How technology can help the ESG data drive

Tech solutions have helped to transform many aspects of the private equity industry in recent years, and ESG reporting is no exception. As fund managers struggle to collect and keep track of copious quantities of ESG data, they are increasingly turning to tech to help them streamline processes.

The growing role of technology reflects how, for many PE firms, ESG is increasingly a core part of their value proposition. Reporting timely and accurate ESG data from portfolio companies to LPs, regulators and other stakeholders has become a critical task.

Oliver O’Bryan, an ESG project manager at Partners Group, says the increasing importance of ESG data means a more systematic approach to collecting and tracking the data is required. “This data informs investment decisions, is sent to clients for their own reporting and transparency needs, and is shared with regulators,” he points out. “Non-financial reporting and data management needs to be treated in a similar way to how the financial reporting takes place.”

Nevertheless, the data revolution is by no means complete. Just 5 percent of respondents in last year’s Private Funds Leaders Survey, conducted by affiliate title Private Funds CFO, reported that they had a fully automated process for collecting ESG data from portfolio companies. Six out of 10 respondents still had a fully manual process.

Excel no longer excels

As LPs’ and regulators’ expectations around ESG continue to increase, traditional approaches to tracking ESG data, often based around Microsoft Excel, may no longer be fit for purpose. 

“Collecting data on spreadsheets increases the complexity of integrating this information and making it consistent,” says Ellen de Kreij, lead adviser in the ESG practice at Apax Partners. “Validation and comparison become very difficult, because you have to merge all this Excel sheet data. It becomes a beast of a thing.

“Oftentimes, different people will provide ESG information, year-on-year or period-on-period, who might not know what was entered in the previous year or where the data came from… They make mistakes.

“That’s where we have found that a tech solution is so much better than Excel spreadsheets and the like, because it allows you to focus in on data quality and data integrity. It also makes the process for portfolio companies much smoother – they just need to log into an online platform, they can input their data and see what was provided in previous years, enabling better data consistency.”

Perhaps no topic demands greater focus from PE firms than carbon emissions. Several of the largest PE firms have pledged to reach net-zero carbon emissions across their portfolios by 2050, while many others are required to report to LPs that have net-zero goals for their own portfolios.

“Decarbonization starts as a data problem,” says Ellen Moeller, head of Europe at Watershed, a firm offering carbon accounting software to investment firms and corporates. “Without understanding where emissions lie in their portfolio, PE firms cannot properly understand actionable decarbonization transition paths or set achievable reduction targets.”

But Moeller warns that many PE firms that attempt to measure the carbon footprint of their portfolio still rely on “spreadsheets that require huge amounts of manual effort, are prone to error, and don’t enable real-time updates or simulations”. A better approach, she says, is to use software that can “quickly identify hotspots and trends, benchmark peers, and simulate and track transition paths across investments”. 

Moeller adds that tech solutions also facilitate reporting to LPs, regulators and disclosure initiatives. “We’re now seeing alignment around frameworks such as [the Task Force on Climate-Related Financial Disclosures] that allow for consistent reporting standards across industries,” she says, noting that Watershed has “built our software to enable seamless data collection and report generation in line with those standards”.

Limits to tech

There is no shortage of firms offering tech solutions to help GPs with various aspects of ESG data tracking. As well as streamlining data collection and estimating carbon emissions, many platforms offer services around screening acquisition targets, conducting due diligence or managing risks. 

Some of these providers of ESG tech services have themselves received investment from private equity funds in recent years. One such company, Novata, was established by a consortium that includes Hamilton Lane specifically to serve private market investment firms. Josh Green, Novata’s chief operating officer and co-founder, says his company’s mission reflects how private market fund managers have often struggled to find ESG tech platforms that tailor services to their requirements. 

“Unfortunately, most ESG solutions offered to PE firms are not fit for purpose,” he says. “Either they are repurposed ESG solutions that don’t solve for the nuances of data collection in the private markets − or they are general data collection solutions that do not incorporate ESG expertise.” 

