ESG in Private Markets – it’s time to act

Mark Thomas, Alex Shelley

As with the wider Asset Management industry, Private Markets are experiencing a growing focus on Environmental, Social and Governance (ESG) during 2020. With the planned changes to Sustainable Finance Disclosure Regulation (SFDR) requirements coming into force next year, many managers are struggling to keep on track with their preparations given the competing demands of the current market.

However, Alpha believes it would be a missed opportunity for firms to treat ESG as simply a cost or compliance issue. For Private Markets firms, embedding ESG risk factors into the decision-making and reporting processes can provide real competitive advantages at a time when investor expectations in this area are only rising. As this article will explain, Private Markets industries also have their own intricacies which need to be managed in relation to ESG.

Key drivers

1. Increasing Regulatory Focus

The upcoming SFDR requirements are consistent with a wider regulatory agenda to promote ESG reporting across the industry. From March 2021, impacted Alternative Investment Firms (AIFs) will be required to:

  • Publish information on any policies on the integration of sustainability risks in investment decision-making processes
  • Disclose how sustainability risks are integrated into their investment decisions
  • Disclose the likely impact of sustainability risks on financial returns of the fund

The SFDR also requires product (AIF)-level disclosures for products promoting environmental and/or social characteristics, and for products with sustainable investment as an objective.

2. Investor Demands

In addition to regulatory initiatives, demand from customers for ESG factors is also ramping up. 2020 saw many ESG-conscious Asset Owners focusing on public markets to provide liquidity buffers and support cash needs. As the environment re-stabilises, we expect these investors to turn their attention to Private Markets. Doing nothing in relation to ESG is not an option from a commercial perspective, and firms who cannot articulate clearly how they are embedding ESG factors will likely lose credibility and fall behind competitors.

3. Performance Advantages

There is an increasing recognition in the investment community that considering material ESG factors can result in a richer understanding of investments and their exposure opportunities and risks. This in turn can lead to better investment and risk management decisions, which are particularly relevant for those Private Market investments which have a longer-term commitment.


Core challenges

1. The Data Challenge

One thing which unites all private asset managers is that the quality and availability of ESG data remains a major challenge. However, unlike managers of public assets, many Private Markets managers will already be familiar with obtaining financial data from portfolio companies. The question then becomes, what other data is missing and needed? An effective and low impact data collection process will be an essential source for all downstream reporting – firms urgently need to think about what data they need to collect how they are going to go out and get it.

2. Asset Class Nuances

Private Markets firms will experience different pain points depending on the asset classes they are responsible for. As an example, Real Estate Managers should collect and present data on their buildings (including energy efficiency information), whereas Private Equity firms may face pressure to demonstrate that their portfolio companies are suitably diverse through metrics such as board composition. Where managers run multiple private asset classes, a clear and consistent approach across asset types is needed to reduce investor confusion.

3. Bespoke Reporting

The production of bespoke client reporting, which demonstrates how funds are meeting investors’ objectives, can be a significant manual overhead with results that can confuse investors. The data that firms provide should be able to identify both positive and negative externalities of the fund on the environment and society and demonstrate how they are taking active ownership of assets under their management. As importantly, client reporting needs to be clear, visual, meaningful, and tailored to specific client needs.

4. Knowledge & Processes

Finally, for any responsible investing initiatives to be successful, fund managers must have the skills and tools to be able to make effective investment decisions. This will require robust investment processes which take ESG risks into consideration and may also require a cultural transformation as well as training on specific aspects of ESG.

Alpha’s view on ESG and Private Markets

Alpha believes that the primary objective of embedding ESG best practice should be improving decision-making while creating the greatest value over the long term. This can be accomplished through:

  • Establishing new research opportunities relating to ESG factors
  • Collecting data to allow for effective monitoring of portfolio companies against ESG objectives
  • Balancing ESG risks against traditional factors during decision-making processes

Alpha has recently launched a dedicated ESG & Responsible Investment Practice and has helped a large number of asset managers to improve their processes, select appropriate vendors, and ensure that they have the right ESG strategy for their business. Failing to act early in this space will create significant challenges over the next year due to the drivers listed above – if you are concerned about your ESG readiness and would like to speak to one of our experts, please get in touch.

About the Authors

Mark Thomas
Senior Manager

Mark is a Senior Manager at Alpha leading work across Alpha’s Alternatives client base. He has extensive experience working with clients within Private Assets, helping them solve business-critical challenges. He also helped to establish Alpha’s ESG practice and is passionate about sustainable investing across the industry.

Alex Shelley

Alex is a Consultant at Alpha with over six years of financial services experience. He is part of Alpha’s Alternative practice focusing on thought leadership, and has worked on dedicated ESG regulatory impact assessment projects during his time at the firm with a background in compliance more broadly.