Insights
New guidance, published today, establishes a consistent approach to measuring progress towards net zero for private equity investments, with an emphasis on achieving decarbonisation of portfolio companies.
This guidance forms the private equity component of the Net Zero Investment Framework (NZIF), the most widely used methodology by investors who have made a net zero commitment, taking the total number of asset classes covered to six.
Read: Net Zero Investment Framework Component for the Private Equity Industry
Intended to support any private equity investors who are active in buyout, growth, and associated strategies, it aims to standardise target setting, engagement and reporting between Limited Partners (LPs), General Partners (GPs) and portfolio companies to support progress towards net zero at scale. The all-encompassing approach – between LPs, GPs and portfolio companies – is one of the guidance’s key strengths.
In the guidance we have developed several key concepts for target setting, including ‘influence bands for LPs and GPs’ to reflect the varying levels of influence LPs and GPs have in encouraging portfolio companies to decarbonise.
The development of this guidance was led by IIGCC with significant support from Ceres and Anthesis. Importantly, select GPs and LPs representative of the market, including different strategies, geography and size, also provided inputs.
The ambition is that the guidance will help catalyse climate-related action across the private equity industry.
Influence bands
Our research and consultation with working group members identified specific challenges in considering net zero for the private equity asset class, which this guidance seeks to address. These include data availability from portfolio companies, as well as the varying levels of influence LPs and GPs can have.
NZIF’s four key targets have been adapted specifically with these nuances in mind.
The private equity portfolio coverage target aims to increase the percentage of portfolio companies ‘managed in alignment with net zero’ throughout the milestone years of 2030, 2040, and 2050.
Investors familiar with NZIF will recognise its alignment maturity scale, but the criteria of each rating in this guidance has been adapted specifically for private equity.
The ‘committed to aligning’ stage considers a company’s net zero ambitions within one year of deal close, for example, while the ‘aligning’ stage considers its foundational emissions management practices within two years of deal close.
An ‘influence band’ key helps GPs and LPs to assess their expected exposure to companies when determining portfolio coverage targets, as well the appropriate level of engagement for the engagement threshold target.
For example, a GP growth fund which is a majority shareholder has a ‘strong’ influence level on a portfolio company compared to a fund which is a minority shareholder, or a fund with no board votes.
The same is true of an LP’s influence on GPs. A ‘big ticket’ LP investor has a stronger influence on its GPs, and so on portfolio companies, than a co-investment, or an investment made through the secondaries market. These two targets are the expected starting point for LPs and GPs.
“Game-changing guidance”
In line with the four key targets of NZIF, the guidance goes on to outline a private equity-specific climate solutions target. It advises that LPs should set targets to increase the amount of invested capital allocated towards climate solutions for the milestone years, whereas this is optional for GPs.
Private equity-specific portfolio decarbonisation reference targets are optional for both, though the guidance does provide some detail and suggested best practices. This target would be most relevant for diversified asset managers/owners that wish to integrate their private equity investments into an existing target.
Underpinning all targets is the need for clear, annual data to measure progress, which should flow from portfolio company to GP to LP.
This release follows the recent NZIF infrastructure component, taking the total number of asset classes covered by the framework to six. In line with the principles of NZIF and our work here at IIGCC, it’s investor-led and able to expand as demand grows.
“With this guidance, we sought to align LPs and GPs’ efforts, targets and actions in order to achieve real decarbonisation at the level of portfolio companies,” explained Misa Andriamihaja, Private Equity Lead at IIGCC:
“Bespoke net zero target types and tailored engagement actions sit at the core of this game-changing guidance for all private equity investors to start and progress in their net zero journey.”
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