Establishing ESG metrics for investment manager due diligence

ESG (Environmental, Sustainability, and Governance) is estimated to be a 70 trillion-dollar asset class, with returns often outstripping traditional rivals by a significant margin. But this golden egg laying goose comes with its own challenges, primarily how to measure and report on the ESG aspects of the investment.

Why ESG due diligence matters

If your ESG investments generate a great return, but are subsequently shown to have fallen short of meeting their original ESG objectives, this can lead to reputational damage, both to your firm and you personally.

This is why your investment manager due diligence needs to be expanded to include measurement of ESG specific metrics as well as your standard due diligence structure, looking at investment strategy, risk, internal controls etc.

How to develop those metrics

Our panel of experts, comprising senior lawyers from the US and UK and a senior accounting firm specialist in the area discuss this in our IMDDA on-line workshop “Due Diligence on ESG”.

Here are a few highlights you can apply right away:

1. Use the quantifiable metrics available

Where your ESG objective aligns with a quantifiable metric, use it. These are the simplest, most transparent ways to observe the degree of adherence to an ESG objective.

Some examples:

• Real estate: You can count units of sustainable housing developed.

• Housing: You can measure energy savings/CO2 emission reduction, etc.

• Jobs & training: You can measure the amount of positions created or the training sessions delivered.

2. Adherence to standards

If an investment manager can commit to following a particular set of standards or a framework in their official documentation (PPM, side letter or LP agreement) then this gives you something that you can measure for your investment manager due diligence on ESG objectives.

Whilst the SEC is still working through building a final standards framework on the measurement of ESG, there are some standards and frameworks available:

• PRI: Their website outlines 6 principles of responsible investing as well as a series of actions for each principle that would enable an investment manager to move from aspirational ESG policies to concrete ESG procedures and actions.

• Sustainability Accounting Standards Board: This organization has developed metric driven sustainability reporting standards, with specific guidance given by industry on its website. These have also been formally shared with the SEC in response to their recent questions so you can expect it to influence the eventual framework developed there.

• BVCA ESG Disclosure Framework: This and similar structures exist throughout Europe and are a more evolved version of the standards we will no doubt see from the SEC in the very near future.

3. Benchmarking

Finally, you need to develop a structure that allows you to compare the values you are measuring and make a meaningful assessment of their worth. Here are a few possible approaches:

• Peers managing compatible portfolios can share their measurements and analyze the wider pool of data

• There are a few common benchmarking indexes available in each industry area, industry averages etc.

• You can also benchmark against your own organization’s historical record for similar investments

• Finally, government metrics in areas such as job creation, energy and housing can also be useful.

To get more detail on this area and other critical ESG investment manager due diligence processes, listen to the rest of the webinar here: