Climate Risk & Action in Private Equity

A growing number of private equity investors are factoring the effects of climate change into their investment decisions, as hurricanes, droughts, wildfires and other extreme weather events become more frequent and severe. According to Robeco's 2021 Global Climate Survey of 300 investors with a total of $23.4 trillion in assets under management, 86% of investors state that climate change will be central or a key factor in their investment policy in the next two years. And while not directly related to climate change, the COVID-crisis was a moment of realization that has accelerated the economy’s decarbonization.

Private equity businesses are seeking to answer climate change challenges, meet stakeholder demands for transparency, reduce the carbon footprint of their portfolio companies, and help those companies spot climate-related risks. To support this transition, we have collected some practical steps for private equity investors to follow as they embark on the climate action journey.

Irina Gilfanova, Sustainability Solutions Architect

Irina works in the EMEA region focusing on defining customer-tailored sustainability consultancy solutions, including climate change and renewable energy strategies across the value chain, greenhouse gas governance, accounting and management, target setting, climate and ESG disclosures.

Growing momentum in portfolio decarbonization

Many private equity (PE) firms have announced ambitious targets and are taking bold action to decarbonize their portfolios. In 2020, Blackstone, the world’s largest PE investor, announced the next step in its ESG roadmap: to cut carbon dioxide emissions across its new investments by 15% within the next three years. As another example, nearly 100 PE firms including large players like Coller Capital, Permira Holdings, and Amundi, representing over $700 billion in assets under management, have signed up to the Initiative Climat International (iCI). The initiative is a first-of-its-kind for climate action in the PE space, led by the world’s largest proponent of responsible investment, UN-supported Principles for Responsible Investment (PRI). It aims to develop guidance for private equity firms on net zero, to be launched at COP26 in November 2021, and create common metrics and methodologies for measuring and reporting emissions to address key data and disclosure challenges in private markets. PE businesses partnering with the iCI are committed to understanding and managing the carbon emissions of their portfolios, and are working towards forward-looking analysis of climate-related financial risk, in line with the recommendations of the TCFD.

In the same Global Climate Survey, respondents reported that half of all assets under management will be committed to net zero in the coming years. However, it also discovered that despite the growing momentum, there are challenges in driving climate action for private equity, including a knowledge gap on the subject. Many investors simply don’t know where to start, or how to make a difference.

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Common challenges and solutions for private equity business climate disclosure and strategy

Across markets and PE business types, there are several commonalities in the main challenges (and solutions) to support climate disclosure and strategy:

1. Understanding the baseline:

Challenge: Data collection and emissions reporting are some of the key challenges for investors in the private equity sector. Measuring financed emissions is a crucial first step in understanding the climate-related risks in a portfolio. It is required to set an emissions baseline, develop science-based targets, act to reduce portfolio climate impact and disclose progress.

The portfolios of private equity firms often include non-carbon-intensive sectors and assets, where other areas of ESG are considered to be more critical. The greenhouse gas (GHG) emissions footprint for these assets is often not available or if available, the quality and coverage of the assessments are limited due to lack of tools and resources.

At the same time, companies with developed emissions inventories and existing processes to collect data and report on emissions may use varying methodologies and follow different standards to calculate and report their footprint. This misalignment may lead to a distorted view on emissions in an investor’s portfolio and mislead the decarbonization strategy. Private equity investments are also often organized to have a limited lifecycle, which creates a need for prioritization of risk management or value creation in a diverse and dynamic portfolio.

Solution: One of the best practices to address data challenges is to provide common guidance and a centralized platform to harmonize emissions calculations and reporting across portfolio companies. A shared data management tool coupled with the best practice methodologies, such as the Global GHG Accounting and Reporting Standard for the Financial Industry, developed by the Partnership for Carbon Accounting Financials (PCAF), helps PE businesses understand the baseline and track performance over time.

By providing a tool and guidance that support portfolio companies in developing their inventories, optimizing reporting processes, and understanding their energy data, PE businesses often uncover significant opportunities and financial savings.

2. Defining the level of ambition and targets

Challenge: Once the baseline is defined and the framework to measure emissions going forward is in place, PE businesses need to set meaningful and actionable targets. There are tools and methodologies available which enable the target modeling process and support public commitments on climate action in financial institutions. However, the complexity around definitions, the difficulty of defining the right levels of ambition, and the technical elements of the target-setting process create challenges for PE businesses with a shorter investment lifecycle. This class of investors needs a pragmatic and efficient way to deliver on decarbonization commitments.

Solution: In April of 2021, PCAF published the Strategic Framework for Paris Alignment. It clearly explains the technical elements of aligning with the ambition of the Paris Agreement and gives guidance to companies navigating the landscape of various initiatives, methods, and tools to support net zero.

