Investment in environmental, social and governance (ESG) factors is a top priority for private equity, and it has been for quite some time. Thanks to the increasing belief that strong ESG scores command a higher premium, ESG has rapidly transformed from a nice-to-have differentiator into an integral component of each stage of the investment life cycle, from the growing mandate for investment in ESG to asset owners’ calls for general partners (GPs) to apply an ESG lens to all potential investments. This change has also shifted the lens through which new investment strategies are underwritten. In fact, 72% of large private equity firms with annual revenues of $50 million to $1 billion have incorporated ESG strategies into their portfolio of asset classes.
Investor demand has played a key role in this transformation, along with efforts from agencies such as the U.S. Securities and Exchange Commission (SEC) to enhance accountability and engender trust. In the first half of 2022, the SEC released its landmark proposal for climate risk disclosure: a proposal that, if enacted, would elevate the timeliness and rigor of ESG reporting to that of financial reporting. While written with U.S. public issuers at the forefront, the proposal has powerful implications for private equity firms, and it is time to prepare.
Through the Enhancement and Standardization of Climate-Related Disclosures for Investors proposal, the SEC is seeking greater specificity, comparability and reliability of public companies’ climate-related data for the benefit of investors, with an upside for other stakeholders such as policymakers. At a high level, the proposed rule would require:
Note that additional proposals from the SEC, specifically the Enhanced Disclosure Rule and the Names Rule, zero in on public investment companies to provide enhanced clarity.
On the surface, the SEC’s climate proposal applies to U.S. public registrants, so it is understandable to overlook its potential implications for private equity firms, many of which operate within the private markets. However, we see applicability of the SEC’s proposal through three angles:
Since demand for ESG data is not going away any time soon, regardless of what is required by the final climate disclosure rule, it is in the best interest of GPs to take a few “no regrets” steps. The specifics of those steps will depend on a number of factors — including industry, maturity of ESG reporting, ownership and degree of influence and proximity to public markets — but there are several considerations that all private equity firms should keep in mind:
On the surface, ESG reporting may look like an exercise in compliance and risk identification, but in today’s environment, it is also an opportunity for value creation. This is an area where GPs and LPs are closely aligned. In the private equity sector, ESG value creation can manifest at all stages of the investment life cycle, from identifying investments in decarbonization solutions to commanding a higher premium for enhanced employee satisfaction upon exit. Reliable data to prove this value creation will engender further trust among LPs and talent. While the SEC’s proposal is heavily focused on the environmental component of ESG, the social and governance components cannot be overlooked. The private equity industry is making a concerted effort to reduce gender and racial inequality across its investments, and regulation surrounding diversity, equity and inclusion (DEI) reporting may be just around the corner. The market is craving greater specificity and transparency in private equity holdings, and as the regulatory environment continues to take shape, ESG reporting is poised to play a leading role.
 KPMG U.S., ESG Considerations for Private Equity, 2022, https://www.kpmg.us/content/dam/global/pdfs/2022/private-equity-considerations-brochure.pdf.
 Humzah Yazdani, “The Bright Spots in a Complicated ESG Framework,” World Economic Forum, July 25, 2022, https://www.weforum.org/agenda/2022/07/still-reason-for-optimism-about-esg-investing/.
 U.S. Securities and Exchange Commission, “SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors,” March 21, 2022, https://www.sec.gov/news/press-release/2022-46.
 KPMG U.S., SEC Proposes Climate Reporting and Assurance Rules, March 2022, https://frv.kpmg.us/reference-library/2022/sec-proposes-climate-reporting-requirements.html.
 KPMG U.S., SEC Investment Management Proposals Focus on ESG, May 2022, https://frv.kpmg.us/reference-library/2022/sec-investment-management-proposals-focus-on-esg.html.
 U.S. Securities and Exchange Commission, “SEC Proposes Rules.”
 KPMG U.S., ESG Considerations for Private Equity, 4.
 KPMG U.S., Private Equity’s ESG Sea Change, May 2022, https://www.kpmg.us/industries/private-equity/esg-sea-change.html.
 Kristin Broughton and Mark Maurer, “Companies Push Suppliers to Disclose More Climate Data,” The Wall Street Journal, November 17, 2021, https://www.wsj.com/articles/companies-push-suppliers-to-disclose-more-climate-data-11637145001.
 KPMG U.S., An Opportunity for ESG Collaboration, November 2021, https://advisory.kpmg.us/articles/2021/opportunity-for-esg-collaboration.html.