Eric Feldman, chief information officer at the Riverside Company, agrees that tech solutions are most useful when deployed alongside ESG experts. “Starting with the tech solution first would be a mistake. There are many solutions to capture data, but if those platforms are only backed by software engineers and not ESG professionals, I would encourage any fund to ask themselves if they just need the tech or could they benefit from the advisory
services too.

“If the latter, look at [companies that] can demonstrate they not only have a great platform but also a bench of ESG advisers who can help to shape the program, too.”

In-house solutions

PE firms also face a dilemma on whether relying on external providers of ESG tech platforms, as opposed to focusing on in-house solutions, is the best approach. Clearly, a tech platform may support the collection of ESG data, but is not necessarily capable of turning the raw data into actionable insights that can help fund managers drive improvements at their portfolio companies. 

Partners Group’s O’Bryan believes that external data providers have a role to play, partly because of the difficulty of accessing ESG data from smaller companies or from companies in which PE firms hold minority stakes. “Data availability in the market is the biggest problem right now for ESG,” he says. “The reality is that at a certain level of ownership you have to leverage external opportunities.”

Yet O’Bryan is one of many ESG professionals in the private equity industry who cautions against an over-reliance on external data providers. “Unfortunately, I see the external providers – and there are many of them – as mainly just a quick fix,” he warns. O’Bryan adds that managers can differentiate themselves from their peers by developing in-house solutions that are tailored to their specific ESG objectives.

One reason why PE firms turn to external tech platforms for support on ESG data is because accurate data is simply not available from portfolio companies. This is particularly the case with portfolio carbon emissions, which are notoriously difficult to estimate.

In the absence of reported data, estimating a portfolio’s carbon footprint typically relies on specialists that can conduct modeling based on proxy data.

Watershed’s Moeller says her firm uses “tens of thousands of emissions factors” to help produce reliable estimates. “Watershed relies on granular data sourced directly from companies to make measurements as accurate and actionable as possible,” she explains. “Where data is not readily available, we rely on smart estimates that are built on our bottom-up measurement experiences with companies.”

Data for data’s sake

Many private equity firms are enthusiastic about the potential for tech solutions, whether developed in-house or by third parties, to assist in collecting and monitoring ESG data from portfolio companies. 

But GPs are much less content with having to respond to ESG data requests from LPs that are delivered via platforms established by the burgeoning universe of tech start-ups.

“We’re dealing with a space where LPs are all sending us their own formats to be filled in on their own data platforms that they’ve just engaged one of these start-ups to do for them in their own templates, and asking for just slightly different pieces of information,” says Apax Partners’ de Kreij. She estimates that around 600 start-ups have formed in response to the perceived need to collect ESG data for asset owners.

At the heart of the problem, de Kreij believes, is that tech start-ups are offering solutions that maximize the collection of ESG data points, without necessarily ensuring that the data is relevant to investors’ strategies. The result is that both portfolio companies and fund managers are at risk of being overwhelmed by requests for immaterial data.

“At the moment, it’s data for data’s sake,” says de Kreij. “Everyone wants to be collecting data, but you have to keep thinking about context, materiality – and about what we are actually trying to do here, which is to engage with the companies in which the funds have invested to help them improve.”

Novata’s Green echoes some of de Kreij’s concerns. “Right now, most organizations are focused on the immediate challenge of collecting data, and most technology solutions are focused on helping tackle this challenge,” he says. In the longer term, however, he is optimistic that tech solutions will facilitate better decision-making on ESG. “Over time, we believe the emphasis will shift from collecting data to continually measuring progress and driving action based on data-driven insights.

“Technology will only be a part of the story,” Green predicts. “Technology works best when it streamlines time-consuming work and essentially fades into the background, so that people can focus on doing the work that only they can do.”