Carbon accounting and sustainability disclosure requirements are coming into force in various jurisdictions, including the EU’s Corporate Sustainability Reporting Directive, the US’s SEC Climate Disclosure rules and California’s Climate-Related Financial Risk and Climate Corporate Data Accountability acts. Complying with these is a priority for investment managers – but they also pose several challenges, as regulatory experts from ILPA, PwC and Seward & Kissel discussed on an ESG webinar last week by our Regulatory Compliance Watch colleagues.

1. What’s in scope?

“There has been a lot of angst around the CSRD of late from our clients,” said Eric Janson, who leads PwC’s private equity practice. There is “ambiguity” around which CSRD and California rules apply to which companies, and the thresholds for in-scope companies are relatively low, he said. For the CSRD, the threshold is: “Do you have in your portfolio subsidiaries that are operating in the EU? You only need to have 250 employees in the EU, €50 million in revenue or €25 million in assets,” said Janson.

2. Getting the data

The CSRD and the California laws both involve Scope 3 emissions disclosures. “Those are probably the most difficult for [clients] to get comfortable with, particularly if you’re looking for some kind of assurance from a third party. This is going to be something that a lot of companies are going to struggle with,” said Debbie Franzese, a partner in and co-founder of Seward & Kissel’s ESG investment management practice.

“Not all of this information is subject to the typical internal control policies and procedures that you might have in your investee companies. It’s not something that sits on the balance sheet,” Janson added. “If you’re trying to disclose whether your electricity is coming from renewable sources or not, and how it’s working through your supply chain, there’s a lot of information that you have to pull from a number of different sources to get to some sort of meaningful disclosure. It’s not going to be without a lot of effort.”

3. Marketing to LPs

The regulations could also affect LP investment appetite, said ILPA managing director Matt Schey. Many institutions will be subject to local disclosure regulations, and many will need to be sure that their fund managers will not fall foul of compliance obligations. “LPs are looking to understand: Do we have a partner who gets what we’re trying to do and is directionally aligned and working towards the reporting and disclosure capabilities that many LPs may need to meet the needs of their boards, their stakeholders and beneficiaries?” said Schey.

Marketing strategies by managers may also need to change as certain ESG claims now need to be backed up by third-party audits. For managers that were “maybe a little more forthcoming” on ESG ambitions when disclosures were voluntary, “it will be interesting to see if they’re now including [these ambitions] in mandated disclosures”, said Franzese. “Or is there going to be more hedging than previous statements?”

The new ESG disclosure regulations are changing the financial norms in private markets. “As I read a lot of the regulatory frameworks coming out… it feels like an accounting challenge. It feels like non-currency accounting,” PEI Group’s financial services reporter Bill Myers, who hosted the webinar, said.