In recent years, we have witnessed geopolitical tensions, a higher frequency of extreme weather events, and rising socioeconomic issues. Companies are already feeling the effects. Increased risks; extra costs from shifting consumer demands; the growing regulatory scope of environmental, social and governance (ESG) factors; and direct business disruption from physical weather events are all having an impact. This is affecting supply chains and business continuity plans. It’s also raising data and governance concerns. So what does that mean for firms operating in private markets? At abrdn, we want to unlock the potential value that is associated with sustainability. 

Questioning companies

Given the long-term nature of private markets, we consider a thematic approach when looking for investment opportunities. This caters to both our near-term tactical investment and the long-term trends that are developing in the market. We recognise sustainability as a mega trend, alongside technology and demography.

To this end, we have built an ESG questionnaire, which supports ESG practices and enables healthy dialogue with general partners (GPs). The questionnaire is a voluntary tool that includes questions about a manager’s approach to, and implementation of, ESG factors. This is our first step in constructing an ESG process and collecting data. We will continue to refine and update the questionnaire as data availability and quality improve, and as market standards advance.

The ESG questionnaire has three benefits. Firstly, it allows us to monitor ESG progress across our private-market managers. This provides us with proprietary data that feeds into new investment decisions and helps us to better assess ESG performance. Secondly, it allows us to take a holistic view of ESG engagement and the industry’s progress. Our questionnaire also facilitates ESG discussions within our investment companies, which helps us identify and monitor ongoing material concerns. Thirdly, it highlights a company’s ESG policies and reporting standards. This helps us identify whether there may be any significant issues and opportunities that require more detailed technical assessment, or that need to be managed pre- and post-investment.

The questionnaire can also highlight material ESG factors that may be used to support reporting during the ownership period. In the future, this information could help GPs and portfolio companies benchmark their current ESG position and make improvements. It also enables greater transparency and more comparable portfolio information for limited partners.

The content of the questionnaire references standards from various groups, including the Sustainability Accounting Standards Board framework, Invest Europe’s Professional Standards Handbook and Responsible Investment Bibliography, Institutional Limited Partners Association’s guidelines and the Taskforce on Climate-related Financial Disclosures.

Creating an ESG handbook

The questionnaire covers a broad range of sustainability factors. And the results vary depending on the company’s geographic location, sector, exposure, and asset classes. Therefore, it should only be used to complement a company’s existing due diligence processes. That said, our ESG questionnaire isn’t just a tick-box exercise. We ask companies for detailed information and the responses create meaningful dialogue with GPs about their ESG practices.

Unlike other asset classes, where standardised ESG reporting may suffice, the nuanced nature of private markets needs a more comprehensive approach to assessing ESG factors. While the questionnaire aims to standardise processes and monitor ESG progress, it’s limited by the complexity of quantifying positive ESG outcomes. The evolving regulatory landscape surrounding data concerns also poses limitations. Therefore, we see our questionnaire more as a handbook for developing good ESG practices.

The rationale behind abrdn’s sustainability questionnaire stems from supply and demand factors. For example, regulations around ESG factors are becoming tighter; there is more demand from clients for detail about companies’ ESG practices; and there’s a desire for more information about the ESG risks and opportunities in private markets.

Key investment challenges

The business case for transparent ESG information is not short of challenges. Collating accurate ESG data for private assets remains a pervasive problem. 

  • Access to appropriate ESG data and reporting standards
    The current disclosure standards aren’t consistent and they’re voluntary. This adds to the difficulty of obtaining reliable ESG data. Disclosing comprehensive ESG information remains a choice for private companies, which means there will always be a significant discrepancy about the accuracy and quality of private-market data. Clear sustainability reporting standards have a key role to play in improving reliability over time. With our questionnaire, we are attempting to standardise our processes. For instance, we acknowledge that some companies may be more advanced in their ESG thinking than others. Therefore, the questionnaire is designed to elicit detailed information, where possible.
  • Ability to reliably quantify positive social or environmental outcomes
    The current focus on ESG measurement means that it’s still difficult to accurately capture the complex nature of social and environmental factors. While measurement is both necessary and inevitable, we must be cautious when interpreting these figures. It’s also important that we understand what businesses could do to act effectively on ESG issues. 
  • Lack of regulatory clarity
    The regulatory landscape is still in its nascent stages of development for private markets. While the EU wants to move rapidly on the sustainability agenda and regulation, there are still concerns surrounding a lack of broad consensus on regulatory regimes and alignment for reporting. It is crucial to clarify the legal obligations surrounding ESG law to prudently manage investment outcomes. Other key concerns about greenwashing and a lack of benchmarking within private markets remain a grey area. We expect more clarity on this area as standards develop. 

Final thoughts…

Sustainability is a core component of our investment philosophy. We will continue to drive increased awareness of best practices and cultural buy-in within the private-market industry. This will help influence positive change in the future. In our view, managers and investors alike should not view ESG integration as a new set of requirements. Rather, it’s a contemporary lens through which to preserve and optimise management and business value.