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How ESG is redefining private equity

Increasingly, private companies who wish to manage risk and improve business performance, are incorporating ESG practices into their business models — irrespective of where they are in their life cycle. Xiaying Zhang, director, private investments, APAC client group and Hillary Flynn, director ESG private investments at Wellington Management present an overview of important steps in this journey for PE firms.
How ESG is redefining private equity
The past decade has seen surging interest in environmental, social and governance (ESG) practices from both asset managers and asset owners. This has been the case especially when considering investments in public companies, which are required to disclose potential ESG risks to investors and regulators.

Private companies, however, are typically not subject to such scrutiny, causing many to overlook or underreport these issues. A recent survey found that only 39% of private company boards assess both ESG risks and opportunities.[i] Instead, these businesses are often more focused on product development, gaining market share and talent acquisition. But ESG risks are becoming increasingly important for private companies, especially those approaching an initial public offering (IPO).

A further consideration is that prior to  a listing, private companies must prepare to meet stringent financial and ESG disclosures requirements from regulators and the general public alike. For some, this is an enormous step up, and one that shouldn’t be taken lightly. In the US, for instance, proposed new rules could see all public companies having to report material climate risks, greenhouse gas emissions and net-zero targets or transition plans.[ii] Should these rules materialise, it will be a significant undertaking for any new public company.

Potential for improved business performance

However, the case for measuring and disclosing ESG risks goes beyond preparing for an IPO. When managed appropriately, material issues ranging from energy and water consumption to talent management may enhance financial performance and generate long-term intrinsic value.

Companies that successfully incorporate ESG practices into their business models can potentially establish stronger brands and wider competitive moats. Studies show that in the US, almost two-thirds of consumers are willing to pay more for sustainable products.[iii] A company’s ESG profile can also affect its culture and employee productivity and help it attract and retain talent.

ESG practices may entice a wider pool of investors as well. With interest in ESG rapidly proliferating among the investment community, ESG assets under management — estimated at $35 trillion today — is expected to grow exponentially in the coming years, eventually exceeding one-third of total global assets by 2026.[iv]

Four emerging priorities within ESG

Looking to 2023, human capital management, governance, cybersecurity, and supply-chain resiliency are four critical ESG factors across private markets.

With regulators like the US’s Securities and Exchange Commission increasing their focus on human capital management practices, public companies are having to disclose information on employee turnover, staff well-being, fair pay, and diversity, equity and inclusion (DEI) metrics. This expectation is spilling into the privates space, aiming to help companies better position their boards, management teams and broader workforces for enhanced performance. 

Private companies also are facing increased scrutiny over governance issues, like oversight, independent and diverse boards and succession planning — key areas of potential added value. Companies approaching an IPO can benefit from familiarising themselves with the proxy voting guidelines of asset managers, which provide a sense of evolving shareholder expectations on key governance issues like dual-class shares, classified boards and supermajority voting requirements.

Likewise, with cybersecurity breaches, inadvertently unethical AI uses, and data privacy and transparency issues all on the rise, private companies are having to adapt to acute cyber risks.

Finally, lingering COVID-19 disruptions, commitments to reduce supplier carbon emissions, and evolving modern slavery and ethical labor regulations are forcing firms to rethink their supply chains as well.

Addressing climate risk

But perhaps today’s most well-known ESG challenge for all companies is climate change. Globally, climate regulation is accelerating; the Task Force on Climate-related Financial Disclosures and others are becoming more standardised; and investor focus is intensifying. While the developments to date are aimed predominately at listed entities, many also require private companies within public company value chains to provide emissions data for reporting purposes.

We believe both public and private companies should disclose location data on physical risks that affect offices, factories and other facilities. In our view, they should provide information on transition risks and mitigation strategies, as well as data on emissions, energy consumption and water usage, among others.

At Wellington Management, we’re partnering with the Woodwell Climate Research Centre[v] and Massachusetts Institute of Technology (MIT) Joint Program on the Science and Policy of Global Change [vi] to better integrate investment management with climate science. Future physical risks resulting from climate change is a special focus area. This convergence is particularly relevant for private firms approaching a public offering, as they seek to better ascertain, understand and disclose a variety of current and future climate risks, including operational, regulatory, reputational and credit concerns.

Notably, though climate risk and disclosure expectations are relevant for every company many private firms are also significantly contributing to climate resiliency with innovations in areas like energy transition, industry efficiency, smart transportation, and food and agri-tech.

Our role

The adoption of ESG best practices is steadily redefining the private equity landscape. At Wellington Management, we encourage all of our private portfolio companies to incorporate thoughtful approaches to ESG risks like climate change into their business models. To assist in this effort, we offer our portfolio companies a range of ESG resources including the ability to benchmark their performance versus peers. By leveraging our ESG experience across public and private markets, we aim to help our portfolio companies unearth and address their potential material ESG risks to allow them to focus on their core businesses.

To learn more about how ESG is redefining private equity, please read related insights


The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

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