Market dynamics reflect a large shift of institutional money towards ESG-focused funds, firms and companies. According to data from Barclays, investment in sustainable assets has grown from $100 million in 2014 to more than $100 billion today. Meanwhile, investment firms and their portfolio companies are increasingly creating new roles, such as "Chief Sustainability Officer," to support ESG within the organization.

As the focus on ESG intensifies, the evaluation and measurement of ESG has matured. There is a heavy focus on returns, and the requirements for data are getting more intensive as firms seek the ability to analyze ESG in a more nuanced way and drive more concrete insights into their portfolios.

ESG data sets are helping firms to gather insight into ESG at their portfolio companies and thereby supporting them to make data-driven environmental, social and corporate governance decisions. However, the need to collect and report on significantly wider and deeper data points is creating new challenges for firms.

More data, more complex analytics and greater analysis required at the portfolio-company level is creating new challenges for both investors and fund managers. It is however also bringing private equity closer to exciting new capabilities and providing more transparency to a historically opaque asset class.

Structuring ESG inputs

ESG metrics, like any other data set, need structure in order to be usable and return meaningful metrics and actionable insights. Firms that plan to prioritize ESG need to strengthen management and analytic capabilities if they want to generate value out of the metrics they collect.

Technology is helping firms bring more structure to the collection, utilization and visualization of ESG data by providing an inbuilt ESG baseline or framework that can be used as a starting point. While every firm will ultimately want to track and measure ESG in its own way, access to an inbuilt foundation to guide these activities gives technology-enabled firms a head-start over those that start the process from scratch.

Automating ESG data collection

The collection of ESG data is laborious and many firms are asking whether the process can be automated. For the time being, at least, the answer is, unfortunately, no. The vast variance in the way firms and investors choose to quantify ESG metrics make it a difficult data set to manage with automation.

The combination of portfolio monitoring technology, supported by managed services for data collection, can, however, help to ease the pressure. Our platforms can also streamline the data collection process using reporting templates designed by our industry experts that make it easier for portfolio companies to submit data to their general partner. And finally, we are enabling our clients to automate their analyses and measure a company's ESG impact against its peers.

Regulatory vs. bespoke ESG models

ESG criteria are still highly interpretive and it's tempting to rely on regulations, such as those imposed by the Securities Financing Transactions Regulation (SFTR), to provide some guidance around the ESG data points to collect. However, these regulations are seen as a starting point only for most firms.

Overall, firms recognize that they need to go deeper than checking a regulatory box. Many regulations remain narrative-driven, requiring companies to attest to maintaining specific policies—compliance and anti-bribery, for example—without actually providing policy details or quantifying their impact.

Measuring ESG within a regulatory framework produces insular results. For example, demonstrating that a portfolio company reduced carbon emissions by 1,000 metric tons is meaningless until it is contextualized against broader industry trends. The ability to measure against peers and quantify impact is key and technology is playing a role in connecting firms to that broader industry data so that they can tell a compelling story.

Standardization of ESG metrics

While bespoke ESG metrics are desirable for many investors, market participants are also open to the idea of standardized metrics and benchmarks. Standardizing ESG is a massive task that requires a large data set and deep domain knowledge across businesses, but cracking that code could transform the capital markets.

In the meantime, however, firms are looking for technologies that can support a customized approach, with different metrics being collected and reported on, depending on the unique requirements of the portfolio company and investor. The ability to extract data and quantify ESG flexibly and with granularity is a key capability, enabling firms to maximize the value of portfolio companies as they get close to the market. Firms are also increasingly relying on technology to support the automated generation of reporting templates that can be customized to meet an investor's due diligence requirements.

Private market perceptions of ESG

In an audience flash poll conducted during recent panel at SuperTechnology North America, 89% of investors and firms agreed that ESG was a positive development and 11% felt that its impact was neutral. Not a single respondent considered ESG a negative.

Clearly, while the early days of ESG measurement in the private markets present some new challenges, the industry as a whole is enthusiastic about the trend and optimistic about its impact. Overall, private market participants see ESG reporting as a trend that will enable them to manage their money more effectively and gain more visibility into a historically opaque asset class. We couldn't agree more.

Posted 02 March 2021 by Alex Merola, Executive Director of Commercial Strategies, ESG & Private Markets, S&P Global Market Intelligence

S&P Global provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.