Unique Opportunities for The Private Equity Industry to Drive Change: Study

A new whitepaper, “Creating Value through Sustainability in Private Markets,” released by the World Economic Forum offers key steps the private equity industry can use to drive change.

This is after the study, which was done in collaboration with Boston Consulting Group (BCG), explored how the private equity industry has a unique opportunity to be a key driver in fighting climate change. With its full ownership model and relative freedom from short-term pressures, the industry is well placed to lead the way in capturing value through the sustainable transformation of its investments.

“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.” 

However, key barriers like knowledge gaps, internal organization misalignments and an overfocus on divestment are still blocking the private equity industry from fully realizing its potential in driving sustainability shifts.

Transforming “Grey to Green” assets

Instead of divestment-only approaches, the study shows that private equity firms can improve the sustainability performance of currently high-emitting assets by investing in long-term opportunities to make them greener.

In fact, the industry is ideally positioned to play this role, due to its full-ownership model and longer time horizon, relative to public markets.

“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, and a co-author of the whitepaper. “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 to 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.”

Three key enablers for this transformation include:

• 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

“The ownership model in private equity allows for meaningful positive change through data and engagement,” said Marcie Frost, CalPERS’ Chief Executive Officer. “As long-term investors, sustainability is critical to value creation, and we believe the convergence and standardization of sustainability data will enable a rapid acceleration in the integration of these factors across portfolio companies in our private equity partnerships.”

“As investors and partners, our job is to improve all aspects of a business to drive growth and improve how they operate over the long haul,” said Kewsong Lee, Carlyle’s CEO. “In a rapidly changing world, that increasingly means helping companies to improve their performance on ESG issues. This is a job we are positioned particularly well for given our ownership stakes, investment horizon, and expertise.”

Five steps for sustainability in private equity

The whitepaper has identified five first steps private equity firms can take to ensure 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.

“Private equity leaders can take these five ‘Monday morning’ priorities as first steps to help their firms fully realize their important role in decarbonizing hard to abate sectors,” says Shrinal. “It is time for private equity to take its role in tackling the global crisis of climate change seriously.”