Friday Letter: Who sets the standards?

What does an LP have the “right” to know about an investment that a private equity firm has ventured to make on its behalf? Financial performance details? Undoubtedly. Employee numbers? Certainly. Carbon emissions? Arguably. Whether the coffee in the portfolio company’s office kitchen is Fair Trade? Well, it depends who’s asking.

At the PEI Responsible Investment Forum last month, co-hosted with Principles for Responsible Investment, LPs, GPs and industry consultants debated just such issues as part of a think-tank discussion on the possibility of moving toward a greater degree of standardisation in ESG reporting.

Across the board delegates were in agreement that some degree of standardisation would be beneficial for all involved, but as to what that would look like, the jury’s still out.

“If we could get somewhere that has just the core elements standardised, [so] that we know what we need to feed back on, and perhaps tailor the remaining 20 percent to the individual concerns of a specific LP […] that would be a fantastic outcome,” Apax Partners investor relations director Ellen de Kreij said.

Producing a report with detailed information about each portfolio company, however, is not necessarily the answer. Panelist Thomas Kristensen, an executive director at LGT Capital Partners, pointed out that his firm is invested in roughly 4,000 underlying portfolio companies. How one would even begin to process such a volume of information is unfathomable.

Sending out 200 KPIs that cover every imaginable ESG question, then, is neither practical nor helpful.

One idea gaining traction is using the same reporting frameworks used by the public markets, for example the Global Reporting Initiative’s sustainability reporting guidelines or the Sustainability Accounting Standards Board standards, as a basis to extract KPIs for an “80-20” model in which the bulk of ESG reporting is standardised and the remainder tailored to each LP’s needs.

A clear benefit would be that LPs, who are often investing across a broad spectrum of financial products, have a concrete way of making comparisons across their own portfolios.

However, a pretty major sticking point is the issue of materiality. Should it be down to the GP to decide what is “material” information for each portfolio company, or should the LP set the agenda?

A GP may not think it’s material, for example, to track water usage in an IT company in Stevenage or Baton Rouge, but if an LP is tracking water usage across its whole portfolio then it becomes material.

“It may not be relevant for their businesses but it may be a very relevant question for them,” said PGGM’s adviser on responsible investment Tim van der Weide.

But, as de Kreij countered, “where do you then draw the line?”

It’s also worth noting, as Kristensen did, that an LP’s “right” to know something and a GP’s “obligation” to provide that information is not unrelated to how important that LP is to the GP. Heavy hitters are likely to find they have much more say over what is “material” information.

A dilemma, then, and one unlikely to be resolved in five minutes. But while moving toward some form of standardisation or reporting framework is an admirable goal, as one delegate pointed out, reporting should not replace active engagement and communication between GPs and LPs, and between GPs and their portfolio companies. After all, it is what is behind the reporting – the GP’s overall approach to sustainable investment and the concrete steps taken to effect an ESG strategy – that is really the crucial point. The industry would do well not to lose sight of that.