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Australia’s Mandatory Climate Reporting Regime

Australia’s Mandatory Climate Reporting Regime

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What Every Director and Board Must Know About AASB S2

Compliance Under the Australian Sustainability Reporting Standards (ASRS)

This is not optional

On 17 September 2024, the Treasury Laws Amendment (Financial Market Infrastructure and Other Measures) Act 2024 received Royal Assent, amending the Corporations Act 2001 to mandate climate-related financial disclosures for large Australian businesses and financial institutions. From financial years beginning on or after 1 January 2025, this framework is law.

The question is no longer whether your organisation should prepare for sustainability reporting. The question is what happens if you do not.

False or misleading climate statements can result in civil penalties of up to $15 million or 10% of annual turnover, whichever is greater. Directors may be held personally liable. Criminal offences carry a maximum prison penalty of 15 years.

These are not hypothetical consequences. They are embedded in the existing liability framework of the Corporations Act and the Australian Securities and Investments Commission Act 2001, and they apply to sustainability reports with the same force they apply to financial reports. As  ASIC Commissioner Kate O’Rourke stated in September 2024, businesses should  proactively engage with these mandatory climate reporting requirements and implement appropriate governance arrangements ahead of the obligations taking effect. 

Sources:  ASIC Media Release 24-205MR, September 2024 ;  Treasury Laws Amendment Act 2024 ;  Thomson Geer–Australia’s Landmark Climate Reporting Regime

This thought leadership piece is designed to provide directors, executives, and governance professionals with a clear understanding of what Australia’s mandatory climate reporting regime requires, the personal obligations it creates, and why early action is not merely advisable but essential.

The Four Pillars of Disclosure

AASB S2 Climate-related Disclosures, issued by the Australian Accounting Standards Board in September 2024, is the mandatory standard at the heart of this regime. It is closely aligned with IFRS S2, the global benchmark issued by the International Sustainability Standards Board, and it is built on the same four-pillar structure originally developed by the Task Force on Climate-related Financial Disclosures (TCFD).

These four pillars are not suggestions. They are the legally mandated structure for climate-related reporting under the Corporations Act.

Sources: AASB S2 Climate-related Disclosures (AASB Digital Standards Portal) ; AASB Standards Announcement

Pillar 1: Governance

Organisations must disclose the governance processes, controls, and procedures they use to monitor, manage, and oversee climate-related risks and opportunities. This includes how the board and management are structured to address these issues, whether specific roles or committees have been assigned responsibility, and how climate considerations feed into strategic decision-making. This pillar is about demonstrating that climate risk oversight is not delegated to a sustainability team working in isolation. It must be embedded at the board and executive level, with clear lines  of accountability.

Pillar 2: Strategy

Organisations must disclose how climate-related risks and opportunities have affected or are anticipated to affect their business model, strategy, and financial performance. This includes current and anticipated financial effects, as well as the entity’s Climate Transition Plan.

A particularly demanding requirement under AASB S2 is the mandatory climate scenario analysis. Unlike IFRS S2, which does not prescribe specific scenarios, the Australian standard requires entities to model at least two scenarios: one consistent with 1.5°C global warming, and another “high warming” scenario that significantly exceeds 2°C. This analysis is intended to test the resilience of an entity’s strategy under materially different climate futures.

Sources:  AASB S2 Climate-related Disclosures, Appendix B ;  Watershed–Australian Sustainability Reporting Standard

Pillar 3: Risk Management

This pillar requires disclosure of the processes used to identify, assess, prioritise, and monitor climate-related risks and opportunities, and how those processes integrate into the entity’s broader risk management framework. The intent is to demonstrate that climate risk is managed alongside and within the same structures as operational, financial, and strategic risk.

Pillar 4: Metrics and Targets

Entities must disclose quantitative and qualitative climate-related metrics and targets. From Year 1, this includes Scope 1 and Scope 2 greenhouse gas emissions, calculated on a location basis. From Year 2, material Scope 3 emissions, including those across the value chain and, for financial institutions, financed emissions, must also be reported. This is where the reporting becomes most data-intensive. Organisations need robust systems to capture, verify, and present emissions data that will withstand assurance scrutiny.

Sources: AASB S2 Climate-related Disclosures ; ASIC Regulatory Guide 280, March 2025

Directors must personally sign off

Under the amended Corporations Act, the sustainability report must include a directors’ declaration confirming that the climate statements and accompanying notes comply with the Act and AASB S2. This declaration must be made in accordance with a board resolution, must specify the date, and must be signed by a director.

What directors are declaring

For financial years commencing between 1 January 2025 and 31 December 2027, directors must declare whether, in their opinion, the entity has taken reasonable steps to ensure the substantive provisions of the sustainability report comply with the Corporations Act. After this transitional period, the full standard declaration requirements will apply.

This is personal. While directors may rely on the special knowledge of their staff or external consultants, ASIC’s Regulatory Guide 280 makes clear that directors must still exercise independent care and diligence. They must understand the climate-related financial risks and opportunities that materially affect their business and ensure that appropriate systems, internal controls, and oversight mechanisms are in place.

Put simply, a director cannot claim ignorance. The existing duties under the Corporations Act, including the duty to act with care and diligence, now explicitly encompass sustainability reporting. As legal commentary has noted, directors who are not across this space risk personal liability, reputational damage, and shareholder scrutiny.

Sources:  ASIC Regulatory Guide 280 (RG 280.57 – 60) ;  Hamilton Locke  – ASIC RG 280 in Practice

Audited from year one

One of the most significant features of this regime is that assurance requirements begin from the very first year of mandatory reporting. There is no grace period in which organisations can submit disclosures without independent scrutiny.

In January 2025, the Australian Auditing and Assurance Standards Board approved ASSA 5000 (General Requirements for Sustainability Assurance Engagements) and ASSA 5010 (the timeline for phasing in assurance requirements). Together, these standards establish a structured pathway from limited assurance to full reasonable assurance.

Sources:  AUASB ASSA 5000 & ASSA 5010, January 2025 ;  PwC  Australia–Sustainability Reporting Standards Finalised ;  KPMG Australia–Australian Sustainability Reporting Standards Finalised

This means that even in the first year, organisations must have their governance disclosures, strategy disclosures, and Scope 1 and 2 emissions data at a level of rigour that can withstand independent review. An organisation cannot simply say anything and expect it to go unchallenged.

Who is in scope and when

The regime applies to entities with financial reporting obligations under Chapter 2M of the Corporations Act that meet specific size thresholds or have emissions reporting obligations under the National Greenhouse and Energy Reporting (NGER) scheme. Implementation is phased across three groups: 

Critically, Australian subsidiaries of international parent companies (ASIC) cannot rely on an overseas parent’s consolidated sustainability report to satisfy Australian requirements. Each in-scope subsidiary must prepare its own report, approved by its Australian directors, and lodged with ASIC.

Sources:  Australian Government, The Treasury, Climate-related financial reporting and guidance (Treasury, 2026) ;  Corporations Act 2001, s292A ;  ASIC RG 280.35–42 ;  DLA Piper–Key Elements of Australia’s Mandatory Climate Reporting

Limited liability protection — But do not be complacent

The regime does include a transitional modified liability framework to encourage complete disclosure during the early years. For financial years between 1 January 2025 and 31 December 2027, certain “protected statements” in the sustainability report are shielded from civil action, except by ASIC or in criminal proceedings.

