The Changing Climate for Private Equity Foreword The Changing Climate for Private Equity by Ceres and the Recently, Ceres has expanded its efforts to work with SustainAbility Institute by ERM (the SustainAbility Institute private equity investors, as evidenced by the launch of the or ERM) aims to accelerate action on the climate crisis by Ceres Investor Network Private Equity Working Group. unlocking the potential for private equity to help attain the goals of the Paris Agreement. ERM’s climate impact comes mostly through client relationships. It helps companies understand climate- That the climate emergency demands urgent action related risk and opportunity and transform business models is now widely understood, in part we trust due to our to support the low carbon economy transition and improve organizations’ efforts to influence action by business, long-term business resilience. This is complemented by investors, policymakers, and other stakeholders. SustainAbility Institute research like From Promise to Action: Delivering Your Company’s Net Zero Ambition. Ceres and ERM believe that the private sector has a critical ERM has deep experience with private equity, serving as role to play in mitigating and reversing climate-related a trusted guide on ESG and climate in the sector. This impacts on natural and human systems, including the work is reflected in ERM’s 2020 survey on private equity economy. While many businesses and financial system and ESG integration Eyes on the prize: Unlocking the ESG actors have committed to reach net zero by 2050 or premium in private markets. sooner, private equity has been slower to act. We believe that action is essential and overdue. The Changing Climate for Private Equity combines our organizations' strengths to study private equity’s grasp Over the last two decades, private equity has outperformed of climate-related trends and the unique climate risks other asset classes while growing tremendously, adding and opportunities faced by the sector. We believe that $US trillions in assets under management. Based on its our world will only develop a net zero financial system recent returns and scale, private equity is more attractive and economy if private equity is part of the solution. This and more influential than ever before. report demonstrates that there is both planetary need and business opportunity to be found in helping transition Given private equity firms’ sway, The Changing Climate markets to the low carbon future so urgently required. We for Private Equity examines how they view climate risk hope the results inspire change and help quicken climate and opportunity and what they expect of companies in progress, and we commit to ongoing work with private their portfolios in terms of net zero goals and climate risk equity and other partners to ensure this happens. management and disclosure. Sincerely, Ceres has been at the forefront of climate leadership in the Keryn & Mindy finance sector for three decades, helping co-found and coordinate U.S. and global multi-trillion dollar efforts like the Net Zero Asset Managers initiative that are reshaping markets. Ceres’ role in Climate Action 100+ showcases its ability to collaborate with other investor networks and investors to convince the world’s largest corporate greenhouse gas emitters to take action on climate change. Keryn James Mindy Lubber Group Chief Executive CEO & President ERM Ceres June 2021 Page 2 of 51 Contents Glossary of Terms and Abbreviations 4 Executive Summary 6 Introduction 8 Chapter 1: Accelerating Action to Address the Climate Crisis: Key Drivers & Progress to Date 12 Chapter 2: Challenges Facing Private Equity on the Path to Stronger Climate-related Performance 20 Chapter 3: Climate Integration in Private Equity: Current Landscape & Emerging Solutions 25 3.1 – Governance & Internal Engagement 3.2 – Risk Assessment & Investment Management 3.3 – Disclosure & Goal Setting Chapter 4: Recommendations & Conclusion 42 4.1 – Recommendations for LPs and GPs 4.2 – Conclusion Participating Firms 50 June 2021 Page 3 of 51 Back to Table of Contents The SustainAbility Institute by ERM in partnership with Ceres The Changing Climate for Private Equity Glossary of Terms and Abbreviations Terms Carbon footprint - The total amount of greenhouse Physical risk - Physical risks resulting from climate change gases (particularly carbon dioxide) that are emitted into can be event driven (acute) or longer-term shifts (chronic) in the atmosphere each year by a person, family, building, climate patterns. Acute physical risks refer to those that are organization, or company.1 event-driven, including increased severity of extreme weather events, such as cyclones, hurricanes, or floods. Chronic General Partner (GP) - A General Partner