Capital Markets Corporate

September 27, 2019

Our ship is sinking. Is it time for private equity to help bail it out?


While climate activist Greta Thunberg recently travelled to New York for the UN’s Climate Action Summit on a shining carbon-fibre, carbon-neutral boat to lobby world leaders into action, the private equity sector does not seem to have set sail yet in efforts to curtail polluting firms.

With public outrage mounting against governments and multinationals alike following a series of blazes in rainforests, a growing number of companies have made environmental pledges, including Amazon and Nike. Yet, despite a poor public perception of the industry following the financial crisis and other high-profile incidents in portfolio companies, private equity has remained relatively quiet on climate risks and more generally environmental, social, and governance (ESG) matters.

A rising tide

ESG criteria are an increasingly popular way for investors to evaluate funds in which they might want to invest. Younger investors in particular have shown a growing interest in putting their money where their values are. That is why the United Nations-convened Net-Zero Asset Owner Alliance, an alliance of pension funds and insurers responsible for a total of $2.4 trillion in investments, announced a commitment to carbon-neutral investment portfolios by 2050.

By following ESG criteria, investors may be able to avoid companies whose practices could signal a risk factor—as evidenced by BP’s 2010 oil spill and Volkswagen’s emissions scandal. Companies with risk management practices that take into consideration broader industry, regulatory and societal risks are more likely to drive long-term sustainable performance—and thus higher returns on investment. In a 2017 CFA Institute survey, for example, 65% of investors said that their motive for taking ESG issues into consideration was to help manage investment risks.

Time for private equity to hoist the ESG flag

If private equity firms are to continue to attract investment and invest in the least risky firms, the time is now to establish best practices in ESG risk management and communications. Private equity should be building their brands in this area to establish credibility with investors as pressures for sustainable practices increase.

Major players such as Blackstone, KKR, Bridgepoint, CVC, and Carlyle are amongst the firms that have already appointed heads of ESG or responsible investment specialists to address the growing demand from investors. But their communications on the issue have been scarce, essentially just communicating around fundraising. Investors are increasingly looking for firms to report on ESG issues throughout the life of a fund.

Equally importantly, as major business investors private equity will be looked to as stewards to monitor how their portfolio companies are managing ESG issues and publicly encourage performance improvement. Also, investment exits will be a great opportunity to have a “great ESG story to tell”, highlighting the improvements made during ownership.

LPs aside, there is also an urgent need for private equity to better communicate on the work they do to a more general audience. As climate impacts become increasingly material and the pace of change in climate action and expectations increases, it is critical for private equity to be more vocal on ESG issues.

Private equity was notably absent from the dialogue at this week’s Climate Action Summit. It is now time for investors to cruise under full ESG sail or risk to be cast away.