Novata’s Take: Four Lessons on ESG in 2022

From changing regulations to rising backlash, 2022 has been a tumultuous year for ESG. However, one factor has remained steady: environmental, social, and governance considerations are crucial for businesses—and will only continue to grow in importance moving forward. Private market participants increasingly use these ESG criteria to inform investment decisions, highlighting the need for firms to move quickly to address requests for ESG data.

As we prepare for the challenges and opportunities of the new year, we’re looking back at our top lessons and perspectives from the past year to inform how private markets approach ESG in 2023. 

1. For investors, ESG is a critical tool for risk management:

Despite the criticism against ESG, many private market players believe that ESG is here to stay. According to Alex Friedman, Novata’s co-founder and Chief Executive Officer, and Scott Kennedy, Novata’s co-founder and Chief Strategy Officer, one reason for this is that ESG is a new tool investors can use to solve an existing problem: managing risk. Many of the questions investors have had to consider, such as the effectiveness of a management team and its board oversight or workforce safety records, are included under ESG metrics today. But companies today also face unprecedented risks — for instance, one study estimates that one in five businesses could face significant operational risks due to collapsing ecosystems. Investors will need to account for these emerging risks in their valuations, and can do so using ESG criteria.. 

ESG data should be tracked, measured, benchmarked, and used by investors to adjust their discount rates and valuations. Read the full article in Barron’s.

2. Prioritizing DEI is crucial in a recession: 

Rising inflation and recent reports of large-scale layoffs pointed to a looming economic downturn in 2022. During challenging times, it’s easy for businesses to move DEI initiatives to the back burner. However, this is the time for companies to double down on these initiatives, writes Novata’s Chief Impact Officer Lorraine Spradley Wilson. 

What steps can corporate leaders take to prioritize DEI? Creating an inclusive work environment, investing in antiracist training, and conducting pay equity analysis are good starting points. Tracking workforce metrics and reporting on progress will provide clear insight into how a company is performing on key DEI issues and reveal inequities that need to be addressed. Companies committed to making change should be prepared to do the work, even through difficult economic times. Read the full article in Impact Alpha.

3. PE’s new generation of leaders will be instrumental for ESG adoption:

With private equity managing more than $9 trillion of assets, the industry has an opportunity to play an important role in addressing global crises and creating positive change. As the industry ushers in a new generation of leaders, the proclivities of this group position them to lead the charge on taking ESG mainstream, notes Novata CEO Alex Friedman in an article co-written for Project Syndicate.

This generation of private equity leaders believes that “generating good financial returns means recognizing that sustainability, the environment, and the dignity of workers are core to building enduring enterprises.” Moreover, with LP and regulator interest in ESG data growing, this group can lead the industry on establishing benchmarks and performance standards as firms track non-financial metrics that matter. Read the full article in Project Syndicate

4. SFDR is an opportunity to combat greenwashing:

In an alphabet soup of ESG regulations, the SFDR has been one of the most watched on the horizon. Although SFDR is a European regulation, the mandate’s impact will extend beyond the continent as it requires sustainability disclosures for funds in the EU and funds that market to EU investors.

As Article 8 and 9 funds prepare to meet new requirements in January 2023, Novata’s COO Josh Green and Director of ESG Methodology Kyle Flick argue that the new regulation is creating meaningful opportunities to combat greenwashing. SFDR aims to provide convergence on how funds describe themselves with respect to sustainability, thereby increasing transparency and ensuring fund allocators and managers are aligned on objectives. Will the SFDR accomplish this goal? The simplicity of the framework and the specificity of data collection are a good start, write Green and Flick, but it’s going to take work. Read the full article in MCJ Collective

With 2023 fast-approaching, we look forward to seeing how private markets continue to advance ESG and what’s next for this quickly evolving landscape.