Recommendations for GP selection and VC-focused assessments included.
Proposed net zero guidance on aligning private equity (PE) portfolios with decarbonisation targets is now available to general partners (GPs) and limited partners (LPs).
The latest component of Paris Aligned Investment Initiative’s (PAII) Net Zero Investment Framework (NZIF) outlines the recommended scope, metrics and targets, and implementation actions investors can use when aligning PE assets with net zero ambitions. The guidance can also be incorporated into net zero strategies for multi-asset class portfolios, the report said.
The initiative was established in 2019 by the Institutional Investors Group on Climate Change (IIGCC), the European membership body for investor collaboration on climate change. The NZIF is used by signatories of the Net Zero Asset Managers initiative and the Paris Aligned Asset Owners to guide efforts to achieve net zero emissions globally by 2050 or sooner.
By investing in PE funds as limited partners, asset owners can access larger stakes in scalable innovative companies offering climate-related solutions. As such this is increasingly seen as an attractive option for positive impact and returns as the world transitions away from fossil fuels to renewables.
“When it comes to net zero, PE is currently a blind spot for institutional investors,” said Stephanie Pfeifer, IIGCC CEO.
This is because there is continued limited visibility of how many PE firms are measuring ESG risks and impacts, and how private companies are integrating and fulfilling ESG-related targets.
The NZIF guidance will offer investors a template for the information they need to be measuring and disclosing to demonstrate the decarbonisation of their PE assets, the report noted.
It is open to public consultation until 27 February and will be finalised Q2 2022.
To the extent possible, all PE investments should be included in investors’ assessments of net zero alignment, the IIGCC said.
The current and future expected performance of PE investments needs to be measured and disclosed, with investors aiming to annually increase the percentage of corporates achieving or aligning with net zero and that are actively contributing to climate solutions.
Investors should leverage existing methodologies and metrics for measuring net zero alignment of PE investments to ensure an effective sectoral decarbonisation approach, including the Transition Pathway Initiative (TPI) and the Science Based Targets initiative (SBTi). Assessments should prioritise PE investments in the most carbon-intensive sectors first, the guidance said.
The selection of climate-focused GPs is also an important part of ensuring PE assets are on track with the asset owners’ net zero targets, the IIGCC noted.
According to the NZIF guidance, investors should select GPs that have appropriate screening and exclusion policies in place, are compliant with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and comprehensively disclosing the emissions performance of portfolio companies to LPs on an annual basis.
There is also more tailored guidance for venture capital (VC) investments. To be included in NZIF-aligned assessments, companies should have been in existence for more than five years, have more than 50 employees and an annual turnover over €10 million, the guidance said.
“For any VC investment in a high impact sector, a GP should seek to ensure a climate risk and alignment strategy is considered within the governance structure and a proportionate climate strategy developed to ensure the business model aligns to net zero over time,” the report added.
The UN-convened Principles for Responsible Investment recently highlighted that VC firms are lagging other private markets investors, failing to sufficiently instil ESG-related values in start-up companies.
“This is an important step in bringing private markets – an ever-expanding and influential part of financial markets – in line with public markets,” said Pfeifer. “Ultimately, the more asset classes that can be incorporated into net zero analysis and strategy, the better chance asset owners and managers have of delivering real-world impact.”
Realising investors’ net zero ambitions
More than 50 asset owners have signed up to the PAII’s Net Zero Asset Owner Commitment, which includes the adoption of NZIF to decarbonise their investments across listed equities, corporate fixed income, sovereign bonds and real estate.
This includes UK-based LGPS Central, which recently set net zero commitments that follow the recommendations of the NZIF.
“The NZIF has already proven extremely valuable in helping us assess our listed equities portfolio against our stated net zero strategy,” said James Turner, Investment Manager for UK pension scheme Railpen. “For the first time, we will soon be able to add the asset class of PE to our analysis.”
The NZIF now covers five asset classes: listed equities, corporate fixed income, sovereign bonds, real estate and PE.