How funds can meet investor demands for effective ESG reporting

17 March 2022
Funds face increasing pressure to deliver greater returns for investors while meeting evolving regulatory demands.

Environmental, social and governance (ESG) issues are among the most significant regulatory considerations for funds today. They have also become top of mind for investors themselves, who see ESG management as essential.

ESG disclosures largely have been voluntary in many countries, including the United States. However, regulators are now moving on this front. The SEC is considering rules to mandate climate-related disclosures across industries and the European Union is implementing sustainable finance regulations that include specific disclosure requirements for funds.

As funds grow and industry standards evolve, funds will almost certainly need to fulfil ESG reporting obligations, no matter where their funds are based. And in the meantime, demands from institutional investors may require funds to quickly implement the right systems and data collection processes to be able to report on key ESG metrics.

Currently, funds are using four key strategies to demonstrate ESG impact, the ROI of initiatives and transparency for investors. Understanding the benefits, drawbacks and key considerations of each can help you decide how to best implement a holistic ESG reporting strategy for your fund.

1. Investing in new technology

Funds are being pushed to report ESG data in ways that resonate with investors and make clear that funds have the necessary expertise and leadership to effectively address ESG matters.

Technology is critical to these efforts because it can streamline and scale the reporting process and make information more presentable to institutional investors — whether through a dedicated microsite or custom reports. Sound technology allows in-house counsel and governance teams to efficiently collect and analyse ESG-related data. However, when it comes to ESG reporting systems, funds often face the question of build or buy.

Building systems in-house requires a detailed software design and development process, corresponding internal governance and data collection policies, and input from cross-functional stakeholders, all of which is time- and labour-intensive, not to mention costly. There are significant benefits, including providing your firm with a robust reporting mechanism that’s truly customised to your needs.

If you choose to develop an in-house ESG reporting solution, it should be flexible enough to evolve with changing ESG regulations and frameworks as well as changing fund domiciles or investment locations. Your firm should ensure you have the IT resources and infrastructure internally to keep up with these changes and seamlessly translate your reporting data to investors in a way that’s easy to understand. It also needs to remain secure in an increasingly challenging data-security landscape.

As an alternative approach, your firm could consider partnering with a third-party service provider, which can give your team quick, easy access to top-of-the-line secure software while defraying overall costs. With more investors requiring customised portfolio statements, having tools with drill-down access and online dashboards to enable complex data management can be very valuable.

2. Expanding your team

In addition to technology considerations, your private equity fund should consider creating a dedicated ESG function.

Some companies have created an internal ESG office or hired an ESG-focused leader to oversee reporting and operations of their ESG program. This person or team plays a central role in procuring or building reporting systems and processes, gathering data from different stakeholder groups, sharing information with leadership and executing the fund’s overall ESG strategy. In some firms, these ESG teams can also help identify ESG-related risks and opportunities for potential investments as well as manage any ESG vendors.

Creating a dedicated ESG function will increase your fund's headcount and overhead, but it may be well worth the investment. Establishing a centralised ESG function can help your firm make ESG a true strategic priority and ensure effective oversight and accountability to satisfy investors.

3. Working with an ESG consulting firm

To fulfil investor ESG reporting demands, your firm also can consider collaborating with an ESG consulting firm.

These firms offer expertise in data and measurement, reporting, and third-party validation for investors. An ESG consulting firm can help your fund aggregate and integrate data, identify information gaps that must be closed to meet ESG standards, and develop an ESG reporting strategy.

Assurance is one of the most significant benefits of this approach. For instance, in the US, your consulting firm can work with an external auditor to provide assurance services compliant with AICPA accounting standards. These services can include everything from greenhouse gas attestation to assurance for corporate social responsibility reports.

It can be costly to engage a consulting firm, which is a potential drawback of this approach. Many of these engagements are also project-based, so your fund may benefit from working with a consulting firm to get your ESG reporting program up and running, but then you will be responsible for ongoing administration. These are considerations to keep in mind when weighing options.

4. Outsourcing administration

A private equity firm's ultimate objective is to provide returns for investors. While ESG rankings have been correlated with higher risk-adjusted listed equity returns, most funds can't manage this responsibility day-to-day, which is why outsourcing elements of an ESG strategy to a business services provider can be beneficial.

A business services provider will offer services similar to those of a consulting firm, including working with your firm to manage ESG data. They should also provide access to tech platforms that allow you to input data, evaluate your portfolio’s performance and report against multiple standards and frameworks.

In a recent survey, investors cited governance as the most impactful — and challenging — ESG factor for decision-making. Outsourcing ESG administration may be a more cost-effective approach than engaging a consulting firm to support in this area. A business services provider can often offer strategic guidance to help improve and drive performance. They’ll have worked with many companies and varying scenarios, bringing valuable perspective and expertise to the table.

A business services provider can also provide ongoing tactical and functional support — such as accounting — that allows your fund to focus on improving portfolio performance and driving greater returns. Working with a business services provider can also bring more legitimacy to your fund's ESG reporting operations. It can give investors comfort that there's independent vetting of your ESG metrics. This independent vetting can also significantly reduce compliance, financial and operational risks.

ESG reporting will continue to be a focus for investors and regulators, which means private equity firms should develop an effective ESG data management and reporting strategy and framework.

As we’ve seen, firms have several options for how to approach this new demand, including building in-house reporting systems, creating a dedicated in-house ESG function, working with a consulting firm, or outsourcing ESG administration. Each approach has its advantages and disadvantages in terms of costs and administrative burdens, and in terms of how it can provide value for your firm and help you advance your ESG reporting capabilities. Whatever approach your firm takes, be sure it effectively communicates to investors that ESG is a mission-critical priority and that you are implementing meaningful ESG controls.

Sadrack Belony, director of investor services at Vistra, contributed to this article.

Learn more about Vistra’s ESG data management and compliance services here, or get in touch using the form below.