ESG needs its own due diligence

Emma Arnold

Emma Arnold

Environmental Social Governance has existed since 2003 so why is there still so much confusion around it?

Most likely, because there is still no one source of guidance and no single regulatory driver.

There is still the misconception in the financial markets that ESG costs money and is just a “nice to have”, despite much research to the contrary.

However, times are changing and there is no doubt that environmental and social issues are going to become more prominent as major global risks.

Managed properly, a focus on ESG in investment decisions not only manages these risks but brings about the opportunity for value creation.

There is a wealth of guidance available on ESG, mainly with the emergence of (but not limited to) – Global Real Estate Sustainability Benchmark, Global Reporting Initiative and UN backed Principles for Responsible Investment.

Generally, GRESB focuses on the sustainability performance of real estate and infrastructure assets, GRI focuses on corporate reporting and PRI is aimed at the financial investment markets.

Underlying these, many big investment houses have their own internal ESG processes that they pass down to asset managers, leading to numerous differing information requests and confusion because when it comes to ESG, there is no one size fits all.

Adding further confusion is the recent emergence of ESG ratings indexes, which are increasingly relied upon by investors to assess ESG impacts.

While ratings and benchmarking are undoubtedly beneficial, the data they are often based on frequently relies upon information disclosed by companies in their annual reporting being accurate.

Independent verification is rare (PRI reported only 11 per cent of fund reports are independently assured), and there is also no regulatory driver for company disclosures on ESG issues to be independently verified.

However, it is coming. Some bespoke consultancies currently offer assurance based on ISO standards, and the emergence of an ISO standard for ESG assessment is on the horizon, as is an increase in regulatory scrutiny.  

So as an investor - what do you do? There is no replacement for the due diligence process, which brings with it an independent level of assurance on risks and opportunities. However, due diligence needs to change and become more consultative and not procured at the last minute.

Various advisers will be required to cover different aspects of Environmental, Social and Governance, and therefore it is important to have co-ordination to prevent investment committees having to assess a variety of information from differing sources at the eleventh hour.

There are questions coming out of this for clients, like who do I need, and how do I get started. My advice for streamlining ESG assessments is:

  1. Get educated and find out which advisers you should include. Appoint ESG advisers early in the deal time-frame, and establish if you need independent assessments. Work with advisers early to establish what key ESG aspects must be considered. If you have internal and external stakeholders, ensure these are consulted early in the process to confirm the scope of your assessment is appropriate.
  2. Encourage dialogue on the scope of your assessments, this will lead to better opportunity creation during the process. For example, tech companies will have different ESG issues to industrial and fashion firms. Be wary of procuring off-the-shelf assessments as this may not fit your needs and consider sector specific options to optimise the benefits.
  3. Ensure all factors of ESG are covered and that your advisers are networked early to enable discussion on cross-discipline issues. For example, social issues will have implications for legal, HR, insurance and environmental teams. Be clear who is covering what part of ESG and that they are appropriately qualified.
  4. Set up regular cross-discipline calls to promote dialogue between your advisers.
  5. Invite advisers to present findings jointly in advance of investment committee meetings so that you can get a holistic view of the issues. Ensure reports are focussed on value creation, not just risks, and following investment that findings are reported to asset managers and tracked throughout the deal lifetime via post-merger integration plans or 100-day plans.

ESG is here to stay, and reporting is only going to become more onerous.

Do not ignore ESG; get up to speed and ensure that you are fully informed.

Use ESG to your advantage to add and create value to your investments beyond the deal date.