ESG in Private Equity
In this article
Industries across the board are adopting ESG strategies to combat the growing impacts of climate change. In the latest IPCC Report, experts uncovered that the impacts of climate change are more severe than anticipated. And while this may be a sobering fact, there's still an opportunity to prevent much more severe impacts of climate change by reducing greenhouse gas emissions (by 50 percent by 2030) and scaling up adaptation resilience.
One such industry that can play a significant role in tackling climate change impacts is the private equity (PE) industry. In addition to measuring their carbon footprint, PE firms are uniquely positioned to control and influence their portfolio companies (portcos), given that ESG and climate-related risks are increasingly material for private equity investors.
Integrating ESG in private equity
As mentioned, PE firms are in a unique position to influence their portfolio companies. ESG and specifically climate-related risks are increasingly material for private equity investors given that:
- Portcos face impacts from the physical effects of climate change, known as physical risks, and transitional risks, such as regulatory actions designed to reduce greenhouse gas emissions (e.g., carbon tax).
- Limited partner (LP) investors increasingly require general partners (GP) to report on their approach to addressing climate-related risks.
Key challenges integrating ESG in private equity
General partners (GPs) often cite several challenges in assessing, managing and reporting on climate-related risks, including:
- Ongoing resource constraints and lack of specific expertise on ESG and climate-related risk assessments.
- Difficulty navigating the ESG and climate data landscape (lack of transparency and standardized definitions).
- Productionizing climate change assessments for an entire portfolio.
These challenges are compounded by LP investors increasingly requiring GPs to disclose how they address climate-related risks. When working to address these challenges, GPs should be asking themselves the following questions:
Application of ESG in private equity
The Task Force on Climate-related Financial Disclosures (TCFD) provides an established and well-considered approach across its key dimensions and has a tailored version of its technical manual specifically for PE firms. For each portfolio company or significant holding, GP considerations follow the four critical areas established by TCFD:
Area | Things to Consider |
| Governance | Increase climate awareness and education throughout the organization (board, executive team, management team, customers). Ensure governance is in place to manage climate-related risks. |
| Strategy | Develop a simplified roadmap that focuses only on the material issues impacting the portfolio company and is integrated with the business strategy. |
| Risk Management | Focusing only on material items in portfolio holdings, identify climate risk exposure and define essential climate KPIs for each portfolio holding:
Ensure climate risk is integral to investment processes. For holdings, provide support structure:
|
| Metrics & Targets | Pre-acquisition and after-climate due diligence focus on engaging with the least resilient companies. |
Final thoughts
Faced with the mandate to develop an ESG strategy and execute targeted initiatives, portco leaders may struggle to identify where to begin the ESG journey or how to leverage risk identification and technology to realize their ambitions and commitments. This isn't surprising as there is a wide range of risk mitigation solutions to consider when enabling ESG initiatives. Take, for example, one of California's oldest winery's use of applying technology to mitigate climate risk to realize improved business outcomes.
Finding a partner with a comprehensive end-to-end approach to ESG — one that starts with assessment and strategy and ends with a practical, actionable roadmap for building and realizing sustainability goals while simultaneously identifying and mitigating risk early — can be a critical step along the way. This approach will accelerate value creation among your portfolio companies.