Over the past two years, ESG (Environmental, social and governance) has become one of the most widely used acronyms throughout the world in various circumstances — from climate change to justice reform to corporate responsibility. ESG continues to gain momentum in the investment world as well. Demand for non-financial disclosures and reporting from public companies has grown significantly, not only among sustainability funds, which are thriving, but also regulators that are increasingly moving toward codifying ESG performance.
Following the investments and regulatory trends, it makes perfect sense for private companies planning an initial public offering to plan for and promote their ESG strategies for investors to assess. A good equity story has historically been what investors looked for, now investors also want an equity story with ESG at its heart--a sustainable equity story--a venture's ESG bonafides which go beyond mandatory prospectus requirements.
Make no mistake, although investors expect ESG to be a core part of a company’s strategy, they’re not quite prepared to accept lower returns simply to meet ESG objectives. Rather, they want to invest in businesses that can satisfy shareholders’ financial expectations and also credibly demonstrate that they fundamentally recognize and are responding to the risks and opportunities ESG practices present, most significantly around climate change. It’s imperative that companies considering going public in the next few years have their ESG house in order.
ESG cannot be an afterthought back loaded into an IPO at the 11th hour as a public relations flourish. Rather, ESG must be baked into the purpose and strategy of an IPO from its very outset: What is the timeline for achieving net zero carbon emissions; for developing workforce diversity, equity, and inclusion; for guaranteeing transparency and accountability among executives and board members? What’s more, establishing an ESG infrastructure from the start will roll over into the company’s non-financial performance evaluations once it goes public and gains even more scrutiny from shareholders, regulators, employees, and other stakeholders.
There are increasingly solid reasons for divulging corporate ESG matters. Consider the amount of investment capital gushing into sustainability funds that focus on ESG elements. A Bloomberg news report estimated that by 2025, more than $53 trillion could be invested globally in sustainability funds and portfolios, up from $37.8 trillion by the end of 2021. Additionally, Reuters echoes that outlook, reporting that $649 billion went into ESG funds in 2021, accounting for “10% of worldwide fund assets.”
That sentiment is reflected in PwC’s 2021 Global Investor Survey, in which 325 investment professionals were polled on their attitudes regarding the growing impact of ESG in their decision-making. Nearly 80% of those surveyed view ESG risks as a major factor in their investment evaluations, and nearly half would divest from companies they believe were failing to deliver on ESG commitments. At the same time, however, almost 50% of respondents said they would not take any hit to returns — and most expressed reluctance to accept a reduction exceeding 1 percentage point — in the pursuit of ESG goals.
So if investors are willing to pump ever-growing trillions into existing public companies that demonstrate their ESG performance, it’s logical for IPOs to feature such information in their documentation. Extrapolating that same logic, not disclosing ESG strategies and activities in an IPO may well preclude the sustainability-minded investor from even thinking about funding the company. ESG considerations should be systematized early, often, and continuously in the IPO process.
As ESG continues to evolve into professional audit and assurance services, regulators are joining investors in search of standardized non-financial reporting. The European Union is leading the way, introducing regulations and even provided a “green taxonomy.” New regulations are designed to provide a common set of rules, and to prevent greenwashing. These regulations also enable comparisons for sustainable investment decisions with SFDR and CSRD attempting to increase transparency on sustainability.,
In December, 2021, the U.S. Government warned, for the first time, climate change was an “emerging threat” to the nation’s financial system citing costs associated with more hurricanes, wildfires and floods caused by global warming. The SEC is expected to propose rules in 2022 that could require companies to report their climate risk and human capital management in annual 10-Ks or other public filings.
Meanwhile, at the recent United Nations’ COP26 climate summit in Glasgow, the International Financial Reporting Standards Foundation announced the creation of the International Sustainability Standards Board. Initially, the ISSB’s standard setting efforts will focus on climate-related reporting; however, specific standards involving social and governance behaviours should follow. Speed is critical.
There will be considerable movement on ESG reporting in the coming years that companies can use — as trust begins to build with investors — as they make their respective decisions. While collectively these new efforts do not directly specify IPOs, private company disclosures, and investors’ due diligence, the handwriting may likely be on the wall. Before long, investors and other stakeholders might expect a full range of transparent ESG criteria to be documented publicly, early and often. IPO companies that don’t publish such information, or that publish information that turns out not to be trustworthy, may very well miss out on investment and access to capital.
Conversely, those companies that do tell a credible sustainability equity story will likely engender the feeling of a company that cares about ESG and takes it seriously. Additionally, we believe regulators will increasingly place focus and challenge the credibility of disclosures as this scrutiny is designed to reduce greenwashing, better protect investors and level the playing field.
As we’ve said in the past, trust is critical because in the IPO business, you don’t get a second chance to make a first impression. Two identical companies could end up in very different places simply by virtue of the quality of the ESG information they share.