EU: As investors demand more sustainability data to understand the risks to their portfolios from climate change, private equity firms will need to make sure that environmental, social, and governance (ESG) reporting is properly implemented in their operations, according to industry reports and forums.

According to a report from the law firm Morrison and Foerster (MoFo) titled Global PE Trends 2022 and Outlook for 2023, mainstream private equity funds have increased their focus on ESG issues in response to rising investor expectations and reporting requirements. However, they will need to increase data collection to show how such issues are integrated into their investment processes.

We anticipate that asset managers will need to granularly substantiate the economic justifications for ESG investment philosophies, emphasising how ESG considerations are essential to enterprise value and the actual risks to assets posed if companies do not take into account ESG considerations, MoFo said in the report.

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Less than half of respondents to the law firm's survey of 100 Asia-based fund general partners with over US$1 billion in assets under management, including managers of private equity firms, conducted ESG due diligence on every deal, according to the results.

Only 29% of funds indicated that they always required the inclusion of clauses in investment documents to enhance or ensure ESG compliance, and only 38% required regular reporting and disclosures of key performance indicators (KPIs) relating to ESG, according to a survey conducted by the Asian Venture Capital Journal in the third quarter of last year.

The law firm stated in its survey report that "the risk of greenwashing is a significant problem for many firms due to the lack of teeth in deal documentation and lack of transparency, as the majority of respondents do not require ESG KPI reporting."

Greenwashing is the term for sustainability claims that are not supported by precise, accepted definitions and can create an inaccurate perception of the overall advantages.

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Despite increasing pressure on businesses to look beyond the carbon emissions they are directly responsible for, only 59% of respondents said they had taken climate change into account when performing their ESG due diligence.

In addition to the required recurring financial reports, all of the nearly 2,500 Hong Kong-listed companies are required to publish annual sustainability reports on their ESG performance. However, private equity firms are not currently required to submit ESG reports.

According to regulations announced in August 2021 by Hong Kong's Securities and Futures Commission, asset management companies with at least HK$8 billion (US$1 billion) in client assets in Hong Kong will need to report the greenhouse gas emissions data of their investment portfolios beginning in November 2022. Of the city's 2,000 licenced asset managers, up to 200 fit that description.

Limited partners are realising how crucial it is to understand their portfolio's [risks] and gather ESG data for their stakeholders. Ben Morley, partner and associate director at Boston Consulting Group, stated this at the Asia Private Equity Forum 2023 last month. "So without consistent ESG data being collected, there's absolutely no way to kind of gauge how their portfolio as a whole performs on ESG topics. The Hong Kong Venture Capital and Private Equity Association was in charge of planning the event.

Limited partners are the funds' investors, while general partners are typically the funds' managers. Without comprehensive and usable ESG data, Morley continued, "it's difficult to know how [to] actually engage with portfolio companies to drive change."

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According to Coller Capital's Global Private Equity Barometer report, which surveyed 112 private-equity investors, nearly three-quarters of private-equity investors would think twice about continuing to invest in a fund if the general partner failed to meet specific standards of ESG-related disclosures, such as the European Union's Sustainable Finance Disclosure Regulation and the US Securities and Exchange Commission's proposed ESG disclosures, in the next three years.