One year into the Biden administration, federal legislative proposals to address climate change have gone nowhere. But federal inaction seems to have had little effect on the implementation of climate goals by private equity firms and their portfolio companies.
“The business community is broadly taking this matter seriously and the LPs on the institutional side are really leading an effort to ensure that managers are doing more,” says Jon Samuels, head of ESG at Vistria, a Chicago PE firm, and a former deputy assistant for legislative affairs in the Obama administration. “All that combined is going to help ensure durable and improving practices on the climate side, regardless of what happens in Washington.”
The lack of federal and state climate policies has actually encouraged PE and venture capital firms to do more to fill in the gaps, says April Crow, vice-president, external affairs and investor relations, at Circulate Capital, a Singapore-based VC firm focused on climate and plastics recycling technology. “We have seen more activity in the last 24 months than in the last 10 years.”
Who occupies the White House can have an effect on the national conversation on climate, such as the opposite positions by the Trump and Biden administrations on the Paris Agreement on climate change, but it doesn’t change LP priorities for ESG in their PE investments, says Mike Bridge, director of operations and ESG leader for MiddleGround Capital, a lower mid-market PE firm based in Lexington, Kentucky.
Learning the lingo
While PE investors are pretty consistently pushing for integrating climate goals and ESG measurements, for some smaller portfolio companies, “it can be quite a lift” to get them to track carbon emissions and learn the ESG reporting language, Bridge says. “This can’t be a burden for the portfolio company. We have to show them how we’re really just a partner with them, and sometimes there’s an element of just education that has to happen.”
PE portfolio companies are understanding that ESG is not different from the traditional levers GPs use to drive investment value, says Lauren Winkler, senior director of ESG at The Green Cities Company, a multifamily real estate PE manager based in Portland, Oregon.
“Portfolio companies are sitting up and taking notice because they’re going to need well-structured ESG programs to realize their value at exit,” Winkler says. “Especially if you’re selling sponsor to sponsor, and you’re going from one entity that has its own integration of ESG and processes around that, you want to be able to demonstrate that this is a company that has had that responsibility mindset through their ownership.”
In the PE investment world, the US lags behind Europe – where institutional investors lead on climate issues – and ahead of Asia, which has the most work to do on the climate agenda, Crow says. Advances in ESG standards usually start with European pension funds or governments, or sometimes in New Zealand or Australia, Winkler says. Then they trickle into the US via large corporations, then into advisers such as Meketa Investment Group, Hamilton Lane and StepStone Group, then to the big US pension funds and the bulge-bracket companies and then into the rest of private equity.
“Unfortunately, government has not really been the leader here. They’re not the tip of the spear,” Winkler says.
One government action that could make a difference is the Securities and Exchange Commission’s recent proposed rule to require public companies to make climate risk disclosures. The proposed SEC rule has added to a new reality that has seemed to settle in for the corporate world over the last two years: that climate change is real and will have to be reckoned with, says Rob Day, partner and co-founder of Spring Lane Capital, a PE firm in Boston.
“It’s just a regular drumbeat of all of these moves in one direction with almost no countermoves in the other direction,” Day says. “Everybody beyond those of us working more specifically around climate solutions, everybody in the broader PE and institutional investor landscape, has gotten religion that this is now a megatrend that they’re going to have to deal with on a decade-old basis.”
The proposed SEC rule could be a good forecast for what to expect in the private markets, Bridge says. “We pay attention to that as an indicator of what we need to make sure we are prepared to report on as well.”
A recent survey of private capital CFOs by Intertrust Group, a Netherlands-based administrative services provider, found that 96 percent recognized ESG as important to their LPs but only 29 percent have integrated ESG into their funds’ investment processes and 51 percent are in the process of doing so.
Most PE firms are happy to engage with their portfolio companies on ESG and climate issues, but the main problem has been the lack of a standardized framework for measuring and reporting on ESG goals, Day says.
In the US, the most popular standards include CDP, GRI (Global Reporting Initiative) and TCFD (Task Force on Climate-related Financial Disclosures). The ESG Data Convergence Project has made some progress toward coming up with a standardized set of ESG metrics, Bridge says. Plus, many PE firms and large institutional investors have their own unique ESG reporting requirements.
Hopefully the PE world will settle on a single industry-based reporting standard in the US, similar to what Europe has with the Sustainable Finance Disclosure Regulation, Bridge says.
“We look forward to just standardization of reporting in general; it’s welcome,” he says. “Anytime you get standardization, you’re able to do more comparative analysis right across funds. It’s great for investors because they can do more accurate comparisons, and they have assurance that the numbers are calculated in the same way.”
Bond rating agencies and insurers will also play a role in requiring climate risk disclosures, which may include examining ESG reporting, Day says. But a US standard on ESG reporting may ultimately come from a decision by a giant pension fund like CalPERS.
“If CalPERS and CalSTRS and lesser-known but other big players want something, they end up getting it,” Day says. “Once somebody like a CalPERS says, ‘Alright, guys, everybody’s going to report according to this standard now,’ everybody will report according to that standard. It won’t just be CalPERS that demands it; even those who don’t have CalPERS as an LP will say, ‘Well, geez, this is the way the direction is heading, so now we’ve got to do it.’”