ESG considerations have become even more mainstream since the pandemic. But with that comes a dizzying choice of key performance indicators and frameworks available to measure and track the progress of sustainability strategies.
Knowing where to start can often be daunting, particularly with the growing mix of ESG reporting standards, rating methodologies, benchmarks and regulations. Even this year, with the UN’s biodiversity conference scheduled for December, many firms may look to add ecological-related KPIs to their ESG strategies, for example.
So, what are the right KPIs to choose? This decision starts with the specific needs of a business and the wider portfolio. One manager may tie carbon emissions to revenues and feel the need to report Scope 1, 2 and 3 emissions, while to an energy transition vehicle that might be irrelevant. At the portfolio level, measuring energy efficiency, water usage and worker safety could all be essential, while at the governance level the board’s diversity or ESG expertise could equally demonstrate ESG commitment. Ultimately, no one size fits all.
“It is very important that the defined KPIs are relevant and material to the core business of the company, otherwise they are meaningless,” says Silva Deželan, ESG director at alternatives manager Stafford Capital Partners. “ESG KPIs need to be agreed with the management of the portfolio companies, monitored and reported on to their board and investors.”
Marco van Daele, co-CEO at Swiss manager SUSI Partners, adds: “As with all other business-related matters, what is not measured will not be managed, and hence it is crucial to devise, design, implement and control clearly defined KPIs.”
Sustainability-linked KPIs will often differ from firm to firm and asset to asset, and flexibility is evidently needed. But at the same time, drawing up a huge list of KPIs could confuse LPs. “In our opinion, it is more impactful to focus on the execution of fewer actions – being as specific and ambitious as possible – and to measure the relevant KPIs linked to them, rather than trying to measure a very long list of metrics,” says Guido Mitrani, founding partner at Madrid-based Asterion Industrial Partners.
Collecting and making use of quantitative data is also at the heart of the process. But the nuanced differences between firms, geographies and portfolio companies also need to be borne in mind.
“I would definitely say that quantitative data is important, and the demand is only going to grow, but the qualitative part is equally key,” says Sabine Chalopin, head of ESG, sustainability infrastructure at manager Denham Capital. “You have to give it context and the way we try to do that is to provide case studies because you need to understand the whole picture.”
A continuous process
Reviewing and updating KPIs is another valuable exercise. Jordi Francesch, head of asset management at fund manager Glennmont Partners, says the firm annually reviews its KPIs and refreshes those depending on the latest financial regulations and changes to the portfolio. “An example would be health and safety KPIs, which regularly need reviewing,” he adds.
“As with all other business-related matters, what is not measured will
not be managed”
Marco van Daele
Health and safety statistics are often misleading. A data point is only registered on failure and injury rates do not necessarily reflect the potential severity of an incident. An equipment slip-up could result in a minor cut or loss of life; it is just the consequence that is registered. All these factors may need to be weighed into more accurate KPIs.
New frameworks and industry standards are emerging to help firms embed KPIs into better financial decision making and disclose performance to investors. Dan Watson, head of sustainability at London-based Amber Infrastructure, says this has often been easier at the investment level than at the fund level. “Elevating relevant ESG disclosures from investment level to fund level for investors has been challenging, but we are finding SFDR, TCFD and the emerging UK Sustainability Disclosure Requirements helpful in standardising our approach to ESG reporting.”
Indeed, the final draft of the SFDR outlines a mandatory set of minimum 18 environmental and social impact indicators, and at least one from each list of optional environmental and social KPIs, offering investors a clear comparison between infrastructure managers. Under the TCFD, the expectation is for firms to highlight which KPIs are being used to monitor progress against targets and provide sufficient information to assess performance. Similarly, managers will be required to explain their metrics and targets.
Greater standardisation alleviates some of the complications and uncertainties that come with having to choose from frameworks like GRESB Infrastructure Asset Management or SASB Standards, says Watson.
“We want to use our resources to improve the sustainability of our investments, and have a strong preference for disclosing in line with widely recognised benchmarks,” he adds, pointing out that reporting against a raft of disclosures that are unimportant to investors may not be the best use of resources. Over time, this standardisation will “shape KPIs indirectly to improve performance of material issues, including greenhouse gas emissions”.
It’s how you use them
Another way to hold managers accountable is “to link the compensation of relevant people to the firm’s performance on selected KPIs, which need to be relevant to the business and its success”, explains Deželan.
Asterion Industrial Partners started the practice this year at the management company level, linking a percentage of the team’s variable compensation to specific targets. “As part of our ongoing commitment to positive governance, one of our key ESG priorities is to implement equity-based or equity-like management incentive programmes across all our portfolio companies,” says Mitrani. “The aim is to share these plans not only with top management, but also allowing very broad participation and ensuring success is shared with the wider management teams.”
The UN-supported Principles for Responsible Investment says that if structured appropriately and implemented effectively, ESG-linked pay could increase firm value, rebalance performance targets in favour of long-term strategy, and create better accountability for sustainability-based results across management.
But critics point to dangers, too. Businesses lagging their KPIs may avoid disclosing accurate information for fear of losing bonuses. Research from NatWest bank found that out of 916 companies surveyed with ESG-linked executive pay globally, the companies with the highest absolute emissions still paid CEOs more than those with lower emissions.
There could be many mitigating factors involved here, but a lack of accountability and data transparency certainly undermines the process and adds financial risk. Under this scenario, managers may need to explain to investors why they missed goals and whether KPI metrics could be improved.
To achieve that elusive blend of authenticity and success, managers need to take their time setting the right ESG goals for the right elements of their portfolio, incorporating those objectives into compensation packages, and putting in the work to keep them relevant and meaningful.