Private Equity ESG and Climate Change Investment Insights

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Investors and private equity (PE) firms have a pivotal role to play in the fight against climate change. The way in which these financial players select, manage, and influence their portfolio companies can have profound implications for our planet’s health. And it doesn’t stop there. By focusing on climate change investment, ESG, and climate action across all their portfolio companies, investors can also unlock significant economic advantages and drive growth. In this article, we round up the most relevant insights and resources on private equity trends in sustainability and climate change investment.

“The IPCC’s Sixth Assessment Report (AR6) underscored the urgency for financial sector action with its finding that finance for mitigation must be three to six times higher by 2030 to limit warming to below 2°C.”

Science Based Targets initiative (SBTi)

Download the 7 Benefits of Carbon Credits: How to Make the Business Case to the C-Suite to learn about how carbon credits can help you and your portfolio companies drive positive impact and business value.

What are financed emissions?

Financed emissions are the greenhouse gas (GHG) emissions from all the companies in a private equity firm’s portfolio, proportioned by how much of those companies’ activities are financed by the PE firm. These GHG emissions are considered to be the indirect carbon footprint of the PE firm. (Pathzero, PwC)

“Financed emissions are more than 700 times higher on average than a financial institution’s direct emissions.” 

Carbon Disclosure Project (CDP)

Climate change investment and private equity ESG valuation trends

How a company embeds ESG and climate action into its operations is increasingly affecting its financial performance and value. PE firms recognize this and look for opportunities to invest in sustainable businesses or look for companies that they can transform into being more sustainable to drive value growth.

“ESG considerations are being taken into account much earlier in deal making processes, with a clear eye to value creation from the outset. Making a ‘brown’ company ‘green’ makes it more valuable on exit and increases the return on investment.” 

Glenn Mincey, Global and US Head of Private Equity at KPMG

(Coller Capital Summer 2022)

  • A majority of investors in all regions of the world (65%) believe that ESG adds value both through proactive change to portfolio companies and through the exclusion of high-risk investments and business practices.
  • Two thirds of European LPs (64%), and nearly one quarter of Asia-Pacific LPs (24%) and North America LPs (23%) have increased the number of sectors their organizations exclude from investment consideration for ESG reasons in the last five years.

(PwC 2023)

  • 70% of PE firms believe that value creation is one of the top three drivers for their organization’s ESG activities.
  • One-third of PE firms say that ESG was a primary driver of value creation in more than half of their organization’s recent deals.
  • More than half of PE firms (51%) say that they looked at ESG factors when sourcing all their deals in the past 12 months.
  • More than half (57%) also said they look at ESG factors when performing all their due diligence reviews during the past 12 months.

“The fact that half of all private equity investors think ESG investing will in itself boost their portfolio returns should be a wake-up call to anyone who still thinks ESG is a ‘nice to have’ or a PR tool.” 

Jeremy Coller, CIO of Coller Capital

(McKinsey 2023)

  • From 2019 until the end of 2022, private-market equity investors launched more than 330 new sustainability, ESG, and impact funds. The cumulative assets under management in these funds grew threefold, from $90 billion to more than $270 billion.
  • From 2019 to 2022, private equity investments in climate-oriented solutions grew by 2.5x from $75 billion to $196 billion.

(Coller Capital Summer 2021)

  • Three quarters of LPs (76%) ranked climate change and sustainability as the most influential mega-trend when deciding where to invest in the next five years.
  • Nearly half of LPs (47%) believe a robust ESG policy will improve their long-term PE returns. 

(Multiple)

