ESG is one of the most talked-about three letter acronyms in private equity. Putting its status as the industry’s buzzword aside, ESG due diligence has been born out of risk management and should be considered along with other operational, liquidity or capital risks.

Here, due diligence software provider Dasseti explores the key reasons why ESG should always be front of mind for investors and managers alike.

ESG metrics are routinely requested 

LPs and GPs are taking ESG factors seriously in 2024. ESG metrics are not just something that concerns SFDR Article 8 or 9 funds – almost every GP is now being asked to provide metrics not only around their own operations but for portfolio companies too.

Dasseti has recorded a 10 times increase in the number of ESG-related questionnaires being distributed from its global LP base in the past 18 months. 

There has also been increased demand from LPs for a solution that can see right through the GP, to the funds and entities or portfolio companies beyond. 

What is driving demand for ESG data? 

The factors driving the demand for ESG data vary, with many LPs integrating sustainability into their investment approach to manage both risks and drive value. 

Dasseti’s head of ESG, Billy Cotter, says: “Even as ESG regulations are nascent in some regions, anticipated regulatory pressures feature highly. Many LPs and fund-of-funds want to get ahead of the curve and start collecting baseline data that they can use when the regulatory need arises. This is then passed along to the GPs, who need to collect the data from their portcos.”

How does technology stack up? 

There has been a significant increase in the number of managed and consultancy services in the ESG and sustainability space in the past few years. ESG and sustainability research firm Verdantix forecasts that the ESG consultancy market will reach $48bn (€44bn) worldwide by 2028.  

However, the manual data collection burden involved in providing ESG consultancy services can be significant, often resulting in overinflated price points for less than optimal service levels.  

Technology is at the intersection of private equity and ESG and can be transformational for the whole sector, including ESG managed service and consultancy firms. 

There is a wide range of tools and systems that can enhance the collection, aggregation, management and reporting of ESG data and metrics, often at a manageable cost. When assessing the technology platforms required, firms across the private equity sector should look for the following capabilities:

1. Data collection and aggregation

By automating the collection of ESG metrics, firms can minimise manual entry errors and enhance accuracy. Centralised data platforms often allow the aggregation of data from diverse sources and provide a holistic view of ESG metrics across portfolios.

2. Data quality and standardisation 

In-built data validation tools can improve the accuracy and completeness of ESG data.  

By standardising incoming data to align with increasingly popular industry specific reporting frameworks such as the ESG Data Convergence Initiative or Sustainable Finance Disclosure Regulation, it becomes much easier to benchmark performance and comply with regulatory requirements. 

However, collecting and aggregating first-party data directly from the source means firms are future-proofed if reporting frameworks or regulations change, or if stakeholders start to coalesce around a different pillar of metrics.

Evan Crowley, senior product specialist at Dasseti, says: “We have seen this happen with climate-related disclosures, which are now pretty much standard for the industry, but also more recently have started to see moves to collect more supply chain data. It is important to have the flexibility in a tech solution to be able to respond to those changing requirements quickly and easily.” 

3. Data analysis and reporting

In its 2023 global market size and forecast report, Verdantix projected that financial services firms will significantly increase spend on ESG reporting and data management software, growing at a CAGR of 32% to reach $470m in 2027.

Advanced analytics capabilities provided by some ESG platforms allow for deep insights, identifying trends and assessing the impact of investments. Reporting that meets the specific needs of stakeholders, including regulatory bodies and investors, is in hot demand. 

4. Benchmarking and performance tracking 

For many LPs and fund-of-funds, tracking impact over time is a core driver for collecting and analysing ESG metrics. Software tools that provide benchmarking to compare performance against industry peers or indices, or time series data to allow continuous monitoring of ESG goals, are crucial.

The GP story

Evan Crowley outlines how one GP in the US is using technology to address ESG data collection and reporting challenges. 

“We have been working with a GP that is a leader in sustainable investment within the energy sector. Around 18 months ago, the GP was facing the dual challenges of manual ESG data collection and stringent regulatory demands, and embarked on a journey to transform its ESG reporting and data management processes. 

“We offered a solution that streamlined data collection through customisable questionnaires but also enhanced the user experience for portfolio companies – driving up response rates and subsequently improving the data quality.” 

Takeaway: Since most GPs are starting from different places in their ESG data journey, operate across different sectors and have completely different reporting requirements, flexibility is the number one priority when looking for solutions to support GPs’ ESG data collection and management efforts. 

The PE fund-of-funds story

Billy Cotter discusses the challenges facing a large private equity fund of funds business in Europe.

“This firm’s ESG team was looking for a solution to manage its ESG data collection and reporting challenges. It operates funds that are regulated under the SFDR, with a requirement to report on fund-level indicators, including Mandatory Principal Adverse Impacts (PAIs) and Optional Key Sustainability Indicators (KSIs), deriving data from their portfolio companies and funds.

“They also need to gather sector-specific impact KPIs from companies within their Article 9 funds for internal sustainability reporting. All data must be fed into their internal platform via API in a standardised format, requiring multiple testing phases for final approval. Additionally, fund-of-funds must now collect asset-level data from external GPs to validate fund-level data, which is an industry-wide requirement.

“The teams were grappling with varying fund-level metrics and needed a customised approach to data collection. There is no one-size-fits-all questionnaire, and data must be tailored to the specific fund holding the issuer. The firm found that some issuers were not providing data at all, largely due to the lack of direct engagement and overly broad questionnaires. 

“Dasseti presented a tech-enabled solution that would garner better engagement and direct data collection, which capitalised on strong existing relationships with issuers. The proactive engagement with issuers and customised approach to data collection have been well received.” 

Takeaway: Fund-of-funds and LPs have similar challenges in meeting reported KPIs and managing significant amounts of data, which can quickly become complex and cumbersome. A solution that can extract and aggregate data at multiple levels has proven to be invaluable when scalability and granularity are high on the requirements list.

This content was produced in association with Dasseti - click here to find out more about Dasseti on our Drawdown Service Provider Profile