Protected statements include Scope 3 emissions disclosures, scenario analysis, and transition plans for the first three years, and other forward – looking statements for the first 12 months. However, this protection is extremely limited in scope:

  • It does not cover statements made outside the sustainability report, such as those in the director’s report, operating and financial review, or voluntary disclosures.
  • It does not apply to statements that are misleading or deceptive under the Corporations Act.
  • Criminal liability is never shielded, and ASIC retains full enforcement authority throughout.
  • After the transitional period, all standard liability provisions under the Corporations Act will apply in full.

The modified liability settings should not be mistaken for blanket immunity. They are a carefully scoped transitional measure, and organisations that treat them as a reason to delay rigorous preparation will find themselves exposed when the full liability framework takes effect.

Sources:  Corporations Act 2001, Division 3A ;  ASIC RG 280.61–65 ;  K&L Gates–Mandatory Climate-Related Financial  Disclosures ;  Clayton Utz–New ASIC Guidance on Sustainability Reporting

What this means for your organisation

The introduction of mandatory sustainability reporting under AASB S2 is not an incremental regulatory adjustment. It is, as multiple legal and professional commentators have described it, a generational shift in corporate transparency. Climate-related risk has been legally elevated to the same status as traditional financial risk, subject to the same oversight, legal duties, and enforcement mechanisms. For directors, this means personal accountability. For boards, this means governance transformation. For organisations, this means investment in systems, data, expertise, and assurance-readiness from the very first reporting period.

Key actions for boards and executive teams

Conduct a gap analysis against AASB S2 requirements. Embed climate risk oversight into board-level governance structures. Establish robust data systems for Scope 1, 2, and 3 emissions capture and verification. Engage assurance providers early. Ensure directors are fully briefed on their declaration obligations. Treat sustainability reporting with the same rigour as financial reporting.

The Australian Government’s Treasury Policy Statement on this regime was clear: a rigorous, internationally aligned and credible climate disclosure regime will support Australia’s reputation as an attractive destination for international capital and help draw the investment required for the transition to net zero.

The organisations that act now will not only meet their legal obligations. They will build the trust, transparency, and strategic resilience that investors, regulators, and stakeholders increasingly demand.

Sources:  Australian Government, The Treasury, Climate-related financial reporting and guidance (Treasury, 2026) ;  AICD–Boardroom  Readiness for AASB S2 Climate Disclosures

Sources & references

 

For those seeking a streamlined approach, ESGTree’s advanced carbon calculator can handle all calculations for both your institution and your portfolio. Reach out to us to learn more!

Contact Us

Email

[email protected]

Office Addresses

Canada: ESGTree, CPA 4th Floor, 140 West mount Rd N, Waterloo,
ON N2L 3G6, Canada

United Kingdom: ESGTree, 33 Queen Street, London EC4R 1AP, United Kingdom

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Mastering Scope 3 Emissions: A Brief Guide for Financial Institutions to Measure, Manage, and Mitigate Financed Emissions 

Mastering Scope 3 Emissions: A Brief Guide for Financial Institutions to Measure, Manage, and Mitigate Financed Emissions

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Key Takeaways

  • Financed emissions account for over 90%  of a financial institution’s total emissions, making them the most critical factor in emissions reporting.
  • Despite their complexity, understanding and mitigating Scope 3 emissions is vital for aligning with net-zero targets, responding to LP expectations, and identifying opportunities for decarbonization.
  • Transparency in Scope 3 reporting is becoming a proxy for sustainability performance, with LPs demanding reliable data from GPs and their portfolio companies (UN PRI’s 2023 Report)
  • Centralized platforms, audit trails, and automated anomaly detection can streamline emissions management and improve accuracy.
  • This guide explores what Scope 3 emissions are, how to calculate them, and why they are challenging to measure. It also highlights best practices adopted by leading private market players to overcome these challenges and how technology can streamline reporting and compliance.

Understanding Scope 1, 2, and 3 Emissions

  • Scope 1: Direct emissions from owned or controlled sources (e.g., fuel combustion in company-owned vehicles).
  • Scope 2: Indirect emissions from purchased energy (e.g., electricity for offices or data centers).
  • Scope 3: All other indirect emissions across the value chain, including financed emissions (investments, loans, and other financial activities).

For financial institutions, Scope 3/Financed Emissions is the most significant, often 700x greater than their direct emissions and representing over 90% of their total emissions.

Key Factors Driving GPs to Disclose their Financed Emissions

  • Global sustainability initiatives like the Net Zero Asset Managers Initiative (NZAM) and the Science Based Targets initiative (SBTi), along with climate targets from COP 28 and COP 29, are intensifying the focus on financed emissions disclosures.
  • Public financial institutions, such as pension funds, are the first to receive these targets and cascade them across their portfolios, increasing pressure on General Partners (GPs) to disclose emissions, particularly Scope 3. 
  • At the same time, regulatory frameworks the Sustainable Finance Disclosure Regulation (SFDR) and the International Sustainability Standards Board (ISSB) are driving stricter, standardized reporting in private equity, pushing GPs to future-proof their portfolios for compliance.

Financed Emissions: The Key Scope 3 Category for Financial Institutions

Financed emissions encompass emissions linked to an institution’s investments, lending, and financing activities. These emissions include the Scope 1, 2, and 3 emissions of portfolio companies and financed projects.

Key Measurement Approaches:

  • Portfolio-Level Analysis: Assessing emissions across an entire investment portfolio.
  • Sector-Specific Analysis: Identifying high-emission sectors for targeted decarbonization strategies.

To measure financed emissions, financial entities take attribution of the emissions from a proportion of their loans, debts, and investments. 

To ensure the correct data is collected and calculated, the Greenhouse Gas Protocol created the “Scope 3: category 15 investments” category, which is a calculation methodology for measuring financed emissions. However, this calculation method had an underdeveloped level of detail for financed emissions calculations, which is why in 2019 the Partnership for Carbon Accounting Financials (PCAF) was adopted as a global standard calculation methodology for financed emissions.

PCAF: The Standard for Measuring Financed Emissions

PCAF provides detailed calculation methodologies for various asset classes of financed emissions, including:

    • Listed Equity & Corporate Bonds: Emissions linked to publicly traded stocks and debt instruments.
    • Business Loans & Unlisted Equity: Emissions associated with loans to private companies and equity stakes in unlisted businesses.
    • Project Finance: Emissions from financing large-scale infrastructure and industrial projects.
    • Commercial Real Estate: Emissions attributed to business properties.
    • Mortgages: Emissions tied to residential property financing.
    • Motor Vehicle Loans: Emissions from financing personal and commercial vehicles.
    • Sovereign Debt

How Investment Firms can Calculate their Financed Emissions:

  • First determine their share of an entity’s value—whether a company, project, or asset—supported by their financial services. This proportion is then applied to the entity’s total GHG emissions. 

  • Use actual reported emissions data from investees. However, if direct data is unavailable, estimates can be derived using sector-level data or emissions proxy factors, ensuring reasonable accuracy in reporting.

Despite these industry efforts to standardize financed emission methodologies,  large financial institutions often have millions of loans, investments, or debt holdings, which make the collection and calculation of data a complex process.

Challenges that GPs Face in Calculating Scope 3/Financed Emissions

Amid the growing emphasis on these disclosures GPs and their underlying portfolio companies face several key challenges when reporting their Scope 3/financed emissions: 

Complexity of Carbon Calculations, which stems from:

  • Carbon emissions data (i.e. Scope 1, 2, and 3 emissions) is spread across multiple reporting entities, from layers of GPs to their underlying portfolio entities and then further down to their respective suppliers.
  • Since GPs and portfolio entities each have a different way of storing this data, either manually or on centralized servers or both, data aggregation becomes complex.
  • Different asset classes are at varying stages of maturity in capturing emissions data, further complicating the data collection process.

