While ESG is firmly established within many public companies, private markets have generally been further behind the curve. However, that may be changing. Private Equity International’s “Responsible Invest 2023” sheds light on key trends among Limited Partners (LPs) and General Partners (GPs) as they make ESG central to their investment strategies.
Private investments are frequently willing to place capital in riskier investments with potential high returns, often in unproven startups and technologies. Much of the innovation in decarbonization technology, climate risk management and critical mineral recycling is yet to be proven at scale. Other high-risk ESG investment opportunities are new types of financial instruments that place economic value on nature, biodiversity and ecosystems. Society is demanding improvements in the environment and corporate social impacts – driving new business opportunities needing capital in response.
Climate funds were popular in 2022 and are expected to keep growing in 2023. Private funds like BeyondNetZero, TPG Rise Climate, and Brookfield’s all introduced climate solution funds which closed in 2022. These are focused on investing in developing energy and climate solutions. BeyondNetZero states that their team “focuses on identifying entrepreneurs who are addressing climate-focused problems and helping them scale.”
Additionally, Goldman Sachs Asset Management announced that its climate solutions fund closed in 2023, showing continued promise for this form of investment. LPs and GPs are realizing that the energy transition and the move to net zero pose unique challenges that will disrupt the status quo. Those who invest in companies that seize on those challenges by producing marketable solutions will likely be rewarded as the market for sustainable technologies grows.
Biodiversity and nature preservation are also getting attention from LPs and GPs. Investors are recognizing the link between the health of the natural environment and the health of the industries that rely on it. The European Commission stated in a December press release that “50% of our economy depends on nature, yet nature is not given economic value.” However, GPs and LPs are starting to see investment opportunities in nature as investors recognize the intrinsic link between nature and climate.
Isabelle Combarel deputy CEO at SWEN points out this link, stating “I believe that nature has to come ahead of, but be linked to, climate. If you focus just on climate, you may be having negative impacts on nature; if you focus on nature, you will have a positive impact on climate.” Alvar de Wolff, a managing director and head of ESG at Bregal Investments predicts that “nature is today where climate was five years ago.” While climate remains the primary ESG issue for GPs and LPs, nature may be moving up the priority list and is an area of interest to watch.
While climate-related funds are drawing the attention of LPs, ESG in private equity does face some unique challenges. Generally, GPs have smaller ESG teams with less resources at their disposal. This can make data collection, validation and analysis more difficult. Andrew Pitts-Tucker managing director at Apex ESG Ratings and Advisory states it as such “It takes people to [gather and validate data] and there are very few GPs with the teams available. It also requires resources to benchmark.”
Benchmarking is also a challenge. Public companies often produce voluntary ESG disclosures and ESG rating firms monitor publicly available information and produce data that investors can use to benchmark their portfolios on a variety of ESG issues. Private companies exist in a less transparent environment. Oliver O’Bryan an ESG manager with Partners Group sums up the problem by stating “Readily available ESG data is new to private markets and often not shared among industry participants, so it becomes difficult to create benchmarks… There are a lot of external providers working on that, but for now the focus is on transparency before we can ultimately move to benchmarks.”
Progress is being made on benchmarking as LPs are pushing GPs to report in line with existing frameworks often used by public companies and investment firms, like the TCFD and the UN Sustainable Development Goals. Kelly Goddard CSO at Brookfield Renewable recognizes the need for GPs to adopt frameworks stating “LPs expect our measurement and reporting of impact to be quantifiable and transparent. As such, we believe that it is important to align these processes with recognized impact and climate reporting standards and frameworks. This includes the Greenhouse Gas Protocol, IRIS+ and the Operating Principles for Impact Management.”
In addition to existing frameworks, Impact Frontiers and PRE have just released a consultation document for a proposed framework designed specifically for private equity. Benchmarking lays the groundwork for progress on ESG and a set of consistent disclosure rules that allow LPs, GPs, and private companies to speak the same language on ESG may provide a basis for future benchmarking efforts and investment evaluation.
Private markets may have some advantages when it comes to ESG. Unlike public companies where ESG progress is often pushed through via shareholder proposals, the nature of private equity means those companies tend to face less pressure to address ESG. GPs can set net-zero mandates and other ESG goals which are then pushed down their supply chains. GPs establishing ESG mandates should engage directly with the companies they invest in and communicate the value of ESG in a way that creates a unified vision as PwC discussed here.
GPs are also recognizing that robust ESG programs help mitigate risks. Martin Calderbank, managing partner at Agilitas Private Equity discusses his firm’s investments in the healthcare industry stating “To mitigate … risks, we have a rigorous investigation process prior to investment that involves conducting extensive due diligence on the business and completing a 66-factor checklist to assess ESG risks.” As investor demand grows, companies seeking capital will need to align themselves in order to pass emerging ESG due diligence screening from GPs.
Private markets are also uniquely positioned to fund developing areas of climate and nature solutions. As the growing interest in climate solution funds shows, private markets accustomed to higher risk investments can benefit from new and innovative companies looking to tackle the climate crisis. Therefore GPs stand to capitalize on the opportunities presented by ESG. These opportunities are being realized particularly in the renewable energy sector as GPs invest in solar, wind, batteries, hydrogen fuels and carbon capture/sequestration/removal.
What this Means
ESG in private equity is still rather new. While interest is circulating around ESG in private markets, frameworks and benchmarking are lagging. However, the nature of private markets may enable GPs to uniquely influence and benefit from ESG. Some predict that private equity will face a slowdown in 2023. ESG development may provide GPs with a way of creating value and mitigating risk which can help counter those headwinds, and pay off big time.
Many PracticalESG.com tools and resources relating to materiality assessments, ESG data collection/validation, voluntary disclosures and ESG ratings organizations (among many other topics) available to members can directly apply in a private setting. If you’re a privately held company wanting access to these and other resources, sign up now and take advantage of our no-risk “100-Day Promise” – During the first 100 days as an activated member, you may cancel for any reason and receive a full refund.