Issue 04 of our print magazine is available to buy now

Issue 04 is out now

Private equity: purpose beyond pound sterling

Private equity: purpose beyond pound sterling

In the world of private equity, where investments can be less visible, there aren’t always the levels of transparency that […]

7 minute read

A photo of orange, white, green, blue, yellow and red umbrellas suspended on a light blue sky

In the world of private equity, where investments can be less visible, there aren’t always the levels of transparency that people associate with listed businesses. However, good corporate citizenship is becoming well established for listed companies in developed markets around the world.

With private equity assets now common in investor portfolios, investors have upped their non-financial performance demands, requiring that privately owned companies hold themselves to greater levels of sustainability performance than they would have historically.

A sector report by thinktank and advisory firm SustainAbility, focusing on the financial services sector, states that 2019 will see banks “gradually start implementing the Task Force on Climate-related Financial Disclosures (TCFD) as they learn how to assess and disclose climate risk, while asset managers, investors and banks will continue to engage portfolio companies on priority topics like climate and gender.”

SustainAbility also expects a further influx of environmental, social and governance (ESG) products and greater scrutiny regarding the impacts of those products.

Private equity is beginning to see some companies develop a social conscience

Private equity-owned businesses enjoy far fewer regulatory obligations in terms of corporate reporting and investors have far less visibility of non-financial performance metrics. This is attracting increasing numbers of investors to the asset class, which is on track to surpass hedge funds as the most popular alternative asset. According to Preqin, 79% of private equity investors intend to increase their allocation to the asset class over the next five years, compared with just 27% among hedge fund investors. By 2023, private equity is expected to house more than $4.5trn in assets, making it the largest alternatives industry.

Private equity is beginning to see some companies develop a social conscience, driven by investors demanding they operate with a purpose that goes beyond making stellar returns alone.

Social purpose is important for these individuals and it is comforting to know that the once opaque and murky world of private equity is listening to the growing list of investor demands around environmental, social and governance (ESG) behaviours.

Sustaining a competitive edge

A photo of a silhouette of wind turbines and trees against a blue starry sky

“The Sustainable Revolution is going to transform all global industry sectors in the coming decades,” says Jim Totty, managing partner of Earth Capital, a London based sustainability private equity manager. “Sustainability will offer an enormous competitive advantage across all industry sectors in the 2020s.”

This recognition that private equity-owned businesses will be at a commercial advantage by adopting an environmental and/or social impact agenda is influencing a shift in values.

“Private equity’s Limited Partner (LP) investors have for some time been concerned about the business risks posed by climate change and the market disruption caused by an increasingly decarbonised world,” says Sarah Gilby, director of ESG at Anthesis, a consultancy.

“Ethical investing is now becoming the mainstream … “

“Properties and operations are threatened by physical impacts such as extreme weather, and LPs are conscious of assets becoming “stranded” in sectors such as oil and gas.

“Many LP’s customers and future pensioners also have an increased and vocal desire to know that their pension contributions are being invested sustainably. In some ways, ethical investing is now becoming the mainstream,” she says.

ESG as a priority

More recently, regulations have pushed the private equity industry to up its game, with European and UK-led regulations demanding greater performance on environmental, social and governance metrics. For directors of privately equity-owned companies, this means considering environmental, social impact and governance issues, in some cases, for the first time.

“There are no hard and fast rules, so private equity funds are often in different places of their ESG ‘journeys’,” says Ms Gilby.

there is an appetite to explore the impact water scarcity and climate change have on future business operations and profitability

Bigger and middle-sized funds are generally further ahead, receiving more attention from LPs and their external stakeholders. For instance, there is an appetite to explore the impact that water scarcity and climate change have on future business operations and profitability, or the importance of equality, diversity and inclusion in the boardroom. The latter has been widely influenced by numerous academic studies, including showing superior financial performance for companies with strong sustainability strategies.

Gilby explains that, geographically, funds in the UK and Northern European typically lead the way, with the exception of Japan, but varying degrees of best practice do exist. Industry should look to key players like Apax, Bridges Ventures, EQT, Permira, and The Carlyle Group as exemplars.

The Paris effect

A photo displaying the complex architectural design beneath the Eiffel Tower against a blue sky

According to Gilby, the Paris Agreement and TCFD have created a further stimulus.

The recent protests, the declaration of climate emergencies and the UK Government’s net zero target shows that the market is moving towards rapid decarbonisation, impacting private equity businesses and their potential opportunities.

“Most firms are shrewd enough to recognise energy efficiency as a cost-saving benefit to their portfolio companies that improves bottom-line performance and therefore asset value. This combination of [current] circumstances has led to an increase in the calculation of carbon footprints and work to reduce and potentially offset these. The setting of science-based targets for reducing greenhouse gas emissions is also rising.” says Gilby.

Waste not, want not

There are great examples of private equity investments in the waste management sector where innovation in sustainable water technologies, such as recycling, pollution clean-up and sanitation leads the way.

According to Totty, many industrial sectors consuming large volumes of water are facing increasing gate fees, tightening discharge limits, and economic and stakeholder pressures to reuse and recycle.

“Across chemicals, energy, food and beverages, and pharmaceuticals, water treatment is becoming a pressing concern,” he says. “Traditional primary and secondary water treatment processes are often unable to treat toxic micropollutants in a cost-effective way, leaving contamination in both rivers and drinking water. Pharmaceutical residues in the environment are becoming a key concern in water pollution.”

the SDGs have become a guide for leadership teams on the areas to which businesses should pay close attention.

Arvia Technology, has developed a revolutionary micropollutant treatment system that destroys highly toxic water contaminants.

By offering low capex, low opex and low energy consumption it provides a route to clean industrial wastewater to a quality that was previously uneconomic to deliver. Customers can meet new tightened discharge limits or to reuse high-quality recycled water at the start of their processes.

Another company making inroads with investors is Propelair, which has developed an air flush system that only uses 1.5 litres of water per flush compared to the UK average of 9 litres.

In 2019 the venture is starting to expand further into water-stressed markets across the globe, such as South Africa, Australia and the Middle East.

Audit additions

Ms Gilby cites The Carlyle Group as an example of a company that is now carbon neutral. They achieved this by calculating their carbon footprint (covering office utility use, air travel, commuting and off-site data centres), implementing reduction programmes and offsetting the remaining emissions through a Truck Stop Electrification project.

Meanwhile, Apex Group recently announced the launch of a ratings and analytics product focused on ESG and sustainable finance.

The Group says that ‘GreenLight’ is an in-house developed ESG rating system that evaluates privately held companies globally. It also offers consulting services to support the integration of ESG across clients’ due diligence, value creation and reporting processes.

Apex founder and CEO, Peter Hughes, explains: “This is just the start of the ESG revolution we hope to pioneer across financial services, enabling us to make a positive impact on the world. We envision a future in which a company’s ESG score is as important as its credit score.”

The sustainability agenda has undoubtedly been driven by the United Nations-backed Sustainable Development Goals (SDG). Originally designed to guide governments, these have been adopted and embraced by investors and fund managers invested in private equity. As a result, the SDGs have become a guide for leadership teams on the areas to which businesses should pay close attention.