Unlocking ESG value with climate tech

This article is co-authored by Sienna Bull, Senior Manager, Risk Consulting, Audit, KPMG in Canada, Margarita Rojkova, Manager, ESG, KPMG in Canada and Vivian Tam, Senior Consultant, ESG, Deal Advisory, KPMG in Canada.

Extreme weather events, such as the relentless wildfires across Canada in summer 2023, are having a dramatic impact on people and property around the world. To address the risks of climate change and prevent irreversible damage to the planet and economies, efforts are underway to limit global warming to 1.5°C above pre-industrial temperatures by 2030 (this more ambitious target is 0.5 degrees lower than the earlier Paris Agreement).

Achieving this demands a $32 trillion investment in decarbonization by the end of this decade and many are looking to private investors to finance 70% of that amount.^1,2 There’s growing hope that private equity (PE) firms will achieve net zero by 2050, and there are frameworks that support this, such as The Net Zero Investment Framework of the Institutional Investors Group on Climate Change (IIGCC)).³ As a result, PE firms are seeking actionable and strategic ways to help address Environmental, Social, and Governance (ESG) pillars across their operations and portfolio companies, while building value and growing their businesses.

The question we’re hearing from PE firms and portfolio companies is: How do we start our ESG journey? And those who have already embarked on their ESG journey are wondering where they go next.

To help PE and portfolio companies move forward on ESG, the Canadian Venture Capital and Private Equity Association (CVCA) devoted a recent Invest Canada webinar to discussing roadmaps and technology to help businesses and portfolio companies decarbonize and automate ESG processes.

A live poll conducted during the webinar shows how committed PE leaders are. One third of participants (33%) said they were eager to kickstart their ESG transformation journey, 19% sought to gain a better understanding of what ESG meant for their organization, and nearly half (48%) wanted to learn how to implement digital solutions for ESG reporting and decarbonization.

As onus falls on PE firms to meet net zero targets and decarbonize, sustainability has become a priority for both the C-suite and the Board. Socially responsible investing is well established and financial reporting frameworks, such as the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI), are increasingly aligned with ESG. Every financial decision is now a climate decision.

This added responsibility is good news for PE firms because ESG funds carry less risk, while also outperforming non-ESG counterparts. ESG integration has become an institutional norm, attracting creative investors and opening access to capital in new markets and government incentive programs. Expanding portfolios with companies that are supporting the transition to a low carbon economy (i.e., develop decarbonization technologies) can be lucrative down the road. By all indications, aligning faster and more strategically with the growing ESG agenda is not just a necessity, but an advantage for PE firms.

The trick is how best to strategically guide ESG transformation to trigger effective and timely change. PE leaders need to define a strategic vision, articulate net zero targets, and develop an ESG roadmap that translates to action for its portfolio companies.

Our experience shows that carbon planning works best with a milestone mindset. A short, medium, and long-term ESG strategy, marked by key activities and processes that bring a lower carbon future, generates trust and confers competitive advantage.

Achievable early steps include: setting a vision, developing a strategy, and conducting current state assessments to determine a starting point for the next stage of your journey.

ESG discovery

Conducting ESG discovery helps establish your organization’s ESG maturity level, identify ESG objectives, and set real targets. Firms with low maturity have limited ESG awareness and governance throughout the business and portfolio, and ESG processes are mostly manual. Medium maturity has some capability and controls in place, such as ESG data repositories and ESG reporting pillars. High maturity demonstrates ESG awareness across the business, with ESG processes fully automated and ESG governance models in place.

If your firm is at an early stage of its ESG journey, you’re not alone. In a survey conducted during our webinar, 43% of PE and portfolio companies considered their ESG approach “ad hoc.” Another 19% have reached mid-stage maturity with some capability in place, and only 5% are fully optimized for ESG.

Digital discovery

Data has become central. With so many sources – from third party ESG data providers, to reporting data from regulators, functional data, and raw proprietary data – there are many moving parts to work into emissions calculations. Data quality and availability, sourcing, collection methods, and compatibility all need to be considered from the beginning of the journey. Conducting digital discovery helps you understand current data challenges, assess your data maturity, identify gaps, and determine data readiness.

Another live poll showed that most PE firms are at the discovery stage when it comes to ESG and data readiness. Over a third (36%) were in data collection mode and 21% had advanced to organizing their ESG data. None had progressed to integrating ESG data or were leading with ESG insights.

