Private equity enters the race to net zero
Last November the Glasgow Financial Alliance for Net Zero marshalled financiers worth $130 trillion to adopt a target of net zero financed emissions by 2050, but one major segment of the financial sector was conspicuously missing. As banks, asset managers, and asset owners claimed the spotlight with their climate commitments, the world’s largest private equity firms stayed silent.
This week, Carlyle Group changed that with a commitment to reach net zero across its full portfolio by 2050, with a plan to bring majority-owned acquisitions into net zero alignment within two years of purchase. The move marks a significant step toward aligning the private equity firm with its finance sector peers, priming its portfolio companies for value creation in a rapidly transitioning economy.
This is new ambition but not totally new territory for private equity, which began integrating climate factors nearly 20 years ago. EDF was an early partner with Carlyle Group, KKR, and others to make environmental measurement and management a best practice for industry leaders and a key strategy for value creation.
Those earlier efforts have led to recent gains. Blackstone, for example, established emissions reduction targets for new investments, while KKR has published a Climate Action Report and launched and scaled its Green Solutions Platform. However, as carbon-intensive assets increasingly flow to private markets, a gap in action by private equity could threaten the success of the energy transition.
Private equity’s approach to asset ownership – often through controlling stakes in companies, board membership, and deep strategic engagement – gives firms unique leverage to drive ESG strategy and execution. As the finance sector leans into climate-aligned investing, focusing on the following three issues will help private equity firms keep up with Wall Street.
Climate Risk Disclosure
The road to net zero begins with enhanced climate risk disclosure. Investors need reliable data to allocate capital to transition-ready assets and monitor portfolio companies’ progress on emissions reduction.
Today, climate disclosure across private markets is notoriously poor. According to a September 2021 study from New Private Markets, less than half of American private equity firms track the emissions footprints of their investments. Limited tracking stems from sparse corporate disclosure. BCG found that in 2019, of nearly 100 private companies surveyed, only 36% reported their greenhouse gas emissions.
Private equity firms can address this gap by requiring their portfolio companies to provide comparable, specific, and decision-useful climate risk information, building on the TCFD framework. Mandating this disclosure will enable firms to calculate their financed emissions, manage portfolio-wide climate risk, and ensure progress towards net zero.
A focus on climate reporting could become even more critical depending on rulemaking from the Securities and Exchange Commission this year. If the SEC mandates climate disclosure for only public companies, carbon-intensive assets may seek private markets to sidestep regulation. In that scenario, disclosure requirement norms can keep the sector from becoming a haven for climate holdouts.
Thoughtful Asset Acquisition
Private equity firms can also lead through climate standards for asset acquisition.
Since 2010, private equity firms have invested more than $1 trillion in fossil fuel assets – double the combined market value of ExxonMobil, Chevron, and Shell. This influx of carbon-intensive business gives private equity firms unique leverage in the energy transition.
Clear, sector-specific climate criteria can help firms wield this influence responsibly. In oil and gas, for example, firms could require companies to commit to zero routine flaring by 2025 or base their methane emission reporting and reduction strategies on measured data to be eligible for investment.
Additionally, as noted in guidance from the Institutional Investors Group on Climate Change, firms can incorporate scenario analysis in investment due diligence to integrate climate risk in asset acquisition.
Responsible Asset Exits
Though private equity firms have become major buyers of oil and gas assets, they also play a key role as sellers. Firms typically exit their investments within five years – too soon to account for the results of long-term transition planning.
Given this investment timeline, private equity firms will need to devote particular attention to exit criteria aligned with net zero. To catalyze tangible climate progress, exit standards should cover both portfolio companies and prospective buyers.
Committing to sell assets only to companies with net zero commitments and transparent emissions reporting, can help firms support long-term environmental stewardship. For oil and gas, investors can ask buyers to address asset retirement, ensuring that wells and facilities are decommissioned appropriately.
Private Equity: A Net Zero Lynchpin
Since 2000, private markets have grown three times as quickly as public markets, with continued growth on the horizon. As private equity’s carbon footprint expands in the near term, clear standards for disclosure, asset acquisitions and sales can help firms position their climate strategy for success in the long term.