How PE firms can be the drivers of climate change action

The global private equity (PE) industry can play an important part in the drive towards a greener economy.

That’s according to a report from the World Economic Forum (WEF) in collaboration with Boston Consulting Group (BCG) which says that PE can be a catalyst to fighting climate change.

But, while PE has the ability, thanks to the full-ownership model and relative freedom from short-term pressure, the industry is yet to step up to the challenge en masse.

“Many private equity firms are missing out on opportunities to create real financial value through long term, sustainable investments,” says Shrinal Sheth, Lead, Investing, World Economic Forum. “Industry leaders who are interested in driving climate solutions must act quickly to ensure their firms are operating in ways that allow them to successfully create sustainable value.”

The report found several barriers to PE taking these opportunities including knowledge gaps, internal organization misalignments and an overfocus on divestment.

Grey-to-green approach

Instead of focusing on divestment, the report suggests that PE investors can drive change in assets with high carbon emissions by investing in their long-term transition to greener operations.

“Many private equity investors avoid ‘grey’ or high-emitting assets in an attempt to decarbonize their portfolios,” said Greg Fischer, a partner and director at BCG. “This is a missed opportunity. We cannot divest our way to global Net Zero. Meeting the world’s decarbonization challenge requires investment and engagement. Private equity—with its ability support strategic transformations and a longer horizon than public markets—is ideally positioned to meet this need, transforming high-emitting assets “from grey to green” and making real progress towards our global ambition.”

There are 3 key enablers for this transition:

• Change-over-time emissions reduction frameworks to supplement existing levels-based portfolio emissions targets
• Carbon pricing to help investors to more directly capture the value of their decarbonization initiatives during the holding period
• Clear retirement and decarbonization policies for high-emitting assets that explicitly define the intended trajectories, provide incentives for sponsors to undertake bold sustainability transformations and make owners accountable for ensuring that the high-emitting assets they divest are sold not to the highest bidder but to new owners with well-defined decarbonization plans

WEF’s whitepaper, “Creating Value through Sustainability in Private Markets,” also sets out some important steps that PE firms can take to ensure that their investments are driving sustainable change:

1. Invest in capabilities and culture: The gap in capabilities is one of the primary barriers to action for LPs and GPs today. Ensuring leadership includes people who have relevant operational and traditional investment experience along with a sustainability mindset can be a vital first step in building institutional capabilities.

2. Focus on a long-term plan: Developing capabilities and driving a cultural change may involve false starts along the way. To stay the course, private-equity leadership needs to take advantage of the greater time horizon flexibility in private markets and optimize for the long-term outcome, not just quick wins by doing things like embracing experimentation and lengthening hold periods.

3. Communicate the plan, along with measurable milestones along the way: Given the lengthy time horizon required to see results at the asset and portfolio levels, communicating the long-term plan and progress towards it to all stakeholders is vital to securing and maintaining buy-in. This should be in by using both standardized metrics customized reporting.

4. Don’t just divest, transform: Private equity’s full-ownership model and flexibility to take a longer-term view relative to public markets should enable the industry to transform sustainability-laggard assets but so far it has not capitalized on this opportunity.

Divestment and sector rotation offer quick wins for a single investor, but they do not remove sustainability-laggard assets from the global mix. Sustainability challenges need to be addressed head-on by deploying capital to transform these grey assets.

5. Collaborate to address key barriers: Addressing measurement challenges and establishing the right incentives cannot be accomplished in isolation. LPs and GPs across the industry must continue to collaborate to set standards and policies.

The full whitepaper is available at: https://www.weforum.org/whitepapers/creating-value-through-sustainability-in-private-markets