Five key ESG topics for private companies in 2023

As we look to 2023, ESG factors remain critical business issues for public and private companies alike. In our view, understanding and incorporating material ESG factors as early as possible enables more informed and strategic business decisions for the year ahead. Yet less than half of private company boards assess ESG-related risks and opportunities.¹ In 2023 and beyond, we will continue to work with our portfolio companies to proactively tackle their distinct ESG issues.

Notably, though materiality differs for each company, we think the following five topics are particularly relevant for private companies today.

1. Human capital management and DEI: Heading into 2023, we believe human capital management and DEI will be increasingly essential factors for companies, investors, and regulators. Many companies have heightened their emphasis on employee well-being, productivity, and attrition given the current labor market environment. In the US, the SEC has intensified its focus on these issues as it considers establishing disclosure standards for human capital management valuation and performance data. Such standards would build on a disclosure rule created by the SEC in 2020, requiring public companies to provide information in 10-K filings on their approach to human capital management. In 2021, the SEC also approved Nasdaq’s proposal requiring companies listed on the exchange to disclose their board diversity and meet minimum diversity targets (such as having at least one female director and one underrepresented individual or LGBTQ+ director on their board).
   
   Crucially, we view a company’s DEI practices as a material input to performance. We’ve joined a growing number of asset managers that are asking companies — both public and private — to disclose their DEI strategies as well as the racial, ethnic, and gender composition of their boards and workforce. Importantly, increased focus on these issues is driving results. For instance, 93% of companies in the S&P 500 Index now disclose board- or director-level racial/ethnic diversity metrics, compared to only 60% in 2021. Moreover, 50% of S&P 500 boards now disclose a formal policy to include individuals identified as diverse in the candidate pool for new directors, a substantial increase from the 39% that maintained such a policy in 2021.² A majority of private companies also indicate that their boards’ oversight and understanding of DEI has improved in the past two years.³
2. Climate mitigation and adaption: Climate change will again be a dominant ESG theme in 2023 as global climate-related regulation accelerates, disclosures such as the CDP and the Task Force on Climate-related Financial Disclosures become more standardized (and in some regions, mandatory), and investors’ focus on the climate intensifies. As active investors, we look for companies across all sectors and stages to incorporate thoughtful approaches to climate change into their business models. This includes building resilience for the accelerating transition to a low-carbon economy and the worsening physical events exacerbated by climate change.
   
   Many companies overlook and/or underreport climate-related risks and opportunities that can be material and important to disclose to stakeholders. However, we expect the scope and quality of disclosure to improve in the coming years. For example, the SEC proposed a new rule in March 2022 that would require public companies to report on material climate-related risks, greenhouse gas emissions, and net-zero targets or transition plans. It would also require private companies within public company value chains to provide their emissions data for public company reporting purposes. We believe companies should provide disclosure of location data (physical risks); transition risks and mitigation strategies; and data on emissions, energy consumption, and water usage, among other metrics.
   
   At Wellington, we’re partnering with the Woodwell Climate Research Center and MIT to integrate climate science and investment management. In our view, these considerations are particularly relevant for private firms as they approach a public offering. We believe boards of directors and management teams should be prepared to answer climate-related questions on oversight, physical risks, and transition risks, with the appropriate level of ESG expertise.
3. Governance and shareholder rights: As private companies grow, they inevitably face more complexity and increased scrutiny from investors and the broader public. We believe this makes corporate governance issues — like oversight, independent and diverse boards (by background and by skill set), and succession planning — vital considerations and key areas of potential value add. Importantly, many asset owners, asset managers, ESG ratings agencies, and proxy advisers are taking a harder stance on governance for newly public companies. For instance, some proxy advisers recommend that shareholders vote against the entire board of directors at companies that go public with multiple class share structures and unequal voting rights without reasonable sunset provisions. Additionally, Europe’s Sustainable Finance Disclosure Regulation (SFDR) makes asset managers explicitly define “good governance” without differentiating between public or private companies.
   