Next steps

After discovery, you can progress to an ESG-specific data readiness assessment focused on implementing tools. With the maturity gained, you can start designing a data strategy, selecting vendor tools, integrating those tools, and eventually progress to end-to-end automated data solutions that are optimized for ESG.

The middle stage along the transformation journey takes tangible steps to integrate ESG into operations.

Establish your baseline

The first win is to define your baseline greenhouse gas (GHG) emissions, which quantifies the emissions profile of the firm’s operations and investments. For PE organizations, the vast majority of emissions – 93%, according to KPMG data – are Scope 3 financed emissions from portfolio companies.

This baseline picture is crucial to help firms (1) identify carbon-intensive parts of their business and (2) set realizable reduction and net zero targets that meet Science-Based Targets initiative (SBTi) emissions goals for PE firms. Having a baseline helps leaders identify key drivers, make better capital allocation and acquisition decisions, and structure a portfolio composition that protects the company and enables growth.

Create a due diligence framework

The second win at this stage involves setting up a due diligence framework that incorporates ESG into the deal lifecycle. This involves screening potential acquisitions for ESG risks and opportunities, then assessing, benchmarking, and summarizing their ESG performance.

Due diligence shows that adopting a climate lens isn’t simply the ethical thing to do. It drives value throughout the investment lifecycle, from deal sourcing to sale. Preliminary ESG assessments help inform the deal value and provide a foundation to help scale or maintain sustainability performance post-close.

Next steps

Private equity is well situated for ESG integration due to its long-term investment horizon and focus on active ownership. Firms have a strong influence on strategy and operations of their portfolio companies, and adding an ESG impact lens generates new ideas and identifies emerging investment opportunities.

One to two years into the roadmap, organizations will have reached several key milestones and there will be clear ESG ambition for your business and portfolio. Emissions should be benchmarked and there will be ESG due diligence frameworks and processes in place.

You’ll have a better understanding of the current state of existing ESG data, you should have identified data gaps (e.g., data from portfolio companies), and have started developing processes for capturing ESG data and reporting on metrics. The next step is to implement ESG technology solutions and launch an ESG monitoring and reporting process for your organization and portfolio.

 ESG monitoring and reporting

Wins at this stage include digitizing and automating ESG processes, such as carbon accounting, climate risk analytics, and reporting, with the ultimate goal of effectively gathering actionable insights to decarbonize.

Whatever ESG software is used, key capabilities to address with automated tools include data collection, calculation, insights, and reporting. Organizations should clarify their functional and technical requirements and specific process challenges before considering vendors and committing to one specific solution. Defining those requirements in advance will help you invest in the right tools and avoid costly backtracking.

When choosing tools, organizations need to:

• Identify reporting requirements early in the process
• Identify existing tools and platforms that they already have and can leverage
• Build a vendor assessment framework to set criteria and assess procurement policies and vendors
• Conduct high-level research to identify which vendors to engage and issue an RFP to selected vendors
• Conduct vendor demos, score the tools, and shortlist vendors. Consider sandbox testing for strong candidates to let your teams test-drive the tools
• Award contracts to vendors that score highest on submission responses and demos
• Consider training needs and change management in your assessment, and recognize that these are always greater than anticipated.

ESG pillars and practices are about sustaining the planet, people, and communities. Driving value is inseparable from those priorities. The key is to align your business decisions with your ESG initiatives, commitments, and targets. Here are five key takeaways to help guide those decisions and drive sustainability across your processes and your portfolio:

• Don’t substitute temporary tactics for strategy. Invest in a realistic strategy that can be integrated into every level of your business
  
• Start small. Narrow your scope. Build momentum with short-term successes
  
• Take a holistic approach. Consider the downstream and upstream impacts of your ESG transformation
  
• Make a smart technology investment. Instead of rushing to buy the latest technology, understand what you can do with what’s already there.
  
• Engage your stakeholders. Your portfolio companies are on your ESG journey with you. To reduce risks, collaborate.

ESG has applications at every point of the business cycle, from strategy and market trend evaluations to due diligence and climate scenario risk assessments during acquisitions, and ESG implementations in management and ownership.

KPMG’s professional consultants have deep, cross-functional experience assisting PE firms and investors to develop and execute strategies to set targets, reduce emissions, perform due diligence, and enhance data readiness for an ESG defined future. Our teams can assist PE firms at all ESG and data maturity levels to develop and implement an ESG roadmap that helps organizations realize quick wins, automate reporting and compliance, and drive value across their assets and portfolio companies.

Want to see what we can accomplish together? Contact the KPMG in Canada Financial Services team to discuss any aspect of your ESG journey.