Franklin Templeton’s Richard Piliero explains why private equity is well placed to drive an investment framework focused on climate impact for a just transition.
We are at an inflection point in harnessing the financial system to drive sustainability and innovation. Public and private debt and equity funds play a role in advancing impact-driven practices and policies. While the former drive change by engaging companies in public markets, the latter can help build better impact practices from the ground up.
Private equity has a vital role to drive impact, especially in emerging and frontier markets. By nature, private – and, in particular, private equity – markets are well positioned to drive positive, lasting, impact-driven practices that foster improved performance. They have a unique toolbox, including:
- Deep engagement: private equity firms engage with portfolio companies at board level, allowing them to influence key decision-makers to adopt and strengthen impact practices.
- Long-term relationship: the longer-term nature of private equity investments, typically over five to seven years, allows for more effective measurement of the climate impact of an investment.
- Contractual enforcement: private equity firms can embed impact best practices into transaction documents and company charters as a precondition for investment.
- Increased level of detail: private equity firms often benefit from higher levels of information transparency than public market investors. This level of granularity helps improve the issue of data materiality.
- Iterative process: the process of driving positive impact is inherently iterative, which follows a nonlinear “theory of change”. Private equity has the benefit of a close and constant relationship with investee firms to build better impact practices through a regular, long-term feedback loop. Since impact measurement and reporting is a relatively new and evolving field, investee companies benefit from this ongoing hands-on investor guidance.
Integrating climate impact in the investment process
The recent Intergovernmental Panel on Climate Change (IPCC) report highlighted what we can all observe – that global warming is real and driving consequential climate change. Our call to action to find solutions through investing in innovative companies needs to incorporate impact assessment in earnest. We believe endto-end integration of impact in the investment process is critical to developing a private equity impact management framework.
We believe a framework should start with an “Investment and Impact Thesis”. This needs to focus on the proper management of financial capital to foster returns, alongside human and natural capital performance measurement to ensure sustainability. Essentially, this should drive climate change mitigation by promoting energy transition toward a low-carbon economy, and supporting adaptation through greater economic resilience of populations affected by climate change. This could be
particularly effective in a private equity context as investment, capital and expertise are provided to growth-stage companies addressing these challenges.
Such an impact management framework would then imply impact integration consistent with the thesis at each stage of the investment process:
- Deal sourcing: climate investment and impact objectives In the deal-sourcing stage, the investment impact thesis would be well developed, involving a coherent impact narrative and data points for each investment. Systematic analysis would identify the specific human and natural capital challenges being addressed, the enterprise- and investor-level activities that will enable progress, and the measurable impact outputs and higher-order outcomes being targeted toward enhanced risk-adjusted returns.
- Deal structuring: contractual obligations Apart from the typical financial and riskmitigation measures, investors can embed deal specific impact measurement and management measures into transaction documents. For example, the sales and purchase agreement can stipulate “conditions precedent” and “conditions subsequent” to deal closing.
- Partnership: building value To help steward the company, the private equity team can engage closely with boards, management and operating teams. This extends to helping portfolio companies adopt and implement impact standards and frameworks and systems to measure and report on climate impact key performance indicators.
- Exit: creating value by reducing risk A successful exit is one that realises the financial gains brought through a successful investment thesis, which is underpinned by sustainability considerations. Incorporating impact considerations into a company’s policies and practices can reduce risks for a buyer and raise company valuation, thereby helping a successful exit be that to public markets or via a strategic sale.
By nature, private – and, in particular, private equity – markets are well positioned to drive positive, lasting, impact-driven practices that foster improved performance.
Richard Piliero
Potential to drive alpha
Stepping back, we believe strong impact practices overall have the potential to drive alpha in portfolios. A focus on climate is where impact and financial return become mutually reinforcing and beneficial for key stakeholders including communities, employees, governments, businesses and investors.
With the right tools and impact approach, private equity is well placed to drive an investment framework focused on climate impact for a just transition, as envisaged in the Paris Agreement.
Richard Piliero is managing director of Franklin Templeton Global Private Equity
