By Ankur Agarwal
In the world of alternative investments, the environmental, social, and governance (ESG) criteria have grown to be an essential component of due diligence, risk assessment, and portfolio management. The growing interest in ESG factors reflects the view that environmental, social, and corporate governance issues including risks and opportunities can affect the long-term performance of issuers and should therefore be given appropriate consideration in investment decisions. This article delves into the emerging standards and best practices in ESG reporting and disclosure in alternative investments.
With the diverse range of assets and strategies, alternative investment managers face numerous challenges when measuring and disclosing ESG information. However, in order to overcome such challenges, industry associations, regulatory authorities, and standard-setting bodies are constantly striving to create best practices and emerging benchmarks for ESG disclosure and reporting in alternative investments. These initiatives are aimed at improving the consistency, comparability, and transparency of ESG information and providing investors with a deeper understanding of the environmental and social effects of their investments.
Best practices and emerging standards
According to a report by Bloomberg Intelligence, global ESG assets are expected to exceed $53 trillion by 2025. As ESG investing gains popularity, limited partners (LPs) are increasingly demanding that investment managers disclose and report on ESG issues. As a result, a growing number of general partners (GPs) are eager to accelerate the incorporation of ESG into their investment strategies.
Alternative investment managers in Europe are increasingly recognizing that ESG compliance is essential for a successful exit strategy. As a result, there is a growing call for greater standardization of ESG reporting across the European alternative investment management industry. A testament to this fact is the rising popularity of regulations and standards like the Sustainable Financial Disclosure Regulation (SFDR), Principles for Responsible Investment (PRI), and the Sustainability Accounting Standards Board (SASB). These frameworks help Alternative Investment managers define the approach to ESG, assess the gaps, and understand the materiality of ESG factors.
In India, regulatory organizations such as the Securities and Exchange Board of India (SEBI) in are also working to establish standards for ESG disclosure and reporting. After some nudge, SEBI’s Integrated Reporting Framework has been widely used by the top 100 companies in India to showcase their ESG performance. It holistically highlights the interlinkages between six distinct but interrelated capitals – finance, manufactured, intellectual, human, social and relationship, and natural. SEBI’s mandate on Business Responsibility and Sustainability Reporting (BRSR) is another landmark. As per its consultation paper published in Feb 2023, SEBI is going a step further by introducing mandatory reasonable assurance on select ESG parameters (called BRSR Core) and adding the listed company’s supply chain to the disclosure criteria. Both are framed to significantly enhance the quality, transparency, and relevance of BRSR reports. These recommendations are also endorsed by prominent investors and financial institutions.
In developing economies like Africa, the LP sentiments are the same as those in developed economies. As more and more African investors are getting convinced that ESG compliance leads to better returns, the demand for ESG reporting is also increasing. However, alternative investment managers in these economies often struggle to incorporate ESG into their investment strategy due to a lack of local standards and regulations, as well as a lack of knowledge and expertise among third-party consultants.
One effective method for ESG reporting and disclosure in alternative investments is adopting a standardized framework like the Global Reporting Initiative (GRI). Frameworks like this provide a common language and structure for reporting on ESG matters, making it easier for investors to compare performance across different investments.
Apart from these frameworks and standards, alternative investment managers can use technology like artificial intelligence and machine learning algorithms to analyze ESG data and identify trends and patterns, thus improving ESG reporting and disclosure.
Naturally, challenges to ESG reporting and disclosure in alternative investments exist. One obstacle is the lack of standardized data and metrics, which makes it challenging to compare performance across different investments. Another issue is the need for greater transparency and disclosure from investee companies, especially in private markets.
Despite these challenges, the trend toward ESG reporting and disclosure in alternative investments is undeniable. Alternative investment managers can not only satisfy investor demand for transparency and accountability but also improve their ESG performance, identify new opportunities, and enhance long-term value creation by adopting best practices and emerging standards in ESG reporting and disclosure.
Conclusion
In this regard, ESG disclosure and reporting can further facilitate awareness and discussion of challenges and solutions related to ESG investing, including with respect to the need for guidance on improving consistency and transparency, alignment with materiality, frameworks, and good practices of benchmark and fund reporting. These are becoming increasingly important considerations for investors and asset managers in the alternative investments industry. Standardization of ESG disclosure and reporting, along with the use of technology and data analytics, is allowing investors to make more informed decisions about the environmental and social impact of their investments. As the industry continues to evolve, it is likely that ESG considerations will become an even more integral part of investment decision-making.
Authored by
(Ankur Agarwal, Co-Founder, CTO, PE Front Office)
