Private Equity and the Climate Imperative

Coming out of Davos, climate change – and how business leaders can build strategies to support mitigation – continues to be a priority topic for government and private sector leaders.  In tandem with the Net Zero Asset Owner Alliance’s commitment to transitioning portfolios to net zero emissions by 2050, the Alliance has also recently called upon private market managers to align their investments with the 1.5° C pathway and to address climate change across all their business activities.

This call to action will require PE firms to step up their climate game. For those firms still contemplating the impacts of climate on their business or stalling for regulatory direction, now is not the time to debate. Here’s a path for firms looking to establish a credible climate approach: 

Be careful of substituting tactics for strategy. With pressure from climate-focused global investors, a world transitioning towards a low-carbon economy, and peer financial institutions moving ahead with robust climate actions, PE firms should focus on driving value by aligning their climate initiatives with core business decisions. By screening and onboarding climate-focused businesses, engaging and supporting existing businesses to decarbonize their operations, creating a transition plan for gradual exit from certain stranded assets such as coal, and making investments to transform heavy-emitting sectors, PE firms can build an all-encompassing strategy that will set them up for long-term success.

Begin by narrowing the scope. PE firms with investments in multiple asset classes and heavy-emitting sectors should assess and identify assets and sectors with highest impact, taking into account the perspective of both, how investments impact the climate and how the changing climate in turn impacts investments. Similarly, PE firms with exposure to asset-light investments should also consider integrating climate risks into their investment decisions; their investments are not immune to the systemic risks of climate change, even though such investments may not be a risk to climate.

Consider additional criteria such as the region of investments, control versus non-control positions, and the holding period of investments. These boundaries help PE firms focus on companies that have the potential to achieve the most impact, demonstrate credible progress to investors, peers, and regulatory bodies, and ultimately help reduce emissions from the real economy.  

Adopt a holistic approach. Establishing an emissions baseline would help with tracking and reporting progress. If emissions data isn’t available, turning toward the growing number of ESG and sustainability-focused technology companies can make it easy to measure scope 1 and scope 2 emissions at the asset level. This baseline then becomes a good starting point to engage portfolio companies.

In addition, incorporate climate standards into onboarding and acquisition and set targets allowing for a gradual increase in capital allocation for companies geared toward supporting the low-carbon transition. With several large pensions funds and foundations having carved out a separate pool of assets to enable climate technology breakthroughs and scale impact, PE firms could work closely with such investors to structure climate-focused funds. 

Invest in data and technology platforms. With intensifying climate regulations and the demand for rigorous climate data from stakeholders, PE firms should monitor data throughout all stages of the investment lifecycle, from pre-deal evaluation to holding period and exit stage. Reviewing current disclosures relative to existing measurement, monitoring, and reporting processes will identify gaps and help understand the rigor and disclosure required to adhere to evolving regulations.

Collaborate. No firm can combat the climate crisis in isolation. However, private equity as a sector is uniquely positioned to enable a low-carbon future. Some actions PE firms can take in step with peers include joining and actively participating in industry working groups to find solutions that transform heavy emitting sectors; engaging limited partners and portfolio companies to set climate expectations and standardize frameworks for climate reporting; collaborating with peers, advocacy firms, and standard setters to pressure-test climate approaches; and share leading practices. Such partnerships, layered on top of firms’ individual climate approaches, can enable holistic, forward-looking change. Most significantly, PE firms can stoke innovative thinking across the sector. This is the time for experimentation and engagement – the low-carbon future requires organizations to take bold steps, and the PE sector is in the perfect position to drive this change.