Climate change and private equity – how environmental concerns will reshape PE strategy

Published on June 20, 2023 by Rabin Thakur

Global investment in PE peaked at USD2,383bn in 2022, an approximately 4% increase from USD2,283bn [1] in 2021. This blog explores the possibility of using PE investments to transition towards a low-carbon economy and meet the needs of adapting to and mitigating climate change. Some estimates suggest that the sector controls approximately USD6.9tn in private assets, either directly or indirectly [2]. Any effort towards reducing global emissions to meet climate-related targets would require the involvement of PE.

Since the Paris Agreement (2015) came into effect, regulations and initiatives around climate-related transparency have increased, particularly focused on public companies and listed fund managers. Private companies, however, escaped this level of scrutiny in terms of climate-related performance at the beginning. In addition to this, countries have time and again come up with national legislation, with issues such as climate change, low-carbon economy and greenhouse gas (GHG) emissions at the forefront. The recent bill presented in France aims to make the country a “decarbonised nation” [3]. The UK Climate Change Act (2008) and the Climate Acts in the Netherlands and Sweden press upon the role national legislations have also been playing in upholding the mandate of climate-related action.

With PE investments increasing, the climate-related impacts of these investments are likely to be noticed and subjected to greater scrutiny. The International Energy Agency suggests that USD21tn in new investment is needed in the next 10 years to meet the Paris Agreement’s target of limiting global warming to 1.5°C. Ten percent of this, i.e., USD2.1tn, is expected to come from private investors, including PE firms, venture capitalists, corporate venture arms and financial institutions [4].

A pertinent question is, what is in it for PE investors taking measures to adapt to and mitigate climate change? A deep dive into the recent trends highlights interesting points on how PE can benefit from a greater focus on climate change.

• Changes in regulatory reporting:
  The changing landscape in terms of sustainability disclosure requires increased reporting from private-market entities. This suggests that private investments would be equally subject to increased scrutiny by regulatory bodies on matters of climate change and emission reduction. As the pool of funds and investments from PE continues to increase, demand for reducing GHG emissions from their investments would rise.

• Risk management:
  The focus on adapting to and mitigating climate change has led to investors seeking information. This has resulted in a need for greater transparency on a company’s material issues, leading to identification of sustainability risks across the portfolio. Identifying ESG risks and managing negative scenarios arising from such risks are critical since recent estimates suggest that “ESG disputes” have cost S&P 500 corporations more than USD600bn in just the past seven years [5].

• Aligning investment strategy with sustainable investing:
  With a greater focus on climate action, PE companies may look to align their investment strategies with investments related to sustainable activities and those with better performance in terms of ESG. Recent reports suggest improved returns from a model portfolio of stocks [6] of European companies considered to be leaders in ESG. Other research relating to real estate indicates early investing in geographies resilient to climate change is likely to generate 70% or higher returns from real estate portfolios by 2030 [7].

• Newer investment opportunities:
  PE investors could capitalise on newer opportunities for investment if they focus on GHG emission reduction and a low-carbon economy. Energy transition, renewables, energy storage, e-vehicles, etc. are newer areas into which investment is expected to flow. Within private investments in low-carbon technologies, the share of emerging technologies, including hydrogen, carbon capture and storage, and carbon offsets, has continued to rise. They accounted for about 1% of all private investments in low-carbon technologies in 2016, rising to 6% in 2021 [8].

• Reducing costs:
  While consensus maintains that working on reducing GHG emissions and moving towards a low-carbon economy is costly, investments in energy efficiency and renewable energy have recently proved to be cost-effective.

• Opportunities for better operational control:
  To meet the requirements of net zero emissions and transition towards a low-carbon economy, PE investors need to engage with their portfolio companies at an operational level. This opens up opportunities for better management of sustainability operations at the portfolio level.

PE markets are witnessing a paradigm shift towards engaging with business models promising to facilitate adapting to and mitigating climate change. A robust, forward-looking approach to climate change is, therefore, the need of the hour, and large PE players are already responding. Private investment in low-carbon technologies such as hydrogen, energy efficiency, fuel cell, e-vehicles and energy storage has continued to increase in the past three years [9]. In fact, it doubled to USD57bn in 2021 from USD30bn in 2020.

“Identifying climate change-related risks and opportunities presents a viable value-generation proposition for PE investments. While on the one hand, portfolio companies are shielded from climate-related risks, it also presents newer opportunities such as investment in transitioning to a low-carbon economy.” – Pratap Narayan Singh, Senior Director and Head of Private Market Services.

How Acuity Knowledge Partners can help

We have been providing bespoke climate research solutions (including regulatory and voluntary reporting) as part of ESG and sustainability support to private-market clients across the world. Our support ranges from climate-related data collection and validation, and climate change research and analysis to net zero target-setting support, value at risk and developing frameworks for analysing companies’ climate-related performance.

We recently delivered the following:

• Published the first-ever ESG disclosure based on the GRI reporting framework

• Data collection on PAIs and the Do No Significant Harm (DNSH) principle for SFDR reporting

• ESG risk profiling for portfolio companies based on publicly available disclosures

• Classification of businesses under Articles 6, 8 and 9 under SFDR

Sources

• [1] Statista: Value of private equity (PE) capital invested worldwide from 2017 to 2022

• [2] Decarbonisation: How PE can make it work (Bain & Co.)

• [3] Le Mode: French Finance Minister mulls ‘green industry’ law

• [4] BCG: Private Investment in Low Carbon Technologies

• [5] Global Risk Management Institute – Article

• [6] Returns on ESG Investing – Reuters

• [7] Harvard Business Review – It is time to invest in climate adaptation

• [8] BCG: Private Investment in Low Carbon Technologies

• [9] BCG: Private Investment in Low Carbon Technologies

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