   For Wellington, shareholder rights, in particular, are significant inputs into our analysis of a company’s governance. We understand that private companies are at an earlier stage in their life cycle and encourage them to make progress toward adopting best practices over time. We strongly encourage private firms to familiarize themselves with the proxy voting guidelines of asset managers to get a sense of evolving public market shareholder expectations on major issues such as dual-class shares, classified boards, independent leadership, and supermajority voting requirements.
4. Data privacy, security, and transparency: Cybersecurity breaches, inadvertently unethical AI uses, and data privacy/transparency issues are all on the rise. Notably, adapting to COVID-19 forced many companies to bypass certain cybersecurity controls, which contributed to an increase in cyber threats for 81% of global organizations and greater downtime due to cyber incidents for 79% of global organizations in 2021. The average cost per incident in the US in 2021 was US$4.24 million (the highest level in 17 years).⁴ Many private company boards took steps to prevent these risks in 2022, as 68% disclosed they now review their data security practices.⁵
   
   In March 2022, the SEC proposed rule amendments to improve disclosures regarding cybersecurity risk governance. We encourage public and private company boards to enhance disclosure on the rigor of their cybersecurity oversight committees to align with external security process best practices — such as those of the National Institute of Standards and Technology and the Cybersecurity Capacity Maturity Model — and to consider incorporating cybersecurity performance in executive compensation plans.
   
   In addition, trends in data privacy regulation have seen a greater emphasis on consumer welfare and control. In 2018, the European Union (EU) created a set of rules designed to give EU citizens more control over their personal data. Several other regions have since begun implementing similar policies, including California’s Consumer Privacy Act in the US. We encourage companies to adhere to these guidelines, use clear and simple language in their privacy policies, provide high-level disclosure on any AI decision-making processes, and facilitate consumer access to the correction, retention, portability, and deletion of data.
5. Supply-chain resiliency and human rights: Companies are more and more focused on supply-chain resiliency and human rights due to lingering COVID-19-related disruptions, commitments to lower suppliers’ carbon emissions, and the need to meet evolving modern slavery and ethical labor regulations. For example, in June 2022, the Uyghur Forced Labor Prevention Act took effect and now requires companies across a broad set of industries, ranging from consumer goods to technology and electronics, to conduct rigorous diligence to ensure their supply chains are not exposed to forced labor in China’s Xinjiang region.⁶ In our view, many companies were caught off guard by the scope of the new requirement and were unprepared for the potential legal and stakeholder risk to their business. Prominent public athletic apparel and automobile companies have faced criticism for their operations’ connections to the region – due to raw material supply-chain issues and labor conditions, respectively.
   
   Not only is it crucial for companies to consider these factors due to their financial impact, but they may also now be tied to companies’ licenses to operate, as more regulation comes to the fore. Regulations include Europe’s SFDR, which requires investors to report on the human rights and labor standards of the companies in which they invest. To date, the SEC hasn’t explicitly outlined guidance on human rights and modern slavery, but companies may face fines and other legal action for noncompliance with regulations in California, the UK, Australia, and other regions.

Bottom line on ESG for private companies in 2023

The ESG landscape in private markets is constantly evolving. In our view, private companies that proactively address their material ESG issues will be better equipped to navigate the market’s changing expectations. To learn more about these topics, visit our ESG insights for private companies homepage.

¹Source: National Association of Corporate Directors, 2022 Private Company Board Practices and Oversight Survey. | ²Source: Spencer Stuart, "2022 S&P 500 Board Diversity Snapshot," June 2022. | ³Source: National Association of Corporate Directors, 2022 Private Company Board Practices and Oversight Survey. | ⁴Source: Ponemon Institute and IBM Security, Cost of a Data Breach Report, July 2021. To calculate the average cost of a data breach, this research excludes very small and very large breaches. Data breaches examined in the 2021 study ranged in size between 2,000 and 101,000 compromised records. Source: Business Wire, November 2021. | ⁵Source: National Association of Corporate Directors, 2022 Private Company Board Practices and Oversight Survey. | ⁶Source: Bloomberg Law, "China Forced Labor Law Prompts Sweeping Supply Chain Reviews," August 2022.