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October 5, 2021updated 21 Feb 2022 1:13pm

Private equity firms pressured to step up on stewardship

Under fire for their lack of transparency and buying of out-of-favour fossil fuel assets, private equity managers are being urged by their clients and others to use their capital and clout more positively.

By Vibeka Mair

private equity, stewardship

Cyrus Taraporevala, president and CEO of State Street Global Advisors, is among those criticising the private equity industry. (Photographer: Kyle Grillot/Bloomberg via Getty Images)

  • There are widespread concerns the secretive private equity industry is not using its influence and capital effectively for positive impact.
  • The CEOs of fund houses BlackRock and State Street Global Advisors, among others, lament that private equity firms are funding fossil fuels.
  • But asset owners and other organisations are pushing general partners to improve their levels of transparency and their focus on ESG factors.

While some private equity firms are taking sustainability more seriously, it will likely take time – and pressure from clients – for the industry to undergo an ESG renaissance. In the meantime, concerns are rife about whether the industry is doing enough to help transition high-carbon assets to a low-carbon economy.

For good reason, it seems. Stewardship is irrelevant to private equity strategies, said nearly half the respondents to a question in a new survey on sustainable investing (see chart below). The poll was conducted by UK-based consultancy Redington, which published the findings late last month.

The finding may come as a surprise to some, given that the UN’s Principles for Responsible Investment (PRI) defines stewardship as: “The use of influence by institutional investors to maximise overall long-term value including the value of common economic, social and environmental assets, on which returns and clients’ and beneficiaries’ interests depend.”

Certainly Nick Samuels, head of manager research at Redington, says “public assertions of stewardship integration are not being backed up in reality, and that’s a major frustration”.

Yet, as the report notes, private equity firms are particularly well-suited to exercise stewardship, given the scale and longevity of their investments and their strong influence over the governance of their holdings.

Redington’s findings will also further worry those who feel that fossil fuel-related investments need robust stewardship to navigate the low-carbon transition. Private equity has emerged as a major buyer of such assets as others have offloaded them, and has thereby been filling the financing gap for thermal coal, says a report published in May by Sustainable Fitch, part of the Fitch Ratings company.

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Capital Monitor contacted several private equity firms that had bought coal assets in the past five years for comment. One declined to do so, while the other three did not respond to queries.

After all, private equity firms “can easily get rid of the CEO if he or she isn’t doing a good job”, Robert Eccles, visiting professor of management practice at Said Business School at the University of Oxford, said during a panel event at the World Economic Forum’s Sustainable Development Impact Summit in September.

“Look what [hedge fund] Engine No. 1 went through to get three people onto the board of [ExxonMobil],” he added.

Growing private equity clout

Yet private equity managers generally have a lot more influence over their investee companies – to go with their typically larger stakes and level of contact with management – than the average hedge fund.

It will only become more important that they do so, given the rapid growth of private equity. The industry’s assets under management are expected to more than double between 2020 and 2025, from $4.41trn to $9.11trn, according to data provider Preqin.

Investor network Ceres and sustainability consultancy ERM published a report in June highlighting the key role that private equity can play in the low-carbon transition.

But there are widespread fears that many general partners (GPs) are not using their clout effectively for responsible purposes – especially as they tend to be secretive.

Public assertions of stewardship integration are not being backed up in reality, and that’s a major frustration. Nick Samuels, Redington

The heads of two of the world’s biggest asset managers – Larry Fink of BlackRock and Cyrus Taraporevala of State Street Global Advisors – have voiced such concerns. They argue that private equity investors holding fossil fuel assets are less transparent and less regulated, and divesting stock to them is akin to greenwashing or ‘brown-spinning’ and will not help the world achieve net-zero emissions.

“Some of these companies are taking the easy way out and getting rid of the assets and selling them to someone else,” Taraporevala said, speaking on the same panel as Eccles. “There are many private equity investors who look at the assets and see an attractive rate of return.

“The irony is that when these assets get sold from publicly traded companies to private equity owners, the real emissions remain constant or in some cases may increase, depending on the owner,” he added.

Taraporevala cited June 2021 research by Ceres and the Clean Air Task Force indicating that several US private equity-linked firms – such as Flywheel Energy, Hilcorp and Terra Energy – were among the top ten methane emitters in the US. And this was the case “despite the fact that in terms of production they are much smaller than some of the fossil fuel heavyweights”, said Taraporevala.

He added that listed companies were subject to public pressure on issues, such as sustainability disclosure and risk of divestment, that are absent for private equity owners.

Pressure from limited partners

That said, institutional clients are increasingly putting pressure on – or working with – private equity managers to improve their levels of transparency and ESG focus.

For instance, California Public Employees’ Retirement System (Calpers) and private equity manager Carlyle unveiled a new project last week aimed at getting private equity investors to aggregate and share ESG data, such as on carbon emissions and diversity, gathered from their portfolio companies.

Moreover, CDP, a UK-based non-profit organisation that helps companies and cities disclose their environmental impact, started issuing a questionnaire to SMEs last month. It did so in response to requests from both private equity investors and managers to help them address a lack of data.

Stefano Bacci, partner at Ambienta, says that since 2018 around half of the firm's limited partners have done ESG-specific due diligence on its investments. (Photo courtesy of Ambienta)

Limited partners (LPs) are driving progress on sustainability among GPs, agrees Manvinder Singh Banga, partner at New York-based private equity manager Clayton, Dubilier & Rice.

“The buyer of a private equity asset is an intelligent buyer,” he says. “It’s either [selling on] to the public markets or another private equity firm. And if in five years the carbon situation of that asset had further deteriorated, you would have to think very hard about what the actual returns might be.”

Stefano Bacci, partner and ESG manager at Milan-based private equity manager Ambienta, which invests in environmental solutions, says that since 2018 around half of LPs have done ESG-specific due diligence on the firm’s strategies.

Clients want to know that ESG is embedded in investment processes, and is not just a box-ticking exercise, found a February round table hosted by US consultancy CohnReznick. They might also ask how GPs manage their ESG performance on topics such as sustainability and diversity and inclusion.

Posing such questions is important. It seems that private equity firms can be more likely than public-market fund houses to ignore or be unaware of potential social issues at their investee companies.

Australian pension fund Aware Super surveyed its asset managers this year about potential risks of modern slavery within their portfolio companies' supply-chains. US-based listed equity manager Artisan Partners was very helpful and accommodating, wanting to know more about the process, said Liza McDonald, head of responsible investments at Aware. But one of the $108bn retirement fund's US private equity managers declined to complete the survey, denying that such an issue might exist in its portfolio.

While not all clients are asking questions on sustainability of their managers, one or two “pivotal LPs asking those questions can drive a huge change”, says Martin Calderbank, managing partner of Agilitas Private Equity, a pan-European mid-market private equity firm.

Institutional investors seem the most likely force to drive positive change in their managers’ behaviour. All power to their persistence.

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