Limited Internal Resources

  • Quantifying financed emissions across an investment portfolio is resource-intensive, especially for firms managing hundreds of portfolio companies or banks overseeing millions of individual and business accounts. These entities operate across various industries, often with intricate ownership structures, making comprehensive emissions assessment a significant challenge
  • Historically, the lack of internal capacity has been a key barrier to financed emissions reporting. However, as regulatory and investor pressure for disclosure increases, financial institutions are recognizing that existing processes are insufficient, driving the need for enhanced data management capabilities.

Data Availability and Completeness:

  • Although over 90% of all emissions are Scope 3 (World Resources Institute), only 12% of organizations measure them (Carbon Emissions Survey, BCG).
  • Even when companies do measure Scope 3 emissions, the quality and completeness of this data is often inconsistent.  Variability in reporting methodologies and data collection practices across industries can make comparisons difficult. To fill these data gaps, LPs and GPs face the burden of relying on emissions estimation methodologies and harmonizing disclosures with other data sources, a process that requires time, resources, and expertise. 

Intricate Fund Structures & Attribution Complexity:

  • Financial institutions depend on investee and borrower disclosures to assess emissions. While financial data is standardized through audited statements, GHG emissions reporting remains inconsistent. Many PortCos either do not track their emissions or, if they do, may not publicly disclose the data, creating significant gaps in financed emissions assessments.
  • This challenge is exacerbated by complex fund structures, which add layers of separation between GPs and underlying PortCos, making data access more difficult. Without clear accountability mechanisms, collecting accurate emissions data across multiple ownership layers becomes cumbersome and resource-intensive. Additionally, investors must navigate the complexities of attributing emissions based on investment type—whether equity, debt, or other financial instruments—further complicating the reporting process.

Best Practices for GPs to Accurately Calculate their Financed Emissions

Leading GPs are adopting technology-driven strategies to enhance the accuracy, efficiency, and reliability of financed emissions calculations and their emissions profile. By leveraging ESG data management platforms that have advanced carbon accounting capabilities, private market players are:

1. Centralizing Data through technology that can:

  • Ingest data from various sources, including databases and document templates.
  • Apply estimation methodologies to fill gaps and generate a comprehensive emissions footprint.

2. Ensuring Data Integrity with Audit Trails: Accurate emissions reporting requires transparent and auditable records. GPs are implementing audit logs within their systems to track:

  • Who entered or modified data.
  • When changes were made.
  • The source of emissions data, ensuring traceability and compliance.

3. Automating Anomaly Detection: To improve data quality, leading financial institutions are integrating automated anomaly detection within their emissions management systems. By setting thresholds, these systems can:

  • Flag outliers and inconsistencies.
  • Reduce manual verification efforts.
  • Improve confidence in reported emissions figures.

Specialized platforms like ESGTree provide tailored modules for both operational and financed emissions, ensuring that investment firms can efficiently track, calculate, and verify their carbon footprint. As AI-driven data validation and automation tools evolve, financial institutions can further enhance accuracy while reducing administrative burdens.

By integrating these best practices, GPs can move beyond compliance and position themselves as leaders in sustainable finance, aligning their portfolios with global decarbonization goals.

 

For those seeking a streamlined approach, ESGTree’s advanced carbon calculator can handle all calculations for both your institution and your portfolio. Reach out to us to learn more!

Contact Us

Email

[email protected]

Office Addresses

Canada: ESGTree, CPA 4th Floor, 140 West mount Rd N, Waterloo,
ON N2L 3G6, Canada

United Kingdom: ESGTree, 33 Queen Street, London EC4R 1AP, United Kingdom

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ESG Data Convergence Initiative: How LPs & Pension Funds Are Navigating EDCI Challenges & Opportunities

ESG Data Convergence Initiative: How LPs & Pension Funds Are Navigating EDCI Challenges & Opportunities

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Just a few years ago, discussions about private market Environment, Social, and Governance (ESG) data centered on how to collect it. Today, the ESG Data Convergence Initiative (EDCI) has shifted the focus to using that data to drive measurable sustainability outcomes. Over 6,000 companies globally have submitted their ESG data to EDCI based on a standardized set of metrics. With this information, EDCI has established the first widely accessible, large-scale ESG data set for private markets — enabling pension funds, institutional investors, PE firms, and VCs to incorporate ESG insights more effectively into their decision-making.

This article explores the key drivers pushing Limited Partners (LPs) and pension funds to align with EDCI, the challenges they face in doing so and the mitigation strategies employed by leading LPs to overcome these hurdles.

However, with the rise in investor ESG data requests and sustainability regulations, the tide has turned. General Partners (GPs) are now taking the lead in developing their own ESG scoring methodologies to increase engagement with their portfolio companies (PortCos), and Limited Partners (LPs) are scoring these fund managers on their responsible investment integration practices. 

In this article, we explore the significance of ESG scorecards in the private markets and the best practices that leading fund managers deploy to create them.

What’s Driving LPs & Pension Funds to Align with EDCI?

  1. Enhanced Transparency & Benchmarking: According to a 2024 Boston Consulting Group (BCG) Report, 90% of LPs cite  transparency as a critical factor for collecting sustainability data. EDCI not only provides unprecedented visibility into the ESG performance of portfolio companies, but also enables LPs  to track commitments and progress against common sustainability benchmarks. For these reasons, a growing number of LPs are aligning with the Initiative
  2. Data Comparability, Risk Management, & Enhanced Investment Decision Making: For LPs, the ability to make informed decisions hinges on the quality and comparability of the data at their disposal. Institutional investors are motivated to align with EDCI because its standardized metrics allow them to assess potential investments through a clearer ESG lens, integrating sustainability into their financial analysis more seamlessly. This not only helps to identify risks and opportunities related to ESG factors, but also answers the growing demand for sustainable and responsible investing. As a result, GPs can better manage their portfolios in a way that reflects both financial and ESG performance, appealing to a broader range of investors. 
  3. Shift from Public Market Data Proxies to Private Market Data: Historically, large financial institutions and pension systems have relied on public market proxies and estimators to report the carbon footprint of their private assets. This approach is far from ideal, as it is often unreliable, imprecise, and offers limited assurance engagement during auditor reviews. EDCI has emerged as a game-changer, providing LPs with access to validated and high-quality private market data, meticulously controlled and verified by BCG. 
  4. Constructive GP Engagement:  LPs increasingly view sustainability data as a tool for meaningful dialogue with GPs. An increasing number of LPs are aligning with EDCI so that they can use insights from EDCI submissions to drive constructive conversations with GPs about strengths and challenges within their portfolios, and to provide guidance to GPs on improving sustainability outcomes over time.

What Challenges are LPs & Pension Funds Facing with EDCI Alignment?

  1. Low  Data Coverage & GP Engagement: LPs that request EDCI-aligned data from GPs still struggle with engaging with their GPs in a meaningful way and getting high data coverage. This is especially prevalent amongst North American GPs (BCG Report). To address these data gaps, LPs are often forced to rely on estimation methodologies and harmonize disclosures with other data sources, a process that demands significant time, resources, and expertise.
  2. Limited Scope for Climate-Related Metrics:  LP commitments to climate initiatives like the Net Zero Asset Managers Initiative (NZAM) and the United Nations’ Principles for Responsible Investment (UNPRI) are driving them to demand more comprehensive climate-related disclosures from GPs that go beyond EDCI, such as physical and transitional risk considerations. By not accounting for these essential climate-specific metrics, EDCI often falls short of LPs’ evolving climate-related reporting requirements, leading them to seek additional, more relevant data from their GPs.
  3. Lack of a Materiality Lens: While EDCI’s standardized metrics have enhanced cross-firm ESG comparisons, they have also sparked criticism for potentially diluting the focus on materiality. Several PE firms’ ESG heads expressed frustration at the 2024 Responsible Investment Forum that data standardization initiatives like EDCI come at the expense of identifying which ESG topics are materially relevant to each company individually. One panelist articulated this tension: “I understand the idea of going to a smaller set [of metrics] so that you can have comparability, but it shouldn’t come at the expense of focusing on issues that are most material to our portfolio companies.” 

