A regular briefing for the alternative asset management industry.
Last week, Carlyle pledged net zero greenhouse gas (GHG) emissions across its investment portfolio by 2050, and committed to significant progress by 2025. The goal itself is important, of course, but the way it will be achieved is perhaps even more newsworthy. As for other private equity firms who have set GHG reduction targets, the commitment is not founded on asset allocation or divestment – an approach whose effectiveness is questioned by academics. As emphasised in Carlyle's announcement, the firm will use the significant influence that it has over the companies in its portfolio to help transition their businesses to a pathway that is consistent with the goals of the Paris Agreement.
This focus on transitioning business through the super-charged engagement that comes with private equity ownership matters. As the Chief Executive of the European industry association, Invest Europe, said recently, the unique features of the private equity and venture capital business model mean that the asset class has a real chance to deliver positive change. That applies to changes that further social and environmental goals just as must as it does to changes that improve financial performance – although, of course, those objectives are increasingly inseparable. Not only is it becoming clear that more capital will flow to asset managers that can contribute to the "just transition", it is also widely recognised that (material) sustainability issues will have a direct impact on risk and on exit value and, therefore, on fund returns.
But the challenges in grasping this opportunity should not be under-estimated. Conscious of reputational and regulatory concerns – and indeed ethical issues – firms are understandably reluctant to sign up to commitments they are not confident they can achieve. Decarbonisation, at least in some sectors and regions, is very challenging, while commitments to invest in climate solutions rely on investible projects being available.
Many private equity and venture capital firms are relatively small and need to invest significantly in the expertise required, both at manager and portfolio company-level. Such investment is certainly in evidence in private markets – and so is guidance that is specifically addressed to private equity. Invest Europe's Climate Change Guide and the private equity specific guidance issued by the SBTi are two prominent examples. Last week saw publication of a consultation draft of another very helpful resource: the IIGCC Net Zero Investment Framework's Private Equity module.
The IIGCC – the Institutional Investors Group on Climate Change – combines over 370 asset owners and asset managers, together speaking for around €50 trillion. The Group launched their Net Zero Investment Framework in March last year, but did not cover private equity. A working group has now addressed that gap, and the draft module is intended to complement the main Investment Framework, giving general partners and limited partners a clear path to committing to Net Zero across the portfolio. The consultation is open until 27 February and the industry may want to weigh in on some of the detail.
The IIGCC Private Equity guidance covers private equity and growth capital, with some recommendations also addressed to venture capital firms. The guidance is designed to be used by investors and by primary funds, but also by funds of funds and secondaries funds – who may find it more difficult to pull the levers needed to fully comply.
...the unique features of the private equity and venture capital business model mean that the asset class has a real chance to deliver positive change...