SPONSORED BY Preqin
There has been a buzz around environmental, social and governance (ESG) in private markets for the last few years. This grew to fever pitch after KKR announced in February that it had raised a spectacular $1.3 billion with its KKR Global Impact Fund. As demand for more sustainably invested assets grows rapidly, so does the need for better ESG-related data in the sector.
ESG propositions will help managers attract inflows and improve their brand value and customer engagement, providing they stand out. Public market players who focused on sustainability and differentiated themselves early had better ESG data processes, a stronger story to tell and captured greater market share. As private markets are ten years behind public markets in developing ESG, early movers can expect the same advantage in private markets.
ESG-related risks can have even greater impacts in private markets because most assets are illiquid. Investors generally hold them to maturity, so cannot sell out of them to avoid risks, as they can with equities. For example, if you made a ten-year private investment into a factory in an area exposed to flooding, this locks you in to climate-related risk for a decade.
Public market players who focused on sustainability and differentiated themselves early had better ESG data processes, a stronger story to tell and captured greater market share. Early movers will now get the same advantage in private markets
Meanwhile, private market investments in carbon-emitting coal and oil companies have seen steep price discounts in the last three years as people realise they are likely to deliver lower returns over a ten- or twenty-year period. Such factors are leading investors and regulators to demand more disclosure of ESG data from private market firms and managers. The increased general use of disclosure frameworks, such as from the Task Force on Climate-Related Financial Disclosures (TCFD), will only intensify this pressure. Private market players will have no choice but to disclose more.
But they are responding and coming together to ask what the data should look like, especially given the lack of a dedicated framework for ESG disclosure in private markets.
Barriers to ESG adoption
Investors are thinking about what ESG data they need to drive portfolio choices, such as sector allocations or selecting new managers, and how quickly it will allow them to act.
Institutional investors, in particular, are deepening their understanding of ESG and asking more savvy, detailed and robust questions. To differentiate, you must answer these questions effectively. For example, you must be able to talk about your ESG goals and processes, and what data you are using and can disclose.
Low levels of data disclosure are a symptom of the market’s private and idiosyncratic nature, but are the biggest barrier to ESG adoption. Investors, for their part, should not let the lack of perfect, fully comparable data lead to inertia. You need less data than you might think to make good decisions, providing you ask the right qualitative questions alongside it.
Another roadblock to further ESG adoption in private markets is continuing questions about the veracity and usefulness of data, and about greenwashing, which means presenting your investment as more ethical than it is. Bob Vickers, head of sustainability solutions at Preqin, says: “We’re just now at the tip of the iceberg with data provisioning in private markets, and we expect continued evolution over the coming years. Preqin is committed to getting the maximum amount of useful data possible from managers and we are unique in our ability to leverage our relationships in private markets and access data.
“As an investor, you want data to be as objective, high quality, consistent and useful as possible. You also want it updated as frequently as possible. Preqin is committed to achieving all those things.”
Vickers also warns the problems associated with ESG adoption are small in comparison to the damage that could come from not adopting ESG criteria, for example, around climate risk.
ESG framework fatigue
One challenge to better data provision is the plethora of ESG frameworks available, such as those from the Sustainability Accounting Standards Board (SASB) and the TCFD. Parts of these frameworks are often not relevant or suited to private markets. This leads to framework fatigue, when investors become so tired of choosing and comparing frameworks, they end up using none.
“We tackle this fatigue by using the most codified frameworks only, not creating new ones,” says Vickers. “By marrying what managers disclose with what we know about who invests where, we can address these problems and create insight and
Preqin’s ESG Solutions provides visibility of environmental, social and governance factors at scale across limited partners, general partners and ESG funds. The range includes transparency and risk attribution modules that map data against the SASB materiality risk matrix and give insights into potential ESG risks. In building ESG Solutions, Preqin looked at 300 data points from a range of frameworks. It filtered them in relation to private markets and found only 15 per cent were applicable and useful. Preqin then transmuted these targeted data points into a private market setting to maximise usefulness. “This solution gives users one view of risk,” says Vickers. “We have found it gives them a palpable sense of relief that they don’t have to create something; we’ve done it for them. Now they can build their processes around those metrics.
“Developing these solutions involved an incredible amount of attention to investors’ needs. We are seeing the fruits of this rigour in client feedback that it’s an excellent, usable starting point. It is a crucial opening baseline as we begin the ESG movement in private markets.
“But it will evolve. We view the challenge of procuring data as an engagement opportunity and a chance to ask why the data doesn’t yet exist. Everyone we’ve spoken to recognises that providing more robust ESG data is inescapable. Some investors and fund managers are advancing in this area, but the vast majority don’t know where to start. They tell us they want to use more ESG data, but have been waiting for someone to help them do it.”
For more information please visit preqin.com/esg-solutions