What Strategies are Leading LPs Employing to Tackle these Challenges?

  1. Leading LPs are using ESG data management platforms to address the complexities of managing large private market portfolios. These platforms aggregate data from a multitude of GPs, transforming it into actionable visualizations, analytics, and insights that are useful for deal, risk, and sustainability teams. By leveraging technology in this way, LPs are realizing a range of benefits, from improved data coverage to enhanced decision making across the value chain. More specifically, LPs are able to:

    1. Streamline ESG Data Collection by: 
      1. Automating manual processes, such as data entry, KPI tracking, and version control, saving them time and money,
      2. Centralizing fragmented data sources into one system by ingesting data from any database and document templates; and
      3. Auto-Filling Data Gaps by leveraging available information, such as company revenue and industry data, alongside EDCI benchmarks, to estimate missing KPIs.  Since LPs frequently receive EDCI submissions that lack critical data on emissions footprint metrics, this approach enables them and their GPs to take proactive action on ESG issues even before complete data is available.

         

    2. Focus on Data Quality & Validity: LPs are placing greater emphasis on the integrity and quality of GPs’ EDCI data submissions. By adopting ESG data management platforms, LPs gain access to comprehensive audit trails that track data entry, timestamps, and modifications, ensuring full traceability. These platforms also generate data quality scores to evaluate the accuracy of GPs’ self-reported metrics and provide transparency into carbon footprint calculation methodologies. By leveraging technology in this way, LPs can identify errors at the data collection stage, enhancing their ability to assess the reliability of submissions for external reporting.

       

    3. Drive Engagement through Automated Scorecards, AI-Driven Forecasting, and ESG Target Setting:  LPs are leveraging ESG data management platforms to generate automated scorecards that deliver actionable insights into GPs’ performance against key ESG/EDCI KPIs, fostering deeper engagement with Fund Managers. These platforms also utilize historical data and AI-driven forecasting to provide predictive analytics, enabling LPs to anticipate future trends and set ESG targets across fund managers and portfolios. By setting ESG targets in this way, leading LPs are driving meaningful conversations with Fund Managers on areas for improvement and making more informed investment decisions at every stage. 

In the ever-evolving ESG landscape, ESG scorecards have emerged as a powerful tool for driving sustainability performance in the private markets. By aligning with global standards, implementing consistent methodologies, and leveraging technology, fund managers have an opportunity to deliver measurable value to investors and PortCos alike. As ESG priorities continue to shape the future, firms embracing these practices will be better positioned to lead with impact.

If you are looking for support, we can connect you to one of our ESG experts for a complimentary consultation, and get you started on your ESG journey today.

Contact Us

Email

[email protected]

Office Addresses

Canada: ESGTree, CPA 4th Floor, 140 West mount Rd N, Waterloo,
ON N2L 3G6, Canada

United Kingdom: ESGTree, 33 Queen Street, London EC4R 1AP, United Kingdom

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Navigating the Complexities of Financed Emissions: Key Insights for LPs and Pension Funds

Navigating the Complexities of Financed Emissions: Key Insights for LPs and Pension Funds

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Table of Contents

Key Takeaways:

  • A financial institution’s financed emissions are, on average, 700x higher than its direct emissions. (Carbon Disclosure Project’s (CDP) Time to Green Finance report)
  • Fragmented data sources, resource gaps, and inconsistent Scope 3 measurements make it difficult for LPs to accurately disclose their financed emissions
  • Centralized platforms, audit trails, and automated detection systems can streamline emissions data management and ensure accuracy.

Key Motivations for Disclosing Financed Emissions

Limited Partners (LPs) and Pension Funds (also known as institutional investors) are facing increasing calls to manage their financed emissions because of: 

Regulatory Mandates

An increasing number of jurisdictions now require institutional investors to disclose financed emissions. Key regulations include:

  1. Canada’s OSFI Guideline B-15: Mandates federally regulated financial institutions and pension funds to disclose the emissions of the companies they finance or insure, driving transparency in financed emissions.
  2. New Zealand’s Climate-Related Disclosures Regime: Requires large financial institutions, such as banks, insurers, and investment managers, to report on climate-related risks and opportunities, including their financed emissions.
  3. The United States’ SEC Climate-Related Disclosure Rule: If finalized, the proposed rules would require public companies, including institutional asset managers, to disclose climate-related risks, metrics, and GHG emissions. 
  4. The European Union’s Sustainable Finance Disclosure Regulation (SFDR): Obligates financial market participants to disclose Principal Adverse Impacts (PAI) on sustainability, including metrics for financed emissions and climate impacts.

Public Commitments & Climate Initiatives:

As LPs and pension funds work towards fulfilling their public commitments on decarbonization, their demands on General Partners (GPs) to disclose emissions increase significantly. Prominent climate initiatives / public commitments on decarbonization include:

  1. Partnership for Carbon Accounting Financials (PCAF): Provides the leading global standard for measuring and reporting financed emissions, ensuring comparability and consistency across companies, portfolios, and industries.
  2. Science Based Targets initiative (SBTi): Offers a tailored framework for financial institutions to set and align financed emissions reduction targets with the Paris Agreement.
  3. Net Zero Asset Managers Initiative (NZAM): Guides asset managers in aligning portfolios with net-zero goals by 2050, emphasizing financed emissions reduction through robust frameworks.

Country Commitments – Annual COP Events

  • In recent years, countries have set ambitious decarbonization targets at annual COP events. Public Financial Institutions, like Pension Funds, are the first to receive these targets, which they then cascade down to their entire portfolio. 
  • COP29 (2024) just established a framework for the mandatory disclosure of financed emissions, public pension funds will be the first movers on this.

Long-Term Investment Risks: 

  • As institutional investors may have long-term holdings, unchecked/rising financed emissions pose a significant risk to the exit values and profitability of underlying portfolio entities. 

Barriers to Disclosing Financed Emissions Accurately

Amid the growing emphasis on these disclosures, LPs and Pension Funds face several key challenges when reporting their financed emissions: 

Complexity of Carbon Calculations, which stems from:

  • Carbon emissions data (i.e. Scope 1, 2, and 3 emissions) is spread across multiple reporting entities, from layers of fund managers to their underlying portfolio entities and then further down to their respective suppliers.
  • Since fund managers and portfolio entities each have a different way of storing this data, either manually or on centralized servers or both, data aggregation becomes complex.
  • Different asset classes are at varying stages of maturity in capturing emissions data, further complicating the data collection process.

Willingness & Resource Constraints:  

  • Smaller fund managers and many portfolio companies often lack the bandwidth, resources, and willingness to conduct detailed emissions reporting, leading to major gaps in their data submissions to investors.

Data Availability and Completeness: 

  • Although over 90% of all emissions are Scope 3 (World Resources Institute), only 12% of organizations measure them (Carbon Emissions Survey, BCG).
  • Even when companies do measure Scope 3 emissions, the quality and completeness of this data is often inconsistent (World Resources Institute). To fill these data gaps, institutional investors face the burden of relying on emissions estimation methodologies and harmonizing disclosures with other data sources, a process that requires time, resources, and expertise.