The science-based targets initiative is noted in the Framework for setting Paris-aligned or net-zero targets for various financial institutions, including private equity firms. More than 80 companies from the financial sector are committed today to set science-based targets, and the pilot SBT validation framework is offering free target validation for the first 20 companies.

Find a detailed overview of SBTs for financial institutions in our previous blog.

In April 2021, the SBTi updated its guidance and target validation criteria for financial institutions to include recommendations for private equity businesses. Because of the heavy influence they often have over their investees, private equity firms are encouraged to use the SBT portfolio coverage approach for all PE investments, regardless of the percentage share the firm has.

3. Strategy definition

Challenge: In order to gain internal approval of the targets and drive performance on declared commitments, PE businesses must outline a clear strategy with a practical set of actions to support implementation. Having an understanding of the impact on investments and exit strategies is key to ensure the success of the program. Consider:

• If you choose the SBT portfolio coverage methodology to deliver on PE climate targets, what can investors do to transition their portfolio to a 1.5 or well below 2-degree pathway?
• How do you prioritize portfolio companies to engage with?
• What policies and actions should be put in place in different stages of the investment cycle?
• What will be the impact of acquisitions and divestments?

All these questions must be answered to ensure a smooth action plan for target implementation.

Solution: Connecting science-based targets with investment strategy is an essential step in defining climate action and translating the targets into practical actions throughout the investment cycle. Some examples of these actions may include:

• Performing climate risk assessments during due diligence processes and assessing climate-related issues in portfolio company business planning and legal reviews.
• Assigning board-level climate responsibility to support the company's low-carbon transition.
• Conducting footprint assessments and target maturity evaluation as part of the onboarding and initial screening of new investments.
• Defining the timeline and allocating resources needed to transform portfolio companies into SBT-aligned businesses.
• Evaluating projected impacts of future acquisitions and divestments.
• Running pilot SBT projects for select portfolio companies to build internal capacity and validate the strategy.

4. Implementation and decarbonization programs support

Challenge: PE busiensses with a solid baseline, bold commitments, and a well-defined strategy may still be hindered by the lack of tangible actions and slow improvement in portfolio climate performance. One of the biggest risks investors face when publicly disclosing their net zero targets and policies to manage climate-related risks is coming under the scrutiny of external stakeholders. While on one hand, climate action commitments uncover many opportunities, they also run the risk of exposing a company to reputational damage if their actions do not match their words

Having a strong implementation record is crucial, but can be especially challenging for private equity businesses with a limited investment lifecycle. 

Solution: Consider both short-term and long-term climate actions you can use to support your portfolio companies. Some examples may include:

• Endorsing the transition towards 100% renewable energy procurement for portfolio companies:

In 2020, EQT launched a project to analyze the use of renewable energy and to establish clear roadmaps towards a green transition. By December 31, 2020, 31 portfolio companies representing 20,000 sites across 50 countries, had initiated a detailed energy usage assessment and 19 companies had started to evaluate renewable energy alternatives.

• Providing support on energy efficiency and procurement activities

Blackstone developed an energy management strategy, which included a cloud-based platform that captures and normalizes energy and utility data. Paired with external consultant support, the company gained the expertise needed to interpret the data, identify, and act on opportunities for efficiency improvements. Blackstone collaborated with over 20 portfolio companies in 11 industries – from food services to hospitality – to launch climate action and energy management programs. This effort resulted in tens of millions in energy savings from sustainability efforts and strategic energy sourcing and reinforced ongoing relationships and cost reduction with companies after they were divested.

• Providing training and exchange platforms

Since 2014, Eurazeo has developed several CSR acceleration programs to promote the exchange of expertise and best practices that accelerate the roll-out of improvement plans for responsible procurement and climate change. In 2019, these programs were digitized in their form of webinars to encourage their dissemination across a growing community, with 83% of the portfolio companies deploying “CSR Essentials”, including GHG footprint measurement across all emission scopes and responsible procurement.

Early adopters will be the winners

Most private-equity firms are used to fast decision-making and ongoing change processes among their investment funds. This strong track record in successful change management can be translated to confront the decarbonization challenge. PE businesses are well equipped to lead the financial sector’s climate transition and accelerate action across their portfolios.

This is important - because there’s no time to waste. Emerging regulation is driving strong pressure on investors, creating an additional incentive to act on climate quickly. For example, the EU Action Plan on Sustainable Finance has led to a number of fundamental regulatory initiatives in the field of sustainable finance, including the Sustainable Finance Disclosure Regulation (SFDR). The SFDR will provide greater transparency on the sustainability of financial products and channel private investment towards sustainable investing while preventing 'greenwashing'. Similar initiatives on greening the financial sector on the rise in many markets.

If you want to learn more about how private equity businesses can set carbon reduction goals and embark on the decarbonization journey, we are here to help. Contact one of our climate action experts.