Dealmaking momentum is expected to continue in the new year after a banner 2021 for private equity. In our outlook for 2022, we see several themes that are expected to play a significant role in PE investments: workforce management, infrastructure, ESG, home healthcare, business travel and new technologies, like cryptocurrency. We also predict that supply chain disruptions will continue to provide PE with opportunities. See below for a sector deep-dive on ESG.
Limited partners are pushing ESG to the forefront of investment decisions, and the measure of their commitment is one familiar to private equity: deals. As transaction multiples surge and portfolio exits abound, nearly three-quarters of institutional investors profess an increased willingness to divest companies that aren’t delivering on ESG goals, according to EY’s latest Global Institutional Investor Survey.
Mergers & Acquisitions recognized firms that are leading the way in our inaugural 2021 PE Innovators in ESG in our November/December issue, but even trailblazers are grappling with ways to measure the deluge of requests from LPs for uniform data. Into the gap between extant data sets and investor expectations, the United Nations’ Principles for Responsible Investing is moving to find a common denominator.
If you run a large, listed company, the Sustainable Accounting Standards Board likely provides an adequate slide rule to measure your firm’s ESG progress. Need a technical protocol to compile data? Activity metrics to notch compliance? The rubric has you covered.
Not so for smaller companies.
“The bulk of the companies that PE invest in are in the middle market,” says UNPRI private equity investment practices specialist Peter Dunbar. “Most of these companies just don’t have that data; it’s not an issue of tech.”
“It’s not just they don’t have expertise, but also the resources,” UNPRI head of fixed income Carmen Nuzzo says in dialogue with Dunbar. “Sometimes they might have the data, but haven’t thought it’s important as it’s beginning to be now. It’s a combination of all these things.”
That means a comprehensive contribution to the race for an authoritative ESG data framework must simplify the data reporting process for companies and GPs.
Currently circulating frameworks can provide starting points—what key performance indicators are already being asked for? Which of these are the most practical for smaller scale companies to supply?
Just as importantly, the industry needs a standard that translates across both private equity and credit. Tying ESG goals to financing is a critical component of credit funds’ strategies, and that means lender standards need to be aligned with those of equity investors.
“They are working in silos,” Nuzzo says. “Whereas it’s really important that, even if they tap into different strands of the capital structure as far as ESG is concerned, that they work together. So creating space for those synergies to emerge is quite important.”
Enter UNPRI’s due diligence template. On the heels of the Institutional Limited Partner Association’s move to enshrine ESG-focused due diligence into its ‘Advanced’ designation for private equity investors, the United Nations’ Principles for Responsible Investing is doing the same.
The organization engaged 35 private investors in October to pilot test its new private equity/private debt template. Preliminary feedback has already been positive. The team fields inbound requests for the template on a near-daily basis, says Nuzzo. Pending official feedback in March 2022, UNPRI plans to roll out the template for the rest of the market.
“By creating this alignment, we can make the life of target companies easier,” Nuzzo explains. Firms can “report once and make it easier. Each reporting framework makes its approach from a different angle, so for the companies this is becoming a real burden.”
So far, pilot firms are seeing that requested inputs can be easily obtained, and many times already constitute elements of their internal data collection, Nuzzo says.
“The advantage of the template is that it will be a public good and it will be a living document,” Dunbar explains.
Flexible revision might be key to the template’s own measure of success—enduring adoption by the industry. That measurement is otherwise difficult to track. Since the template asks investors for criteria common to other frameworks, there are no signifying questions that, if widely adopted by ESG credit and equity investors, would prove the template’s influence.
Its impact might instead be felt by inbound requests, and hopefully, a lighter reporting load for investors and their portfolio companies. That in turn could realize limited partners’ goals of standardizing environmental and social goals into the industry once and for all.
For more in Mergers & Acquisitions’ M&A Outlook 2022 series read:
- Managing the Workforce in an Era of Hybrid Work
- Infrastructure Will Get an Infusion
- Healthcare Heads Home
- B2B Travel Forecast: Cloudy with a Chance for Upside
- Crypto Braces for Dealmaking Frenzy