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MSCI Analyzes The “E” in ESG for Private Equity

Zbynek Burival

When investors or asset managers consider a publicly-traded company as an ESG investment, they usually have a variety of tools at their disposal, such as public disclosures, sustainability reports, and ESG ratings. Many global regulatory bodies have also been pushing for deeper and wider ESG disclosures by public firms. 

Photo Courtesy Jason Briscoe

But what happens when it’s a private firm? Private equity is an asset class that has provided superior returns over the past two decades, yet it has been a lot less transparent about its sustainability engagements. And because of its private character, it’s also received less governmental scrutiny.

But things are finally starting to change. MSCI, a global leader in ESG Ratings, analyzed the “E” in ESG for private firms and how they tackle carbon exposure.

“Both private and public companies exposed to regions with high carbon-emission reduction targets are similarly vulnerable to regulations and policies aimed at reducing companies’ direct emissions,” said Manish Shakdwipee, executive director and head of climate research in ESG research at MSCI, in the report.

Shakdwipee said that this issue has become more pressing as the proportion of private assets has increased dramatically in institutional portfolios, but in comparison to the public markets, there’s less information available on how they plan to transition to a low-carbon economy.

After analyzing more than 9,000 public and over 18,000 private firms, MSCI found that mainly three sectors were contributing to emissions: utilities, energy, and materials. Private companies had a lower carbon contribution in overall emissions (68% of total emissions) than public firms (82% of total emissions).

This was due to lower exposure to carbon-intensive sectors within private equity.

However, when adjusted for where the private companies were located and how strict that country’s carbon-emission goals were, private companies scored worse. For any of the top 10, 50, 100, 150, or 200 emitters, private firms had a bigger contribution to carbon emissions than public firms. For example, the top 10 private firms contributed 28.2%, while the top 10 public companies had a 16.4% carbon contribution. For the top 100, this was 77% vs. 54.4%, respectively.

Photo Courtesy Carlos Santos

MSCI concluded that private companies are equally vulnerable to the growing number of regulations and policies aimed at reducing their direct emissions. Shakdwipee advises investors to ask for more comprehensive disclosures of private firms they hold in their portfolios and assess their climate-transition-related risks.

“To date, institutional investors have been slow to act on the climate-transition risk associated with their private-company allocations,” he noted. “As allocations to private assets increase, the importance of addressing these exposures grows.”

For this purpose, sustainability nonprofits Ceres and the SustainAbility Institute by ERM have examined how private equity firms view climate risk, as well as what investors should expect in terms of disclosure and net-zero goals of companies in their portfolios.

After conducting in-depth interviews with representatives of 27 top private equity actors and performing additional research, Ceres and ERM found the following:

Positive drivers supporting private equity action on climate included increased awareness of investment returns related to climate action; growing pressure from Limited Partners in private equity firms to integrate those risks into investment processes; a better understanding of the systemic nature of climate impact; policy momentum, regulatory changes to require more detailed disclosures; and stakeholder expectations, including customers, money managers, media and employees.

However, several obstacles still remained: limited access to high-quality data, a lack of universal standards, inconsistent regulatory requirements, a lack of a universal standard for setting net-zero goals within investment strategies, limited understanding of climate issues among some private equity senior executives, and insufficient use of Limited Partners’ considerable influence over General Partners to increase integration of climate-related risks.

“There are signs that private markets are increasingly recognizing the importance of supporting the transition to a low carbon economy,” stated the study. While many LPs and GPs showed more substantial ESG investment approaches, many others lagged.

“The level of climate understanding – even the acceptance of this topic – still varies widely based on factors including firm size, location, asset class participation, and so on, but our research suggests uptake is accelerating,” concluded the study.

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