In defence of ESG disclosures

London Business School (LBS) has revised its ESG Disclosures in the Private Equity Industry study, suggesting firms that are more transparent about ESG are more likely to invest in portfolio companies with good environmental performance and achieve higher financial returns.

The study analysed data from 21 years’ worth of ESG disclosures on PE firms’ websites. Disclosures analysed spanned across 75,000 websites of approximately 6,000 PE firms in more than 30 countries. Half (50%) of the GPs involved in the study were situated in the US, followed by the UK, Canada, Germany and China.

The data was collated using an algorithm to track ESG-related language and its evolution since the turn of the century. It also tracked which areas of ESG have seen the greatest growth in disclosures.

Florin Vasvari, co-author and academic director of the Institute of Entrepreneurship and Private Capital at LBS, comments: “We primarily wanted to understand what is driving these disclosures. We wanted to see whether the disclosures are different between different types of firms. Some of them focus on buyout, some of them focus on venture, some of them are global asset managers that do everything. We found that the ESG regulations in the public markets also drive disclosures in the private market, for instance.”

The study has been public since November 2022 and is a working paper.

The lowdown
Despite question marks around PE’s ESG claims, with concerns about greenwashing and the overuse of sustainability jargon, the study demonstrates that regardless of the amount of ESG disclosures on a PE firm’s website, environmental performance of portfolio companies significantly improves a year after the deal, and chemical releases were found to decrease by 10%.

As well as the link between ESG disclosures and fund performance, there is a direct correlation between higher ESG disclosures and portfolio companies’ environmental performance. In other words, GPs with more ESG disclosures were more likely to invest in companies with lower levels of environmental pollution.

This finding is supported by Simon Kucher & Partners’ European PE Climate Impact Radar, a study based on responses from more than 130 PE professionals across Europe, which found three-quarters (78%) of respondents believe reducing carbon emissions in their portfolio companies has a positive impact on overall fundraising performance. This would suggest the disclosures are not simply tickbox exercises, but are supported by the industry’s belief in the value of ESG measures.

However, the link between more ESG disclosures forming part of all the general disclosures on a website and better PE fund performance is not a causal relationship. There may be other reasons for a fund’s successful performance, particularly with larger and more well-known fund managers that might be more likely to be aware of ESG issues and have a wider vocabulary on the matter.

Rise of the social
The study also highlights the evolution of ESG disclosures across the years. It found that ‘E’-related terms dominated at the start of the century.

Then, between 2016 and 2018, social issues became the main point of conversation. While there is no concrete explanation for this, Vasvari adds: “The only determinant we have is regulatory requirements for public firms. So, it is possible that when a fund manager plans to exit a company, through a listing or by selling it to a publicly listed entity, they follow the same requirements as public firms to make the exit easier. What we find is that in those countries where those regulations are adopted for publicly listed firms, fund managers talk more about ESG. So, clearly they have an eye on the public mark.”

LP influence
Analysis is ongoing and Vasvari elaborates on trends that are yet to be published. He states: “We are finding that if GPs have LPs invested in parts of their funds, and those LPs are also signatories of the UN PRI, then those GPs also tend to disclose more about ESG on their websites. So, there might be a link between UN PRI pledges leading to more disclosure about ESG on GP websites.”

However, the conviction that fund managers are catering to demand, rather than wholeheartedly embracing an ESG mindset, still needs to be tested further.