is one of two or physical risks refer to longer-term shifts in climate patterns more investors who jointly own a business and assume a (e.g., sustained higher temperatures) that may cause sea day-to-day role in managing it.2 For the purposes of this level rise or chronic heat waves. report, private equity firms are considered the General Partners. Portfolio company - Those companies that private equity firms hold an interest in. Greenhouse gas (GHG) - Any gas that absorbs infrared radiation in the atmosphere. Greenhouse Private equity - Private equity is an alternative investment gases include carbon dioxide, methane, nitrous oxide, class and consists of capital that is not listed on a public ozone, chlorofluorocarbons, hydrochlorofluorocarbons, exchange. Private equity is composed of funds and investors hydrofluorocarbons, perfluorocarbons, and sulfur that directly invest in private companies, or that engage in hexafluoride.3 buyouts of public companies, resulting in the delisting of public equity.7 Institutional investors - An institutional investor is a company or organization that invests money on behalf of Science Based Target - Targets are considered ‘science- other people.4 Examples include pension funds, mutual based’ if they are in line with what the latest climate science funds, and sovereign wealth funds. deems necessary to meet the goals of the Paris Agreement – limiting global warming to well-below 2 degrees Celsius Limited Partner (LP) - A Limited Partner is a part-owner of above pre-industrial levels and pursuing efforts to limit a company whose liability for the firm's debts cannot exceed warming to 1.5 degrees Celsius.8 the amount that an individual invested in the company.5 For the purposes of this report, pension funds, endowment Transition risk - Transitional climate risks are incurred from funds, etc. are considered the Limited Partners (or asset policy changes, reputational impacts, and shifts in market owners). preferences, norms and technology. Transition opportunities include those driven by resource efficiency and the Paris Agreement - The Paris Agreement is a legally binding development of new technologies, products, and services, international treaty on climate change. It was adopted by which could capture new markets and sources of funding. 196 Parties at COP21 in Paris, on 12 December 2015 and entered into force on 4 November 2016.6 June 2021 Page 4 of 51 Back to Table of Contents The SustainAbility Institute by ERM in partnership with Ceres The Changing Climate for Private Equity Abbreviations AUM Assets under management ESG Environment, Social, and Governance GP General Partner GRI Global Reporting Initiative LP Limited Partner PRI The Principles for Responsible Investment SASB Sustainability Accounting Standards Board SBTi Science Based Targets initiative TCFD Task Force on Climate-related Financial Disclosures VC Venture capital $ USD June 2021 Page 5 of 51 Back to Table of Contents The SustainAbility Institute by ERM in partnership with Ceres The Changing Climate for Private Equity Executive Summary The Changing Climate for Private Equity outlines the direction of the private equity sector with respect to climate. The report is driven by learning derived from in-depth interviews with representatives of 27 top private equity actors and complementary research. It finds the industry facing increasing pressure to align investment activity with carbon reduction targets and other climate-related goals as well as in need of better guidance and tools to support the development and implementation of climate-aligned investment strategies. Drivers supporting private equity action on climate include: Obstacles hindering faster integration of climate considerations into private equity investment practices also > Increasing awareness of investment returns and surfaced as follows: opportunities related to climate change, which has helped direct more private investment toward climate > Limited access to high quality data, which restricts solutions. private equity firms’ ability to assess and demonstrate how investments align with the goals of the Paris > Growing pressure from Limited Partners for private Agreement. equity firms to further integrate climate-related risk into their investment processes to align with climate goals > The lack of universally adopted and mandated and initiatives. frameworks and standards to guide climate-related disclosures and help improve performance, resulting in > Increased understanding of the systemic nature perceived inconsistency in expectations from GPs and of climate impacts, increasing the possibility that LPs. investment performance will be significantly affected by climate-related factors. > Inconsistent regulatory requirements, slowing climate integration