Intricate Fund Structures & Attribution Complexity: 

  • The intricate structures of investment funds, such as complex ownership layers (IMF Working Paper) and diverse asset classes,  makes it challenging for LPs to trace emissions data back to specific activities or entities.
  • Without clear lines of accountability, obtaining accurate data from multiple layers of ownership becomes cumbersome and resource-intensive. This process is further complicated when investors have to determine how to attribute responsibility for those emissions correctly, based on the type of investment (equity, debt, etc.) 

Looking Ahead: Mitigation Strategies for Institutional Investors

  • Centralize Data via Technology: In our experience, the challenge of collecting sparse data across multiple stakeholders can be mitigated by leveraging a unified platform capable of automatically:
    • Ingesting data from any database and document templates. 
    • Applying estimation methodologies based on available data to provide a full emissions footprint. 
  • Create Audit Trails for Data Integrity: Ensuring the validity of emissions data is critical. By incorporating audit logs into existing/new systems, LPs can track who entered the data, when it was added, and whether any changes were made, ensuring data traceability. 
  • Implementing Thresholds for Outlier Detection: Leading LPs and Pension Funds are implementing thresholds to automatically identify outliers within their emissions data. As data management systems become smarter,  they will be able to automatically identify outliers, reducing the manual effort involved in tracking and verifying emissions data.

By adopting these mitigation strategies, LPs and Pension Funds can navigate the complexities of financed emissions disclosure with greater confidence, ensuring that they remain on track to meet regulatory requirements, country-level commitments, and their overall sustainability goals.

If you are looking for support, we can connect you to one of our ESG experts for a complimentary consultation, and get you started on your ESG journey today.

Contact Us

Email

[email protected]

Office Addresses

Canada: ESGTree, CPA 4th Floor, 140 West mount Rd N, Waterloo,
ON N2L 3G6, Canada

United Kingdom: ESGTree, 33 Queen Street, London EC4R 1AP, United Kingdom

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Demystifying ESG Scorecards: Do They Really Help in Value Creation?

Demystifying ESG Scorecards: Do They Really Help in Value Creation?

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The rise of environmental, social, and governance (ESG) concerns has fundamentally shifted how business performance is measured. Investors are increasingly demanding objective ways to assess a company’s ESG performance; while the public markets have responded with a proliferation of ESG rating agencies, the private markets have been slow to respond. ESG scoring for private market companies has been a relatively new concept with its own set of challenges, including reliance on fund managers for data collection and the absence of relevant scoring benchmarks and clearly defined performance targets.

However, with the rise in investor ESG data requests and sustainability regulations, the tide has turned. General Partners (GPs) are now taking the lead in developing their own ESG scoring methodologies to increase engagement with their portfolio companies (PortCos), and Limited Partners (LPs) are scoring these fund managers on their responsible investment integration practices. 

In this article, we explore the significance of ESG scorecards in the private markets and the best practices that leading fund managers deploy to create them.

The Private Markets Push Towards ESG Scorecards

What the Market Has Shown us:

  • A Critical Risk Management Tool: ESG scorecards are invaluable for identifying and managing risks that could impact a company’s long-term success. For instance, a scorecard might highlight vulnerabilities in a company’s supply chain due to environmental changes or reveal gaps in diversity and inclusion policies that could lead to workforce dissatisfaction or legal challenges.
  • Impact on PortCo Engagement & Action Planning:  Increasingly, LPs, GPs, and PortCos are using ESG scorecards to develop actionable ESG improvement plans that can be tracked over time, making them an essential tool for driving engagement and performance improvement.
  • Impact on LP Fundraising Allocations: LPs are now using sophisticated scoring mechanisms to evaluate fund managers’ ESG performance, influencing fundraising allocations. GPs that adopt the best practices below can increase PortCo data coverage, drive quality improvements in their ESG scores and reporting practices, and potentially capture a valuation premium (KPMG).

Creating ESG Scorecards - Best Practices by Leading Private Equity Firms

Leading PE firms are developing internal ESG scoring methodologies to provide LPs and PortCos with a clear framework for tracking ESG performance, enhancing decision-making, and effectively communicating progress.

We’re seeing GPs adopt the following best practices to develop ESG scorecards internally: 

  • Align with Global Standards: Leading PE firms are aligning with global frameworks like the ESG Data Convergence Initiative (EDCI) and Sustainability Accounting Standards Board (SASB – now part of the IFRS ISSB Standards), in order to standardize ESG metrics and establish a solid foundation for their ESG Scorecards.
  • Conduct Materiality Assessments: As an added layer, PE firms are also conducting detailed materiality assessments to identify the ESG topics that are most important to their underlying portfolio entities and stakeholders. This enables them to collect data on decision-useful metrics and generate value-driven scorecards.
  • Develop a Consistent Scoring Methodology:  Consistency and transparency are key. Leading GPs are implementing clear scoring methodologies based on pre-defined thresholds for each ESG metric. These methodologies then create a strong foundation for incorporating custom indicators.
  • Leverage Technology: To simplify the entire process, GPs are increasingly adopting third-party ESG Scorecards from ESG management and reporting solutions that are designed to address the unique needs of the private markets. These technology solutions automate ESG data collection, centralize fragmented ESG data sources, and provide Scorecards that deliver performance insights at the firm and portfolio levels, including peer and industry benchmark-comparisons. 

Create Active Engagement Mechanisms on ESG within the Investment Portfolio: PE firms are utilizing ESG scorecards to actively engage with their PortCos and identify ESG-related risks and opportunities. By providing value back in this way, GPs are not only increasing PortCo engagement but also data coverage. At ESGTree, we receive a lot of queries from our clients’ PortCos on why their ESG scores have increased/decreased, with the motivation to understand, track and improve their ESG performance.

In the ever-evolving ESG landscape, ESG scorecards have emerged as a powerful tool for driving sustainability performance in the private markets. By aligning with global standards, implementing consistent methodologies, and leveraging technology, fund managers have an opportunity to deliver measurable value to investors and PortCos alike. As ESG priorities continue to shape the future, firms embracing these practices will be better positioned to lead with impact.

If you are looking for support, we can connect you to one of our ESG experts for a complimentary consultation, and get you started on your ESG journey today.

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Tech, Teams, and Tactics: A Complete Approach to ESG Data Management in Private Equity

Tech, Teams, and Tactics: A Complete Approach to ESG Data Management in Private Equity

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The Private Markets ESG Data Collection Conundrum

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Private market investors face 3 major inefficiencies when it comes to ESG data collection: 

1) Manual Processes: 

Private market firms often rely on manual ESG data collection processes, which usually consists of:

  •  Spreadsheets or static data collection documents 
  • Fragmented ESG Data sources (e.g. sustainability reports, employee handbooks,  policy documents) that are difficult to extract, scrape, and aggregate data from. 
  • Several data contributors across the organization, leading to data validation issues
  • Manual Data-sharing via email, leading to version control issues

With the growing number of investor data requests and ESG regulatory requirements, sustainability teams are becoming resource strapped, making these manual processes redundant.

2) Low Data Coverage Rates from portfolio entities, mainly because of:

  • Fragmented Data Ownership: Since different PortCos have different internal structures, it can be unclear who is responsible for managing ESG data. For example, some data may be under the responsibility of the finance team, while others could be with HR or compliance departments. This fragmentation not only complicates the data collection process but also creates delays in obtaining accurate ESG metrics across the portfolio. 
  • Limited Understanding of ESG Importance: PortCos will often deprioritize ESG data collection if they don’t see ESG as a value-driver, leading to incomplete or delayed reporting.

