Why successful investors focus on sustainability pre- and post-IPO

An EU directive will soon obligate companies to adopt an ESG strategy. In anticipation, pre-IPO candidates should articulate their position.

In brief

• EU is increasing its ESG regulation where investors need to prioritize ESG in their communication strategy as required reporting is likely to begin in 2023.
• There are three ESG reporting strategic questions IPO-bound companies will need to ask when preparing their comprehensive communications plan.

For companies seeking capital and investors alike, sustainability reporting and evaluation has gone from leading practice to standard procedure. Investor relations officers in IPO-bound companies need a compelling environmental, social and governance (ESG) position, strategy, and communication plan to attract and maintain investor attention pre- and post-IPO.

Sustainability reporting is standard for listed companies

Corporate Social Responsibility (CSR) reporting is already a regulatory obligation for many companies listed in the EU and major stock exchanges. Its importance grows as capital market players and institutional investors increasingly consider long-term value and non-financial performance indicators when making their investments. 

With exchange-traded funds (ETFs), special purpose acquisition companies (SPACs), funds, index products and derivatives, as well as equity direct investments, the spectrum of sustainable investments expands. This calls for more information and greater responsibility on the part of financial product providers toward their end investors. 

Since the introduction of mandatory CSR reporting, sustainability reporting has become standard for many listed companies. Therefore, even in the phases before and during the IPO, voluntary communication around CSR criteria, such as ESG, is a key factor for a successful capital market debut. Comprehensive reporting obligations that non-listed companies will be expected to follow from the reporting year 2023 onward further support the impetus for IPO-bound companies to comply.

ESG is one major decision-making factor for investors

When investors are making decisions on where to put their money, one of their top criteria is whether an organization has a robust ESG strategy and comprehensive communication plan. Organizations that don’t will find their pool of investors rapidly shrinking. 

During the 26th United Nations Climate Change Conference of the Parties (COP26), other asset managers joined the “Net Zero Asset Manager” investor initiative. Moreover, in EY’s Global Institutional Investor Survey 2021, 74% of the 324 investors surveyed say they disinvested in companies with poor ESG positioning, while 86% said that companies demonstrating a strong ESG program and performance would have a significant and direct impact on analyst recommendations today. 

Investor relations officers need to make ESG an essential component of their communication strategy

As the communication liaison between the company and capital market participants, such as investors, analysts, regulators and companies, investor relations officers have a significant role to play in successfully attracting the right investors. 

“Yet, in recent surveys of IR officers currently cite a lack of harmonized standards and only limited comparability for investors as challenges in the field of ESG.” Many companies use a formal framework, but there is more than one framework to follow. Nearly two-thirds used Global Reporting Initiative (GRI) for the 2020 financial year, while approximately 10% used the German Sustainability Code (DNK) as a framework for non-financial reporting. 

Index providers and rating agencies also support investors in evaluating ESG criteria. The rating and inclusion or participation in an ESG index, as well as the index ranking, also give clear signals to senior management and their IR departments for positioning and communication.

Investors do their due diligence to assess sustainability risks

However, for investors, the question of existing sustainability risks also arises. There has been an increasing demand for ESG due diligence from venture capitalists and private equity investors in the pre-IPO market phase. They want to know early whether the company carries any sustainability risks that could negatively impact the value of the company.

These may include risks that affect both the course of business (outside-in perspective) and impact people and the environment (inside-out perspective). The outside-in perspective refers to risks to which the company is exposed, such as political decisions (EU Green Deal) or regulatory measures, as well as greater social awareness of sustainability. At its core, it is about the medium- to long-term resilience of the business model during the transition to a sustainable and climate-neutral economy.

The inside-out perspective concerns risks related to the social and environmental impacts of economic activity on the entire value chain of the company. In addition to risks from liability for damages, this is primarily about reputational risks and their impact — particularly on market potential and attractiveness as an employer. As a listed company, the investor relations function must include these sustainability risks as part of the company’s internal risk and compliance management programs.

Standard procedure will become a mandatory requirement from 2023 onward

While ESG reporting may form a company’s standard procedure now, from 2023 onward, content relating to sustainability risks will form a part of the reporting obligations in the management report for all large companies and listed companies — with the exception of listed microenterprises (listed smaller companies). [Does this have a definition quantitively?]

This is another significant change in the context of the revision of the EU Directive regarding sustainability reporting. Compared with the reporting requirements currently in force, this proposal contains comprehensive innovations. 

In the future, companies will need to explain their sustainability-related strategy and the objectives derived from it, the role of the Executive Board and the Supervisory Board, and the significant negative effects in connection with the company and its value chain. This information will be a part of the management report from the reporting year 2023 and is subject to a statutory audit obligation. 

In addition, the EU Taxonomy Regulation — which has already entered into force — obliges certain capital-market-oriented companies to indicate from the reporting year 2021, the share of “green” revenues, investments (capital expenditure) and operating expenses (operational expenditure) in relation to six environmental objectives.

Conclusion

Investor relations officers in publicly listed companies need a comprehensive ESG communications plan that clearly articulates the company’s position and strategy to address ESG to attract investors and satisfy the capital market and regulators.

Therefore, it is vitally important for IPO candidates to act as if they are a listed company with respect to ESG long before they go public. Doing so will enable the company to be classified as a sustainable investment pre- and post-IPO and address wider groups of investors internationally.

In preparing an ESG strategy and communications plan, IPO-bound companies will want to ask themselves the following strategic questions:

• Does the company have an ESG position and strategy?
• Which short- and long-term, as well as financial and non-financial performance indicators does your own company want to be measured against in the analyst guidance?
• What do investors and analysts expect in terms of equity or bond-story-specific topics, and is your company well-prepared to meet regulatory reporting requirements?

Ideally, IPO-bound private companies prepare for this at an early stage as part of a holistic IPO readiness assessment.