By Jessie Miller
Senior Manager of ESG Services, Novata
As ESG matures in private markets, private equity is well-positioned to lead the charge on progress. A recent Novata and Oliver Wyman study underscored the strategic advantage private equity firms have to tap into the value creation opportunities of ESG by considering these environmental, social, and governance factors across the investment lifecycle. The report revealed four archetypes representing the various states of ESG maturity across European PE funds, ranging from basic to best practice.
According to the study, the majority of firms surveyed fall somewhere in the middle, having moved beyond basic compliance but still on the path to unlocking improved risk management and value creation. To truly wield ESG as a competitive advantage, firms will need to adopt ESG best practices ahead of their peers and adapt to changing expectations. Improving ESG integration strategies, establishing clear governance structures, and, importantly, engaging portfolio companies to advance ESG practices are critical to this progress.
Private equity firms can find value in integrating ESG at various stages of the investment lifecycle, from pre-investment screenings and due diligence to ownership and exit. However, the ownership phase provides the greatest opportunity for ESG integration, given the high level of engagement between a GP and its portfolio companies and the typical value creation-driven private equity model.
Effective portfolio engagement supports greater overall alignment between a firm and its portfolio companies on ESG priorities. Proactively engaging with portfolio companies can lead to better risk monitoring, enable GPs to set more accurate targets, and ultimately improve outcomes of ESG initiatives. Developing an effective strategy requires GPs to consider several factors to create an approach that feels authentic to how they manage investments and resonates with portfolio companies. The best way to do this is to incorporate ESG into the firm’s existing engagement strategy and how it deals with traditionally non-ESG factors – whether that means board oversight, performance improvement plans, or annual monitoring. If a firm does not have an existing engagement strategy for non-ESG matters, this is the perfect opportunity to rethink how it engages portfolio companies.
Data and data-driven insights should also play a critical role in informing goals and prioritising actions that enhance value. Respondents to the Novata/Oliver Wyman study identified the resource-intensive nature of managing ESG metrics across diverse portfolios as a hurdle to using ESG as a competitive advantage. Having a well-defined strategy makes it easier to address this challenge by setting expectations for portfolio companies around data requests and their relevance to the firm and the company. It is essential for portfolio companies to understand why they are being asked to provide this data, how it will be used, and how the metrics were selected. Many GPs on Novata’s platform opt to collect metrics that are material to the portfolio company in order to increase relevance and usability of the data. Novata’s Services team also works with GPs to conduct materiality assessments of their portfolios to identify material topics and inform metric selection.
The recent rise in ESG regulation and industry demand for data point to the fact that ESG is here to stay. Working with portfolio companies to collect relevant data and manage progress can be a strategic advantage for firms as they build stronger portfolios in the long term. By continuously engaging on material topics, both sides are better positioned to identify and implement value creation initiatives that benefit all stakeholders.
Jessie Miller, Senior Manager of ESG Services, Novata – Jessie helps clients develop and improve their ESG strategy while aligning to leading international standards, frameworks, and regulations. She specialises in creating ESG processes, uncovering data-driven insights, and developing action plans while considering how ESG can serve as a lever for value creation and risk mitigation. Jessie collaborates with cross-functional teams to optimise customer experience and develop new offerings.