3) Lack of Standardization in ESG Metrics & Benchmarking:

While initiatives like the ESG Data Convergence Initiative (EDCI) and ILPA’s Diversity In Action (DIA)  are standardizing ESG metrics in the Private Markets to a large extent, custom investor KPIs and the evolving nature of ESG standards make it difficult to consolidate and compare ESG data across portfolios.

A Triangular Approach to ESG Data Management for Private Equity

1) Human-in-the-Loop Approach & Portfolio Engagement

The demand for talent with the expertise to collect, analyze, and report on ESG data is on the rise, and PE firms are investing in sustainability teams to build internal capacity. However, this alone is not enough to improve data quality and coverage rates. You can have a skilled sustainability team to operationalize the ESG imperative, but if your PortCos don’t recognize the strategic value of ESG, data submissions and engagement will be low.

What the Market has shown us:

  • Effective ESG data collection hinges on PortCo buy-in, particularly from senior leadership.
  • GPs are implementing targeted strategies to build PortCo awareness and engagement:
    • Allocating Sustainability Champions: Some GPs are assigning dedicated ESG champions who actively work with PortCos to showcase the financial and long-term value of ESG integration. By fostering a collaborative relationship, these champions can support PortCos in understanding how ESG performance aligns with strategic business goals.​
    • Annual Refresher Sessions: GPs are organizing annual workshops and refresher sessions to educate PortCo leadership and staff on the evolving importance of ESG. These sessions can cover the latest regulatory requirements, industry benchmarks, and potential cost savings or revenue growth opportunities tied to ESG initiatives.
    • Incentivizing ESG Goals: Some firms are even exploring financial incentives/recognition programs for PortCos that meet or exceed ESG benchmarks, creating a direct link between data collection efforts and positive outcomes.
      While these efforts can improve response rates from portfolio entities, they cannot effectively address the inefficiencies associated with ESG data collection. In fact, PE firms are realizing that sustainability teams and PortCo engagement are just one part of the solution to the private markets ESG data collection conundrum.

While these efforts can improve response rates from portfolio entities, they cannot effectively address the inefficiencies associated with ESG data collection. In fact, PE firms are realizing that sustainability teams and PortCo engagement are just one part of the solution to the private markets ESG data collection conundrum.

2) Combining Technology with Human Teams

More recently, we’ve seen GPs adopt a hybrid approach, where sustainability teams/roles are supplemented by ESG management and reporting solutions that optimize the entire data collection and reporting process. 

What the Market has shown us:

  • This hybrid approach mitigates the inefficiencies around ESG data collection and lowers the barriers to PortCo data submission by:
    • Automating Manual Processes such as data entry, KPI tracking, and version control,
    • Centralizing Fragmented Data Sources into one system, where PortCos can directly upload documents, spreadsheets, and reports, and auto-extract key ESG metrics and calculations via in-built scraping tools,
    • Facilitating cross-departmental communication through in-built collaboration tools that allow sustainability teams to effectively coordinate with PortCos, including all the technical, regulatory, and knowledge-sharing support required for the reporting journey.

  • Quality Improvements in ESG Reporting Practices and Coverage Rates can Translate into an ESG Premium: Building internal capacity in this way will likely lead to quality improvements in GPs’ ESG reporting practices, increasing their chances of capturing an ESG premium during fundraising and/or exits (PwC).

3) Leveraging External Data Sets

While the hybrid approach above provides a strong foundation for collecting quality ESG data, leveraging external data sets brings the entire process full circle. GPs increasingly view external data sources as an essential component of ESG reporting, as they not only complement internal data but also provide sector-specific and geographic benchmarks, offering a comprehensive view of portfolio-level ESG performance.  For instance, if a GP wants to assess its PortCos’ carbon emissions, it can use industry- and region-specific data on carbon outputs to establish meaningful performance benchmarks. By integrating external data in this way, GPs and PortCos gain a comparative framework, allowing them to evaluate where they stand relative to industry standards and peer metrics.

Clearly, solving the private markets’ ESG data collection conundrum demands a multi-faceted, triangular approach that integrates technology, skilled sustainability teams, and external data sets. By taking decisive steps now, private market players can transform ESG from a compliance exercise into a powerful catalyst for long-term value creation and sustainable growth.

 

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IFRS S1 and S2: How Investment Firms Can Prepare for ISSB Reporting

IFRS S1 and S2: How Investment Firms Can Prepare for ISSB Reporting

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On 26th June, 2023, the ISSB finally launched its inaugural sustainability standards, ushering in a new era in international corporate reporting

On 26th June, 2023, the International Sustainability Standards Board (ISSB) launched its inaugural IFRS Sustainability Disclosure Standards (IFRS S1 and S2), ushering in a new era in international corporate reporting. With 20+ jurisdictions (including Canada, the UK, Australia, New Zealand, China, & Japan) already engaged in the adoption process, these standards have become the baseline for most regulatory adoption of sustainability disclosures worldwide. In the same way that standardized accounting practices emerged decades ago to establish a baseline for corporate reporting, the IFRS S1 and S2 represent the next step in the evolution of these practices. 

While these standards are not yet mandatory, investment firms that adopt them early on can gain a competitive edge through improved ESG reporting practices, which can lower a firm’s cost of capital and translate into a valuation premium (Accenture). 

What are the IFRS S1 and S2? A Brief Overview

  • IFRS S1 provides a framework for disclosing sustainability-related information that is material to a company’s performance. This framework uses the Sustainability Accounting Standards Board (SASB) Standards (now absorbed into the ISSB).
  • IFRS S2 sets out specific climate-related disclosures, including climate-related physical & transitional risks, any net-zero targets, and Scope 1, 2, & 3 greenhouse gas (GHG) emissions.

    In a nutshell,  S1 & S2 are characterized by  key elements highlighted in the table below:

For more on the IFRS S1 and S2 Standards, read our Thought Leadership Series for unique insights on this Global Milestone, What’s New, and What’s to Come.

Common Challenges to Implementation - Preparing Investment Firms for IFRS S1 and S2:

Investment firms looking to start their ISSB-aligned ESG Reporting journey  must first assess the challenges to implementation that may arise along the way. To help these firms prepare for ISSB reporting, we have identified three common challenges to implementation that should be considered before adopting the IFRS sustainability standards. We have also supplemented each challenge with potential mitigation strategies.

Challenge 1 – Integrating New Requirements into Existing Systems

  • Typically, financial and sustainability reporting is managed separately. However, the IFRS Sustainability Standards have created a shift in traditional reporting norms, requiring sustainability data to be a part of the financial reporting process. To adapt to this, investment firms must ensure that their internal systems are flexible enough to manage both financial and sustainability data while maintaining efficiency. This may require system upgrades, new processes, and additional support to handle the complexity of combined disclosures.

Mitigation Strategy: Evaluate the Reporting Requirements; Assess Materiality: 

  • A thorough evaluation of reporting requirements, grounded in a materiality assessment, is essential for effective ISSB disclosure. For smaller firms, this assessment typically focuses on internal operations. However, for investment firms with portfolios of multiple entities, the materiality scope is far broader. Each entity may face unique reporting obligations depending on its industry, geography, and operations. By focusing on materiality, investment firms can streamline the reporting process, ensuring that only relevant data is disclosed and unnecessary reporting burdens are avoided. For additional Gguidance on materiality assessments, read Steps 2 & 3 in Part 2 of our Critical Success Factor Series for ESG Integration in Private Equity, or book a free consultation with our team of experts. 

Challenge 2 – Concerns of Internal Capacity & Accessing Cross Departmental Information: 

  • While finance teams are experienced in managing financial data, the inclusion of sustainability metrics demands coordination across multiple departments. Additionally, departments that previously had no involvement in reporting may now need to provide critical data for disclosures.  Quantitative indicators under the ISSB Standards add another layer of complexity to cross-departmental collaboration. For example, calculating a single indicator might involve inputs from three or four different departments, including calculations that must be precisely applied.