  • In 2022, two-thirds (66%) of total private capital fundraising came from managers with an investment policy that includes ESG issues. (McKinsey 2023)
  • 70% of leaders in private markets report high or very high expectations they will earn a premium for a portfolio company that prioritizes decarbonization and about 65% have high or very high expectations they will be penalized if a portfolio company makes insufficient progress. (BCG 2023)
  • 71% of LPs would consider stopping investing in a fund if the GP did not reach certain standards of ESG-related disclosure within three years. (Coller Capital Winter 2022)
  • 93% of private equity investors said they would walk away from a deal if there was an ESG concern. (Bain 2022)
  • Seven in ten investors agree that businesses should have initiatives to reduce emissions and should develop products and processes that are climate-friendly. (PwC 2022)
  • 53% of revenues of the 500 largest US companies and 49% of revenues of the 1,200 largest global companies are generated in business activities that support the United Nations Sustainable Development Goals (UN SDGs). Moreover, nearly a third of revenues generated by US and global companies align with the EU Taxonomy for Sustainable Activities. (S&P Global 2021)
  • Sustainable investing is projected to grow to $53 trillion by 2025. (Bloomberg 2021)
  • 81% of sustainable indices are outperforming their peer benchmarks. (Accenture/WEF)
  • Publicly traded ESG outperformers that also outperformed peers on margin and growth delivered 200 basis points in excess return to their shareholders over companies that only outperformed financially. (McKinsey 2023)
  • 83% of investors and C-Suite leaders say they expect ESG programs will contribute more shareholder value in five years than today. They’d also be willing to pay a 10% median premium to acquire a company with a positive record for ESG issues over one with a negative record. (McKinsey 2020)
  • JPMorgan Chase plans to invest more than $2.5 trillion over 10 Years to advance long-term solutions that address climate change and contribute to sustainable development.  (JPMorgan April 2021)

(HBR 2022, INSEAD 2020)

  • 90% of LPs factor ESG into their investment decisions and 77% use it as a criterion in selecting general partners.
  • 89% of LPs agreed that ESG criteria play a role in their investment decisions.
  • 77% of LPs already screen private equity fund managers based on ESG criteria, but only 36% believed they received detailed and comprehensive information on ESG issues at the portfolio company level.
  • The top 3 frameworks LPs use when considering a fund investment are the UN PRI, UN SDGs, and SASB.
  • The top theme LPs consider for the UN SDGs is Goal 13, Climate Action.

(PwC, 2022 landing page and report)

  • ESG-oriented assets under management are projected to grow to US$33.9 trillion by 2026, outpacing the industry as a whole.
  • Nearly 8 in 10 institutional investors (79%) plan to increase their allocations to ESG products over the next two years.
  • 8 of 10 US investors plan to increase their allocations to ESG products over the next two years.
  • 81% of US institutional investors plan to increase their allocations to ESG products in the next two years, almost on par with Europe (83.6%).
  • 6 in 10 institutional investors report higher yields on their ESG investments, compared with non-ESG equivalents.
  • More than three-quarters of investors would be willing to pay higher fees for ESG funds.
  • 9 in 10 asset managers believe that integrating ESG into their investment strategy will improve overall returns in the long run.

“In five years, I anticipate that ESG will firmly be part of a company’s equity story. The ESG and climate equity story will be so embedded as a critical part of a company’s competitiveness and value proposition that it will no longer be a separate ask.” 

Glenn Mincey, Global and US Head of Private Equity at KPMG 

Regulatory trends affecting private equity: ESG and climate disclosure

Regulations around ESG and climate disclosure for companies and financial organizations are on the rise. It’s critical for PE firms to stay ahead of this quickly changing landscape to avoid penalties for non-compliance, and to take advantage of incentives that could help transform portfolio companies into more sustainable businesses.

  • More than three-quarters (78%) of investors say that managing regulatory risks is an important factor in including sustainability in their investing decisions, second only to client demands that their portfolios have an ESG lens (82%). (PwC 2022)
  • Disclosure of financed emissions is currently voluntary in the US, though already mandatory in the European Union. US regulators are signaling expectations for enhanced climate risk disclosures, which for financial institutions will likely include an analysis of carbon exposures in their portfolios. (PwC 2023)
  • There are 68 carbon pricing instruments implemented worldwide, including taxes, emissions trading systems, and crediting mechanism. Some jurisdictions allow voluntary carbon credits for compliance. (World Bank 2022)
  • The US Inflation Reduction Act includes several economic incentives for climate technologies – for example, up to $180 per metric ton of stored CO2 in the case of direct air capture (DAC). (McKinsey 2023)

Climate change and reputational risk around ESG claims are becoming de facto business risks that most industries need to account for in their operational planning. It follows that PE firms need to consider these risks during all phases of the investment cycle.

Climate risk

  • Per SASB, climate change is likely to have material financial impact on companies in 72 out of 79 industries. (Harvard Law School, 2021)
  • 93% of companies in the S&P 100 are reporting exposure to material risks (physical or market transition) associated with climate change. (Ceres, 2022)
  • Climate change is the most important environmental focus of investors’ ESG programs – with 93% of LPs reporting that they focus strongly on this risk. (Coller Capital Summer 2022)
  • 43% of PE firms are assessing climate risk in 2022, up from 32% in 2021. (LGT Capital Partners 2022)

Reputational risk (PwC 2022)

  • 87% of investors think corporate reporting contains unsupported sustainability claims (e.g., greenwashing)
  • Three-quarters of investors (75%) say their confidence in sustainability reporting would receive the biggest boost if it were assured at the same level as companies’ financial statements (e.g., reasonable assurance).

