BCG – How private equity can create value through purpose

With pressure growing on private equity firms to address ESG issues, and generate profits, BCG identifies steps the industry can take to drive change

The private equity industry has the potential to be a key driver in fighting climate change, but barriers continue to block the industry from fully realising this potential.

That’s according to a new report, Creating Value Through Sustainability in Private Markets, by the World Economic Forum and Boston Consulting Group.

The report reveals how private equity is uniquely placed to lead the way in capturing value through sustainable transformation of its investments, largely thanks to its relative freedom from short-term pressures and full-ownership models.

However, many firms are missing out on the chance to create real financial value through long-term, sustainable investments thanks to various barriers, with knowledge gaps, internal organization misalignments, and an excessive focus on divestment continuing to block the industry from driving sustainability shifts.

“It is time for private equity to take its role in tackling the global crisis of climate change seriously,” says Shrinal Sheth, Lead, Investing, World Economic Forum.

Transforming ‘grey to green assets’ is sustainability solution

According to the study, firms can improve the sustainability performance of currently high-emitting assets by investing in long-term opportunities to make them greener, instead of pursuing divestment-only approaches.

“Many private equity investors avoid ‘grey’ or high-emitting assets in an attempt to decarboniSe their portfolios,” says Greg Fischer, a partner and director at BCG.

Greg points out that by doing this, firms are missing an opportunity to create real financial value through long-term, sustainable investments.

“We cannot divest our way to global net-zero,” he says. “Meeting the world’s decarboniSation challenge requires investment and engagement [and] private equity, with its ability to 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 toward our global ambition”.

The report points to three enablers for such a transformation, including changing over-time emissions reduction frameworks to supplement existing levels-based portfolio emissions targets.

Also key is carbon pricing, as this will help investors capture the value of their decarbonisation initiatives more directly during the holding period. And clear retirement and decarbonisation policies for high-emitting assets are also essential – to explicitly define the intended trajectories, provide incentives for sponsors to undertake bold sustainability transformations, and make owners accountable for ensuring that the high-emitting assets they divest are sold not to the highest bidder but to new owners with well-defined decarbonisation plans.

“The ownership model in private equity allows for meaningful positive change through data and engagement,” says Marcie Frost, CEO of CaIPERS. “As long-term investors, sustainability is critical to value creation, and we believe the convergence and standardisation of sustainability data will enable a rapid acceleration in the integration of these factors across portfolio companies in our private equity partnerships.”

So, what first steps can private equity firms take to ensure their investments are driving sustainable change? Here, the report identifies the steps to take:

  1. Invest in capabilities and culture The gap in capabilities is one of the main barriers to action for limited partners (LPs) and general partners (GPs) today. Ensure leadership teams include people who have relevant operational and traditional investment experience along with a sustainability mindset.
  2. Focus on a long-term plan Private equity leaders should take advantage of the greater time horizon flexibility in private markets and optimise for the long-term outcome, not just quick wins.
  3. Communicate the plan, along with measurable milestones Given the lengthy time horizon required to see results at the asset and portfolio levels, communicating the long-term plan and progress toward it to all stakeholders is vital to securing and maintaining buy-in.
  4. Don’t just divest, transform While divestment and sector rotation offer quick wins for a single investor, they do not remove sustainability-laggard assets from the global mix. Sustainability challenges need to be addressed head-on by deploying capital to transform these grey assets.
  5. Collaborate to address key barriers Addressing measurement challenges and establishing right incentives cannot be achieved in isolation – LPs and GPs industry-wide must continue to collaborate to set standards and policies.

Creating value through sustainability in private markets report

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