend towards the privatisation of high-carbon assets, such as BP’s sale of its Alaska Oil and Gas business to Hilcorp Energy, risks diminishing transparency and performance on ESG issues since private companies do not have to comply with the reporting requirements of a listed entity,” states non-profit global environmental disclosure platform CDP.

It adds that PE net asset value has grown three times as fast as public markets since the turn of the century, doubling eight times compared to 2.8. This year has been particularly strong for PE with figures from KPMG showing that in the UK in the first half of this year there were 785 deals worth £73.7billion, up 61% on the same period last year. It marks the highest level in five years.

In the US, according to PwC, the first five months in 2021 saw PE deal volume increase 21.9% compared with the same period last year, resulting in 2,346 deals. It says private equity firms are benefiting from “significant market tailwinds triggered by historically low interest rates as well as record fundraising, which is at an all-time high with US PE dry powder at US$150.1 billion”.

“We’ve seen a spate of deals across industries in the last few months,” says Claire Elsdon, Joint Global Director of Capital Markets at CDP. “At the time, there is always a great deal of public commitment and assurances given but in reality, the track record of the PE industry is one where returns have prioritised over other things.”

Futureproofing with ESG

However, there is plenty of evidence that PE investors are increasingly aware of ESG concerns and are beginning to be more committed to and open about reporting them. Developments suggest ESG is now less a ‘nice to have’, with a growing understanding among PE firms that they are managing risk and getting future-proofed by tackling ESG.

Examples include Blackstone which in May launched new quarterly ESG reporting guidelines for its portfolio companies and Muzinich which is set to produce TCFD-aligned reporting from 2022. Private market investors including M&G, Neuberger Berman and Nuveen are also, for the first time, requesting standardised environmental disclosure from over 1,000 privately held companies through a new venture through the CDP.

The month-long Private Markets Pilot’s objective is to increase disclosure from private companies of all sizes, including the mid-markets and SMEs, and those with high-impact business activity that have historically avoided scrutiny on environmental issues and pressure to decarbonise.

CDP’s standardised disclosure platform will allow investors to benchmark private companies and compare like-for-like on environmental/emissions performance, ideally covering Scope 1, 2 and 3 emissions. To meet anticipated gaps in reporting, because some firms will never have tried to collect such data before, CDP will augment it with emissions estimates such as electricity usage, allowing private market investors to calculate financed emissions so that they can set and report against their own net-zero commitments.

“There was a belief previously that with an average holding period of four and a half years what sort of environmental change can you really evidence in a PE portfolio company? Was the priority there when it came to balancing climate need with investor return?” says Elsdon.

“But the landscape has changed and now there is a greater need for transparency. It could be beneficial for PE and private firms in that it could make them distinctive in a crowded marketplace. Private equity investors, particularly those with control stakes, can significantly influence the sustainability strategy and governance policies of investee companies. This pilot will hopefully help them to start building their reporting capacity.”

Data barriers

Jennifer Signori, a New York-based Managing Director at Neuberger Berman, agrees that PE firms recognise the importance of ESG disclosures, but may not know where to start or how to implement.

“Field-building activities such as the CDP private equity pilot are helpful in this regard,” she says. “We provided feedback and guidance on the proposed data collection survey. We also connected a few of our general partners (GPs) and their portfolio companies to participate in the pilot. The bar is rising across the board for both public and private companies. We believe providing the industry with roadmaps and tools is a productive approach.”

She says however that one of the key barriers is the availability of granular ESG data, which is often presented in different forms, and being able to translate the information into insights that can be comparable and aggregated.

Elsdon adds that the pilot is essential to avoiding “emissions leakage” as public companies sell carbon-intensive assets to private companies in a bid to avoid scrutiny and transparency. “It doesn’t mean that the emissions have been wiped off the face of the earth,” she says. “It is a significant concern.”

Signori says the issue is complex. “Rather than categorising between public to private firms, I would segment companies along a value chain. There could be some scenarios in which larger companies focus on their Scope 1 and Scope 2 emissions, and the carbon-intensive activities reside down the value chain at suppliers which are likely smaller companies that are also more likely to be private,” she states. “There is also the potential for the same to apply to geography, between developed and emerging markets.”

Coming to the rescue?

Signori argues that PE can be part of the solution rather than be blamed for the problems.

“We generally believe PE firms are uniquely positioned to improve ESG disclosures and standards through their control ownership, especially as part of value creation plans. It is in the company and the investors’ best interest to uphold and improve upon ESG standards,” she says. “We are focused on long-term partnerships and engage with private equity firms to promote ESG integration best practices, including ESG integrated ownership and reporting. Investor engagement can go a long way to signal the importance of ESG considerations.”

Gillian Karran-Cumberlege, founding partner at executive search firm Fidelio Partners, also sees more PE involvement in ESG as being beneficial for all industries. “PEs are very financially driven with some very fine numerical minds in there. They are good at monitoring and measuring and capturing data. There will be KPIs that will be followed through with financial rigour. It is interesting to see what this will drive,” she says. “Maybe we will find the Holy Grail link between good governance and valuation.”

Further, she argues that PE is learning to appreciate corporate governance. “We have seen a number of PE and their portfolio companies beginning to look at ESG very seriously largely driven by their ultimate investors laying a lot more value on it. In the past they would have [only] focused on this heading to IPO or exit. Now much greater attention is being given to thinking through the link between governance and valuation,” she says.

Increasingly, PE houses are evaluating and actively developing the effectiveness and composition of their portfolio companies’ boards, increasing external perspective and by making them more diverse. “They are doing this even without the requirements you have with listed firms. There is more reporting being done to their own investors, but it is not standardised,” says Karran-Cumberlege.

Mandatory disclosures

Tom Powdrill, Head of Stewardship at PIRC, a UK-based independent shareholder advisory consultancy, says it is inevitable that private companies will have to make mandatory ESG disclosures. “The expectations on ESG reporting in the public market are going to follow the capital as it goes private,” he says. “It is only going in one direction.”

Even today, Neuberger Berman’s Signori doesn’t see such a large a gap between public and private disclosures. “The UK Government has consulted on requiring TCFD aligned climate reporting for large private companies, and the Financial Reporting Council (FRC) is applying corporate governance principles to large private companies – hence the public/private divide is not so clear cut anymore,” she says.

If and when Morrisons does go private, we will be able to see whether that confidence holds true. We’ll be able to judge for ourselves when we put those sustainably packed baked beans – or not – into our baskets.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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