The private equity industry is stepping up its adoption of ESG amid a growing appreciation that the energy transition could play to the industry's strengths in terms of pricing decarbonisation and turning around businesses with carbon liabilities.
Private equity firms have been slower to respond to ESG than the investor community, which initially led the charge, but are picking up the pace as they are facing increasing scrutiny from banks under pressure to meet regulators' demands and their own internal net-zero targets.
"We are moving to a world where the sustainability and cost of capital question is more related to what banks are doing rather than investors," said Tanguy Claquin, head of sustainable banking at Credit Agricole, speaking at European private equity firm PAI Partners' Sustainability Summit in London.
Commitments under the Net Zero Banking Alliance, which is part of the wider Glasgow Financial Alliance for Net Zero, are starting to change the way lenders do business as they implement sector decarbonisation pathways for their own portfolios, which could accelerate the pace of change.
Europe’s Corporate Sustainability Reporting Directive will require banks to show data and detailed transition plans to regulators to demonstrate the action that companies are planning to take, and this will increasingly be reflected in cost of capital as banks steer their portfolios using pricing linked to clients' decarbonisation trajectories.
“Because of our regulations and commitments, banks are going to start asking more pressing questions to private equity funds and their clients about their environmental and social data and action plans,” Claquin said.
As ESG disclosure and reporting demands increase, the availability of data is a key issue for private equity firms and leveraged finance more generally, and is one of the priorities that the European Leveraged Finance Association has been seeking to address to empower lenders and drive change, along with carbon reporting for borrowers.
ELFA is seeing differences in data availability between different debt market and instruments, surprisingly with more transparency in the private leveraged loan market than the public high-yield bond markets.
"The broadly syndicated loan market has become the most transparent when it comes to ESG because they're completing ESG fact sheets and putting them in data rooms and the data is there for the lenders to see," said Sabrina Fox, ELFA's CEO.
"Whereas the high-yield market, which is driven by an offering memorandum that is subject to regulation, does not have enough ESG data in there and that really needs to be stepped up," Fox said.
“Future-proofing”
Private equity firms have an edge in decarbonisation due to their ability to price risk and there are significant opportunities for firms in the energy transition and transformation of the energy system that are able to calculate the capex and opex required to decarbonise at the point of entry and exit.
PAI Partners is unusual among its peers as it is already operating with an internal price of carbon that was launched in the second quarter and allows the firm to evaluate and manage potential carbon liabilities of target portfolio companies.
An internal carbon price allows PAI to calculate during its due diligence phase the investment required for decarbonisation and allows for benchmarking the target companies in terms of efficiency.
"We are seeing significant technology drivers in decarbonisation. Investors have to sit up and wake up, and think about how they price this," said Mark Campanale, founder and director of think tank Carbon Tracker.
Campanale sees electrification as the key driver of the energy transition, which will require heavy investment in grids that will ultimately provide energy savings and a resilient financial system to absorb the inevitable writedowns.
"Decarbonisation is going to be expensive, but we're going to end up with a net gain as investors," Campanale said.
PAI has more than €26bn of assets under management and among its 42 portfolio companies, seven have targets validated by the Science-Based Targets Initiative.
Updated story: Updates assets under management in last para