     

  • These shifts mean that investment firms must build capacity within departments and develop a cohesive strategy for accessing, processing, and validating cross-departmental information. 

Mitigation Strategy 1: Conduct a Data Gap Analysis:

  • Conducting a data gap analysis will allow firms to understand what’s missing and where new processes are needed. This gap analysis will then guide firms on how to:

Mitigation Strategy 2: Develop Internal Competencies and Assign Responsibilities:

  • To effectively execute the ISSB imperative, investment firms need to build internal capacity and competencies. Larger firms tend to do this by hiring in-house sustainability teams that can coordinate and deliver on the many moving parts of the ESG data collection and reporting process. However, this option is neither scalable nor economical. Instead, firms can take a hybrid approach by assigning overall responsibility for ISSB compliance at the C-suite level,  investing in a designated ESG resource, and supplementing this with an  ESG reporting technology platform that offers implementation support at the portfolio company (PortCo) level. For more guidance on developing internal capacity, read Part 4 of our Critical Success Factor Series for ESG Integration in Private Equity, or book a free consultation with our team. 

Challenge 3 – Portfolio Management:

  • As part of ISSB reporting, investment firms must also disclose sustainability data from all of their PortCos.. This process involves collecting, aggregating, and validating data from diverse entities and creates challenges around data accuracy, completeness, and consistency.

Mitigation Strategy 1: Create Sustainability Champions across Portfolio Entities:

  • For investment firms, especially those managing diverse portfolios, assigning sustainability champions within each PortCo is critical. These champions coordinate sustainability efforts, align internal teams, and ensure the timely collection and validation of required data. Their role is also to advocate for sustainability initiatives within the organization, preventing the dilution of efforts across multiple departments. Once this is established, the firm will be better equipped to:

Mitigation Strategy 2: Support Portfolio Entities on Materiality Assessments: 

  • Conducting materiality assessments across PortCos can be complex and resource-intensive. Investment firms can add value by providing support for these assessments, whether through in-house expertise or by engaging third-party advisors. This not only streamlines the data collection process but also enhances PortCos’ understanding of the importance of sustainability, leading to better reporting and stronger alignment with the firm’s overall ISSB/ESG strategy. For additional guidance on materiality assessments, read Steps 2 & 3 in Part 2 of our Critical Success Factor Series for ESG Integration in Private Equity, or book a free consultation with our team. 

For a more in-depth guide to preparing for ISSB reporting, watch our exclusive webinar below, held in collaboration with CPA-Ontario and sponsored by CSPM-University of Waterloo. You can also download the webinar slides here.


Preparing Investment Firms for IFRS S1 and S2

The ISSB Adoption Timeline: As shown in the timeline below, the ISSB has provided temporary reliefs/exemptions to ease compliance and make the adoption process more manageable for companies. In the very first reporting cycle  (i.e. January 2024),  companies only have to report on IFRS S2 and Scope 1 & 2 emissions. In the second reporting cycle (i.e. January 2025), companies have to add IFRS S1 and Scope 3 emissions to their reporting obligations. By the third reporting cycle (i.e. January 2026), IFRS S1 and S2 (along with Scope 1, 2 & 3 emissions) must be fully incorporated for all entities.

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How GPs Can Operationalize ESG Integration by Investing in ESG Resources

How GPs Can Operationalize ESG Integration by Investing in ESG Resources

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The Private Equity (PE) Market has seen greater adoption for Environment, Social, & Governance (ESG) in these past four years than ever before. Factors such as changing investor priorities and rising pressure from regulators have fueled this paradigm shift and, while the tide has not unilaterally turned, sustainability is no longer a fringe concern. 

Our Critical Success Factor (CSF) Series has shown that, to remain competitive, General Partners (GPs) need to be intentional about incorporating ESG factors into business practices and stay agile in meeting changing expectations. For Mid-Market PE firms, this entails:

  1. Building a robust ESG integration strategy and policy (see. CSF #2)
  2. Choosing decision-useful ESG metrics (see. CSF #3)
  3. Operationalizing ESG goals by investing in ESG resources 

This triangular approach to firm-wide ESG integration will enable GPs to stay ahead of Limited Partner (LP) due diligence questionnaires (DDQs) and regulations.

Investing in ESG Resources to Operationalize ESG Integration

A. Why is it Important?

Emerging ESG standards and regulations are requiring entities to report on sustainability information in tandem with financial information; while Finance Teams are equipped to deliver on the latter, they may struggle to collect sustainability data. This is because ESG data collection requires inputs from all ends of the organization, which cannot be done without developing internal capacity and competencies for ESG. 

B.What Can You Do?

In order to develop internal capacity and competencies for ESG in your firm, you should consider:

Establishing Designated Roles for Sustainability and Supplementing them with Technology

 
  • Normally, smaller PE firms don’t have a designated Head of ESG, so ESG is often clubbed under Finance, Compliance, or Investor Relations. Even in cases where PE firms have a Head of ESG, they will typically be supported by at least one resource tasked with manually creating templates for ESG KPIs, sending those KPIs to Portfolio Companies, liaising with them, trying to get data back, version control, and then making sense of this data.  As LP and regulatory requests get more sophisticated and complex, these manual processes become cumbersome.

  • To effectively execute the ESG imperative, PE firms need to build internal capacity. Larger firms tend to do this by hiring in-house sustainability teams that can coordinate and deliver on the many moving parts of the ESG data collection and reporting process. However, for Mid-Market PE firms this option is neither scalable nor economical. In fact, even for larger PE firms, this one dimensional human-centered approach will only take them so far in meeting their ESG integration goals. 
  • A better way to operationalize ESG integration goals is to adopt a hybrid approach that will enable you to retain a lean and efficient organizational model while ensuring scalability. So, instead of hiring an entire sustainability team, you can  invest in a designated ESG resource and supplement that with an ESG automation and reporting platform that offers implementation support at the PortCo level. Building internal capacity in this way will likely lead to quality improvements in your firm’s ESG reporting practices, increasing your chances of capturing an ESG premium during fundraising and/or exits (PwC).

  • Many firms are looking to start their ESG journey today, so it is imperative they start building capacity now.

Select an ESG Reporting and Advisory Platform using the Evaluation Criteria Below:

  • Oftentimes, determining the fit of an ESG technology solution can be a difficult process. To make  it easier for you, we’ve developed a list of capabilities and features to consider when evaluating ESG reporting platform providers

 

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How GPs Can Meet ESG Integration Goals by Choosing Decision-Useful Sustainability Metrics

How GPs Can Meet ESG Integration Goals by Choosing Decision-Useful Sustainability Metrics

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The Private Equity (PE) market has seen greater adoption of Environment, Social, & Governance (ESG) in the past four years than ever before. Factors such as changing investor priorities and rising pressure from regulators have fueled this shift and, while the tide has not unilaterally turned, sustainability is no longer a fringe concern.

In this article for GPs, we address the two major ESG pain points experienced by Mid-Market PE firms, namely: 

  1. Choosing which ESG metrics to prioritize and report at all levels, and 
  2. How to collect complete, consistent, and reliable ESG data 

We’ve also embedded a Decision Tree below to help GPs assess which regulations and sustainability standards apply to their specific use-case.