“We know that climate risk is investment risk. But we also believe the climate transition presents a historic investment opportunity.” 

Larry Fink, Chairman and CEO of BlackRock

Scope 3, or the GHG emissions that occur in the value chain of an organization, are usually the largest source of a company’s emissions – accounting for more than 70% of total emissions in many cases. PE firms and their portfolio companies will not be able to achieve meaningful ESG targets without addressing Scope 3. Depending on the business, this will not be possible without the use of carbon removals. Companies that have high unavoidable emissions are starting to plan now for how they will address them over the next ten years.

The UN Intergovernmental Panel on Climate Change (IPCC) said in its April 2022 report on mitigating climate change: “The deployment of carbon dioxide removals to counterbalance hard-to-abate residual emissions is unavoidable if net zero…emissions are to be achieved.” 

-(McKinsey)

  • As of February 2023, the Partnership for Carbon Accounting Financials (PCAF) reported that more than 100 banks, asset owners and asset managers have publicly disclosed their Scope 3, Category 15 emissions aligned with PCAF methodologies, including many of the world’s largest financial institutions. (PwC 2023)
  • More than 4,902 institutional investors and PE firms, representing more than $121 trillion of assets under management (AUM) have committed to the United Nations’ Principles for Responsible Investment (PRI). (UN PRI 2022)
  • More than 450 financial institutions belonging to the Glasgow Financial Alliance for Net Zero (GFANZ) have pledged about $130 trillion toward net-zero goals. (McKinsey 2023 and GFANZ 2021).
  • More than 315 signatories with USD $59 trillion in AUM have committed to net zero by 2050 under the Net Zero Asset Managers Alliance (Net Zero Asset Managers Alliance as of Aug 2023). 
  • Nearly 90 private equity firms representing $700 billion AUM signed up to a global climate initiative ahead of COP26. (UN PRI, Mar 2021)

Applying ESG and climate action to portfolio companies

Decarbonization is key for portfolio companies to become more sustainable, and therefore more valuable. However, carbon credits should also be an integral part of any holistic sustainability strategy, particularly for hard-to-abate residual emissions. And as the climate crisis continues to heat up, it’s likely that carbon negative companies, or those that go beyond net zero, will be the ones driving the most value in the future. Carbon credits provide an effective path for portfolio companies to achieve this status.

“Many private equity investors avoid ‘grey’ or high-emitting assets in an attempt to decarbonize their portfolios. 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 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.” 

Greg Fischer, Partner and Director at BCG

(PwC 2023)

  • 90% of PE firms integrate ESG-related risks and opportunities into transformation plans, either systematically or on an ad hoc basis. —up from 73% in 2020.
  • 95% of PE firms embed ESG into due diligence, as well as monitoring and reporting.
  • Nearly 9 in 10 (89%) of PE firms embed ESG into governance, policies, and procedures.
  • 8 in 10 PE firms embed ESG into a post-deal value creation plan.
  • More than two thirds of PE firms (69%) PE firms embed ESG into exit preparation (sale or IPO).
  • One third of PE firms embed ESG into valuation analysis.

(LGT Capital Partners 2022 and 2023)

  • Nearly half (47%) of PE managers are addressing climate change through their ESG policies in 2022, up 13% from 2021.
  • 40% of PE managers are monitoring GHG emissions in 2022, compared to 28% in 2021.
  • 55% of private equity (PE) managers have implemented an approach to climate change in 2023 versus 32% two years ago. Regionally:
    • (a) 62% of PE managers in Europe are actively managing climate change risks, compared to 50% in 2022.
    • (b) 60% of PE managers in Asia are actively managing climate change risks, compared to 40% in 2022.
    • (c) 43% of PE managers in the US are actively managing climate change risks, compared to 33% in 2022.
  • The proportion of portfolio companies disclosing/tracking their carbon emissions in 2022 was 81%, up from 20% in 2016 and 45% in 2020.

