The U.S. private equity industry is increasingly embracing environmental, social and governance strategies in the wake of the COVID-19 crisis, but challenges related to reporting and the lack of standards persist, according to Hameer Vaid and Hunt Holsomback of Alvarez & Marsal Holdings LLC's private equity performance improvement service.

Although the U.S. trails Europe in advancing ESG strategies, it is slowly catching up due to the increasing emphasis among key investment firms to address these issues. Many of the newer funds now have "ESG provisions and covenants baked in," and large banks and financial institutions are mandating ESG as a component in their lending criteria, Vaid and Holsomback said in an interview with S&P Global Market Intelligence.

The duo, however, warned about certain obstacles to ESG implementation, including the lack of comparative data, evolving global standards on requirements, variability in reporting impact across alternative investment asset classes and implementation cost and time. A survey of investors released Oct. 13 by EisnerAmper LLP likewise cited the lack of standardized reporting and data sets as the biggest hindrance to the adoption of ESG investment, followed by sourcing quality investment opportunities and eliminating the notion of poor returns.

Activity is underway to address some of these challenges. For example, a group of general partners and limited partners representing more than $4 trillion in assets under management, led by The Carlyle Group Inc. and the California Public Employees' Retirement System, unveiled a collaboration to standardize ESG reporting at the end of September. Blackstone Inc., Bridgepoint Group PLC, CVC Capital Partners Ltd., EQT AB (publ), Permira Advisers Ltd. and TowerBrook Capital Partners LP are among the general partners in the group.

The initiative is a move in the right direction, but it could also face adoption risk, said Vaid, who noted that quantitative reporting is still in the nascent stages and benchmarking from a cash flow perspective is still in the works. A reporting standard could still be a year or more away, Holsomback added.

When it comes to ESG integration in the private equity sector, "perfect is going to be the enemy of the good," Institutional Ltd. Partners Association CEO Steve Nelson said at the recent EisnerAmper 2021 Annual Alternative Investment virtual summit. Source: leonard_c/E+ via Getty Images

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There is some evidence that private equity involvement has a positive impact on the ESG profile of portfolio companies. S&P Global Trucost data, which assigns ESG scores to publicly listed companies, shows that between 2017 and 2020 the highest-scoring companies largely improved their ratings after private equity investment.

Ecolab Inc. and Republic Services Inc. grabbed the first and second spots in terms of ESG scores in 2020 at 77 and 65, respectively, beating the average of 21 in their respective specialty chemical and commercial service industries. Both companies are backed by Cascade Investment LLC, an investment firm founded by Bill Gates. Also on the list are two companies backed by KKR & Co. Inc. and TPG Capital LP, both of which have impact strategies. Ingersoll Rand Inc. has a score of 61 and Cushman & Wakefield PLC's score is 34, both above the average score of 17 in their respective machinery and real estate industries, Trucost data shows.

Perfect is the 'enemy of the good'

External pressure for widespread ESG adoption has created some lofty goals for private equity, and the risk is that expectations may be far from what can be achieved in a practical sense.

The push for deeper ESG dialogue and creative solutions from limited and general partners and the community as a whole could give the private equity industry tools for progress in relatively short order. However, "perfect is going to be the enemy of the good here," said Institutional Ltd. Partners Association CEO Steve Nelson during a panel session at the recent EisnerAmper 2021 Annual Alternative Investment virtual summit.

"Industry-led ESG solutions are going to be the best possible outcome for us, as opposed to a rigid regulatory mandate," Nelson said. "The hope is that we don't end up at the end of this with 15 competing frameworks and a whole range of definitions and solutions that don't track across markets or across strategies. That sort of tangle will be a major impediment for all involved."

Trucost is part of S&P Global Market Intelligence.