Understanding business and sector-specific exposure to climate change can help identify risks and opportunities in the transition to a low carbon economy, says Permira’s head of ESG, Adinah Shackleton
The conversation around climate change is becoming louder and more urgent. How do you get a foothold on such a broad and complex issue?
As you say, climate change is a very broad and complex issue. We are constantly reviewing and adapting our approach, considering how we integrate climate considerations in the investment process, respond to our investors and focus our engagement with portfolio companies on climate change. Recently we completed a climate risk screening across the Permira private equity funds and the PDM funds (including the direct lending and the CLO strategies advised by Permira Debt Managers). Together with consultants we screened more than 200 companies. This has helped us understand which companies demonstrate higher physical risk in terms of exposure to extreme weather events, such as wildfires, water scarcity or flooding, and whether business models may be impacted – positively or negatively - by the transition to a low carbon economy.
What will you do with the results?
With the private equity funds, we will use the results of this risk assessment to identify which portfolio companies require further assessment, such as a more detailed climate scenario analysis, and then engage with management teams around their approach to respond to climate-related issues. For example, whether physical or transition risks from climate change have been considered as part of their risk management processes, strategy and board discussions. On the private debt side, the PDM Funds are supportive lenders, often behind an equity sponsor, which means that we are generally one step removed from the asset. At PDM, we want to use the results to understand the climate profile of companies in the portfolio and engage with the sponsors on businesses we deem to be at higher risk from the impacts of climate change.
Where does tracking your carbon footprint fit into this?
Our carbon footprint project is undertaken alongside the climate risk screening and has been an important aspect when looking at climate risk. We have requested carbon footprint data from the private equity portfolio companies since 2016 and have also undertaken a top-down carbon footprint estimate across the portfolio for 2018 onwards to address the gaps in the reporting. However, out of all the ESG key performance indicators we collect across the portfolio, the carbon footprint is the hardest to obtain. We have seen an increase in reporting of carbon footprint data from portfolio companies. However, for some companies there are other ESG areas which are seen as more of a priority, especially where the carbon footprint is calculated on a voluntary basis, or they don’t yet have the systems and processes in place to collate the data. This will be an area of focus this year as we look to actively engage with the portfolio on climate change more broadly, including on the benefits of carbon footprinting, such as identifying opportunities for energy savings or supporting them in defining a path to net zero.
What opportunities are there for collaboration on climate change and ESG?
Most recently, we joined Initiative Climat International, which is supported by the Principles for Responsible Investment. This initiative provides the opportunity for signatories to get together and address a significant challenge. Firms are very open in terms of their approaches and what has worked for them, so others can learn from their experiences. Such collaborative initiatives are important for advancing ESG within the private equity industry.
The other area for collaboration is on ESG reporting. We are coming to a point where different ESG standard setters are starting to speak with one voice about their expectations for investors and portfolio companies on ESG reporting. This year we have been participating in a collaborative initiative run by the European Leveraged Finance Association, which is working with PRI to encourage alignment on ESG monitoring and engagement in direct lending. Having broader industry consensus on the ESG factors which should be reported for this asset class will be very useful.
On the private debt side, how do you exert ESG influence as a firm?
Since 2015, we have integrated ESG into the pre-investment process, leveraging the due diligence conducted by the sponsor and using our own questions and advisors. At PDM we have formed a specific ESG group and are looking at what more we can do to engage with investments and sponsors during the investment period. In businesses where there is no sponsor or where the PDM Funds have equity, we can get quite involved and have undertaken site visits and joined management meetings to discuss ESG topics. Where there is a sponsor, they lead on engagement with portfolio companies. However, we believe there is also an important role for a private credit investor to ensure there is a focus on ESG within the underlying portfolio companies.
Do you think the industry is thinking about ESG in an increasingly strategic way?
Yes, I do, and I can also see a step change underway. With regard to climate change, ultimately, we want the funds’ portfolio to be resilient. That means looking at potential impacts before the funds actually make an investment. In the past, we have walked away from potential investments if we felt those businesses were not sufficiently aligned with a transition to a lower carbon economy. Going forward, we want to develop this approach further so that climate change is better integrated into our investment strategy. This will assist the investment teams in identifying both climate-related risks or opportunities as part of the origination and deal process.
We also plan to engage with our sector teams on climate change to help them think through what physical and transition risks mean for their specific sectors and markets, encourage them to reflect on their strategy, and identify where the opportunities are. This is a big project for 2021. Climate change is clearly increasingly going to become another lens to look at potential deals and will influence how and where we invest.
How will you conduct this sector strategy review?
Our plan is to start with one sector and take it from there. We will work with the sector head and a small team. We will provide training on the climate science and implications for key subsectors and work with them to understand where the key risks or opportunities may be for their strategy. During this first review we are not going to come up with all the answers, but our approach should evolve as we become more sophisticated in thinking about physical and transition risk.
Are portfolio companies giving the same level of attention to climate change priorities?
Generally, companies are really interested in climate change, particularly high energy users. Some of the portfolio companies have done great work on climate-related initiatives and we want to start sharing more of what they have learned, for instance around carbon footprinting and installing renewable sources of energy.
For example, the South African data centre business Teraco has installed solar panels at its main site and is looking to use that as a blueprint for its other data centres. Dr Martens and LegalZoom – which have very different business profiles – also have solar panels on their buildings. We are also looking at applying those lessons to other portfolio companies in other geographies.
Beyond climate change, what new themes do you expect to come into focus this year?
The EU is launching new regulations on reporting and disclosure in sustainable finance, which we are watching closely while reflecting on our monitoring and reporting approach in general. We are also working on our first publicly available ESG report, which we will publish this year. We have provided an ESG report to our investors since 2015, and now we recognise that we should be sharing more of what we are doing as a firm in terms of sustainability and how we engage with portfolio companies on ESG. Over time we think there will be an expectation that private equity firms disclose more about their ESG approach. It is part of the trend toward improved transparency in the sector.
How important is ESG within the firm?
ESG is extremely important within the firm, including from senior management. Everyone across the firm takes ownership of ESG and everyone has a role to play. Each deal team has an ESG lead, the monitoring teams will engage with companies on these topics, and I tend to get involved with higher risk companies or where we believe there is more room for improvement on the ESG side. There really is a recognition that companies which manage these issues well will be more successful and sustainable in the longer term.
It’s also really important to us to lead by example on ESG. For example, through the CarbonNeutral® company certification (which we’ve had since 2018), the diversity and inclusion initiatives and the work of the Permira Relief Fund, which was set up in response to COVID and provides financial support to charities through the Permira Foundation.
How have you engaged with portfolio company Teraco on ESG?
When I joined Permira in 2015, the data centre business was the first company I engaged with. We conducted an ESG review with external consultants, and the support of Teraco’s Chief Financial Officer. The Permira portfolio monitoring team were also involved in the engagement and helped elevate the recommendations with the management team and at Board level. One of the opportunities identified related to energy efficiency and renewable installations. Since then, the business has installed a solar renewable energy system at one of its main sites covering the roof, car park, and other spaces. The installation feeds energy into the data centre generating renewable energy, cost savings and energy security advantages.
The company also set up a Social and Ethics Committee. These structures are important as it means that when the Permira funds’ exit this investment, those ESG processes will remain in place, enabling further development of the company’s sustainability approach, strategy and performance.