Choosing Decision-Useful Sustainability Metrics to Meet Your ESG Goals

A. What the Market has Shown Us:

  1. ESG encompasses a wide array of topics, from climate change and sustainability to diversity, human rights, consumer protection, and corporate governance. Depending on specific circumstances, certain ESG factors may greatly influence PortCos and funds, while others may not.  Because of this, GPs struggle to prioritize which ESG metrics to report on at all levels (The Metrics Working Group – SMI Private Equity Task Force).
  2. Meanwhile, Limited Partner (LP) priorities and regulatory requirements are putting pressure on PE firms to build more sophisticated data collection and reporting capabilities. This can be an overwhelming process for GPs of mid-market PE firms, who consistently report lacking internal resources for handling ESG data collection and needing guidance around ESG data collection methods (read our Industry Report on GP Sentiments around LP Data Requests to learn more). In short, mid-market PE firms (specifically those with < $1 Billion in AUM) struggle to collect complete, consistent, and reliable ESG data.

B. Why Does it Matter?

Identifying the type of ESG data that needs to be collected is critical to investment analysis and PortCo management. Today, ESG metrics have become highly relevant because:

  1. LPs now use them to monitor progress on ESG for invested funds and underlying PortCos,
  2. PE Firms (GPs) need them for compliance with evolving sustainability regulations and LP demands
  3. Deal Teams now rely on them (along with financial and operational metrics) during Due Diligence for investment decisions, and
  4. PortCos use them to drive action and become more transparent among their stakeholders (customers, boards, GPs). Since PortCos are usually the main source of data for most ESG metrics, a major point of interest for GPs is maximizing ESG data coverage from their PortCos. However, materiality factors such as geography and regulation, ownership and influence, and investor data requests makes this acomplex goal to achieve.

What Can You do?

Step 1: Conduct the Preliminary Assessments in CSF Part 2  (Steps 2-3)

  • During this assessment phase, GPs should look into how Geography & Regulation will influence the ESG metrics they select for their firm and PortCos. Unfortunately, this can be a challenging task for Mid-Market PE firms; according to a 2024 Accenture Survey, most GPs did not feel ready to meet many of the new regulatory requirements. This, along with the fact that GPs globally are expecting an increase in mandatory disclosures over the next three years, builds a strong case for PE firms to prioritize understanding the impact of existing and emerging mandates across their value chain.
  • Our table below does exactly that, providing an overview of the most relevant ESG disclosure regulations and standards for Private Markets, as of 2024.

Step 2: Choose ESG Metrics Specific to Your Use-Case by Using Our Decision Tree Below:

In parallel, consider aligning your firm and PortCos with the global baseline for sustainability reporting, i.e. the IFRS ISSB Sustainability Disclosure Standards. These Standards also contain the SASB Materiality Finder that can further help you identify decision-useful and industry-specific ESG metrics for reporting.

While Steps 1-2 are useful to GPs who are starting their ESG journey, they are just one part of the equation. GPs can have a solid understanding of the ESG metrics material to their use-case and still not be equipped to operationalize ESG reporting. This is what most PE firms struggle with (Accenture). According to an Accenture Survey, most executives feel ill prepared to meet upcoming reporting and compliance requirements, with only one out of three European investment managers and one out of five North American investment managers reporting being confident about ESG integration in their fund’s practices and policies.  To tackle the conundrum of operationalization, you can:

Step 3: Invest in ESG Resources for Best-in-Class ESG Reporting and Compliance

Normally, smaller PE firms don’t have a designated Head of ESG, so ESG is often housed under Finance, Compliance, or Investor Relations. Even in cases where PE firms have a Head of ESG, they will be supported by at least one resource tasked with manually creating templates for ESG KPIs, sending those KPIs to PortCos, liaising with them, trying to get data back, version control, and then making sense of this data.  As LP and regulatory requests get more sophisticated and complex, these manual processes become untenable. One of the ways that this can be solved without increasing headcount is by automating this process with a technology platform that offers implementation support at the PortCo level.

To learn more about operationalizing sustainability for firm-wide ESG integration, read our CSF part #4 

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How an ESG Integration Strategy Helps in Staying Ahead of LP DDQs & Regulations

How an ESG Integration Strategy Helps in Staying Ahead of LP DDQs & Regulations

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It is evident that, to remain competitive, General Partners (GPs) need to be intentional about incorporating Environment, Social, & Governance (ESG) factors into business practices and be agile in meeting changing expectations. Once you’ve understood the importance of quality ESG reporting and the critical factors driving ESG integration in private equity (PE), you can take the first step to successfully execute the ESG imperative: i.e. building a robust ESG integration strategy & policy. This will establish your firm’s reputation as a responsible investor and signal priorities to both sustainability- minded investors and acquisition targets.

Building a Robust ESG Integration Strategy & ESG Policy

Why does it matter?

  • An ESG integration strategy (a.k.a ESG strategy) is a broad term used to describe how an organization integrates ESG considerations into its investment portfolio and decision-making processes. Fundamentally, ESG considerations lead to better risk management and value creation by helping investors account for material risks—such as climate change or looming regulatory requirements—and identify opportunities to increase the profitability of portfolio companies (PortCos). 

  • While every GP has its own investment philosophy and investment process, having an ESG strategy that embeds sustainability across the investment lifecycle can enable your firm to make the following gains at each stage: 
  • As highlighted in CSF Part 1, material ESG risks have shown to lower company valuations in 80% of cases and can even turn into a deal-breaker. Vice versa, companies with strong ESG fundamentals tend to outperform their counterparts on EBITDA margin by up to 21% and have less systemic risk exposure, lowering the firm’s cost of capital and translating into a valuation premium (Accenture).  For this reason alone, an ESG strategy and resultant ESG policy that incorporates ESG considerations into decision-making processes  is a crucial lever to pull for your stakeholders.

What Can You Do?

Step 1. Have a Stakeholder-Led ESG Policy Development Process
You can do this by:

This first step will guide your vision for ESG integration and will ensure that your ESG policy is relevant to the concerned stakeholders. The second (and arguably most impactful) step will anchor your ESG policy in LP demands and regulatory requirements by helping you:

Step 2. Asses where you and your PortCos Stand on Key Materiality Factors

As discussed in Part 1 of our CSF Series, one of the biggest challenges to ESG integration in PE is prioritizing which ESG metrics to report on, at all levels. To address this challenge, a best practice is to first assess where you and your PortCos stand on the 3 materiality factors known to influence a PE firm’s decision on which ESG metrics to report on (elaborated in Image 1 below):


Step 3. Apply an Industry-Specific Lens to Choose the Right Metrics & Sustainability Frameworks

Once the context is established in Step 2, PE firms can then apply an industry-level lens to selecting decision-useful ESG metrics. This can be done by first identifying the relevant industries across your firm’s value chain, and then leveraging the SASB Materiality Finder (now part of the IFRS ISSB Standards) to help you quickly find the ESG metrics & disclosure topics that are material to your and your PortCo’s industry. To gain a deeper understanding on choosing the right metrics & frameworks for your specific use-case, read Part 3 of our CSF series, or book a free consultation with our team.

While Steps 1-3 are useful to GPs who are starting their ESG journey, they are just one part of the equation. You can develop a great ESG strategy and policy and still not be able to operationalize it fully. This is what most PE firms struggle with (Accenture). According to an Accenture Survey, most executives feel ill prepared to meet upcoming reporting and compliance requirements, with only 1 out of 3 European investment managers and 1 out of 5 North American investment managers reporting being confident about ESG integration in their fund’s practices and policies. Oftentimes, GPs find themselves committing valuable time and resources to obtain and measure ESG data from their PortCos and end up spreading themselves thin. 

To learn more about how you can address this conundrum, read Part 3 of our CSF Series.

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Canada: ESGTree, CPA 4th Floor, 140 West mount Rd N, Waterloo,
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