(Multiple)

  • Three quarters of European LPs (75%) have dedicated personnel responsible for ESG within their institutions, followed by 38% of Asia-Pacific LPs and 21% of North American LPs. (Coller Capital Summer 2023)
  • Nearly three quarters (71%) of LPs would consider eliminating a manager from consideration if it was unable to provide acceptable standards of ESG-related disclosures. (McKinsey 2023 and Coller Capital Winter 2022
  • Nearly half of LPs (47%) believe a robust ESG policy will improve their long-term PE returns.  (Coller Capital, Summer 2021)
  • Private sector financial institutions (FIs) accelerated their adoption and implementation of science-based targets, quadrupling the number of validated FI targets between 2021 and 2022. (SBTi)
  • 44% of PE firms indicated they planned to focus on improving ESG related factors in their portfolio companies in 2022, and 32% were seeking investments with a good ESG track record, up from 29% in 2021. (S&P, April 2022)

(HBR 2022, INSEAD 2020)

  • The top 3 ESG metrics most important to LPs investing in portfolio companies are carbon emissions per $ of revenue, % renewable energy in energy consumption, and diversity.
  • 64% of the 50 largest funds reported using the PRI and the UN SDGs to integrate ESG into their investment processes. However, only 16% adopted accounting-based frameworks like Sustainability Accounting Standards Board (SASB). 

“The ESG value story today is more than whether the right policies and procedures are in place, it’s about how ESG is embedded in the way the company does business and communicating the way it adds to or preserves the value of the business. A common area for enhancement is improving the alignment of ESG with, and as an enabler of, their broader business strategy.” 

Tania Carnegie, Global and US ESG Lead, Private Equity and Asset Management at KPMG

Private equity ESG: from bottom line to sustainable growth

PE firms are increasingly integrating ESG and climate action measures into their investment strategies. These firms, once primarily driven by bottom-line returns, now recognize the importance of sustainable practices for driving future growth. By decarbonizing their portfolio companies, they position themselves for long-term growth in an era marked by environmental challenges and evolving stakeholder expectations.  

To achieve this value, many PE firms are beginning to set specific emissions reduction targets for their portfolio companies during the investment hold period. Depending on the business, achieving those goals will likely not be possible without the use of carbon removals. Leveraging high-quality carbon credits to achieve decarbonization goals quickly is an effective and complementary approach for moving portfolio companies to more sustainable practices. Examples include offsetting company events and corporate travel.  

Carbon credits can also provide a path to innovation and additional value creation for portfolio companies. For example, Cloverly customer Redwood Logistics, a portfolio company of AEA Investors, created a new offering where their customers can measure and offset their emissions related to shipments. Another example is banks that are offering customers the option to offset emissions related to their credit card transactions. And a global hospitality chain is offering travelers the ability to make climate contributions to help offset their trip.

How Cloverly can help

On a global scale, the rate of carbon removal is falling short of what is needed to meet the goals of the Paris Agreement. To make true progress on addressing climate change, companies must invest in impactful carbon removal alongside decarbonization. However, many PE firms and portfolio companies lack the expertise on when and how to incorporate climate action into their ESG strategy. The voluntary carbon market (VCM) is complex and can be challenging to navigate. With Cloverly as a trusted partner, PE firms and their portfolio companies can gain the education and intelligence needed to effectively engage in the VCM, de-risk their investment, and strategically embed positive climate contributions into their business. Cloverly provides vetted selections of high-quality credits in our Marketplace that are backed by our in-house climate expertise and three independent ratings agencies. Scaling climate action through Cloverly empowers PE firms to take immediate steps toward their own climate goals while also powering their portfolio companies to take action.

To learn more about how you can leverage carbon credits to drive business value for your portfolio companies, download the white paper: 7 Benefits of Carbon Credits: How to Make the Business Case

You may also be interested in reading the Ultimate Guide to Building a Carbon Credit Portfolio to see how to include high-quality carbon removal credits in your climate action portfolio.


About the author:

Julie Yamamoto is the Senior Content Manager at Cloverly. She has over 20 years of global experience spanning multiple sectors. Her work has been featured in several enterprise and nonprofit digital channels, as well as Forbes, TechTarget, GreenBiz, and American Forests. In previous roles, she led content marketing for the OneTrust ESG & Sustainability Cloud and the IBM Center for Applied Insights. She is also a trained Climate Reality leader and has led sustainability initiatives such as IBM AI for Social Good (Environment), Watson Green Advisor, Forests for the Earth, and conservation data science. She has a Master of Science in Marketing Management from Nanzan University and a Bachelor’s in Business Administration from Oglethorpe University.

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