IIGCC’s Mahesh Roy: “Engagement in private markets is critical for net zero”
Part 1 of NZI’s Stewardship Series looks at best practice engagement strategies for private equity and private credit investors
Activist investors that pressure listed companies to adopt sustainable practices generate a useful spectacle, as difficult questions surrounding hard-to-transition companies, notably oil majors, receive ample media attention.
The recent actions of Dutch campaign group Follow This towards Shell and ExxonMobil come to mind, for example.
However, only 30 of the world’s top 100 carbon emitters are listed on a stock exchange. That means what happens in private is just as important as the latest high-profile shareholder resolution.
The Institutional Investors Group Climate Change (IIGCC) recently published guidance material to help investors engage with private markets: one on private equity, and the other on private credit.
Net Zero Investor sat down with IIGCC’s Investor Strategies Programme Director, Mahesh Roy, to find out more.
Are private market engagements an important part of efforts to reach net zero?
The short answer is yes.
Private market investors can have a material impact on companies and their orientation towards net zero. They have the money, capacity, technical knowledge, and most importantly, agility, to be owners that engage meaningfully with companies on decarbonisation. This is why we published two resources for private markets investors following strong interest from our members to do so.
What are the main engagement tools and how do they work?
First, investors must determine the nature of their relationship, or as we describe it, which “influence band” they occupy in relation to a portfolio company.
These “influence bands” are classed as either “direct influence” or “indirect influence”, with more granular distinctions within each group. Investors can then choose an engagement strategy appropriate to their influence band.
Our guidance provides for two main engagement strategies.
The first strategy is a general partner-limited partner engagement, where investors with indirect influence look to engage with those with more direct influence and set expectations on timelines and information flows around investments being managed in alignment with net zero.
The other engagement strategy emphasises interactions between general partners and portfolio companies, where the investor’s focus is helping the portfolio company take increasing steps towards net zero alignment.
As for the engagements themselves, the most important factors are regular communication and transparency regarding the transition of portfolio companies, which we define using an alignment maturity scale.
Could you share more details about the “influence band” classification system?
There are significant differences in terms of the influence private market investors have over portfolio companies, depending on their position in the investment value chain. A general partner that can appoint a majority of voting seats on the portfolio company’s board can exert influence on a company’s management, while a general partner with limited or no voting seats may have less influence on the direction of the company.
Similarly, a limited partner who invests while the fund is still being launched has a greater ability to influence general partner actions or fund characteristics than one that enters the fund through the secondary market.
In PRI's 2021 reporting framework survey, many private investors said stewardship didn’t apply to private equity. Is that still a common position or has the narrative moved on?
Whether you call it stewardship or not, we know there is significant “engagement” being used to drive broader uptake of net zero commitments across the space. Active engagement is one of the most important actions for climate conscious investors in private markets. In private equity, limited partners can try to engage the general partners with whom they invest, and general partners can do the same with co-owners of portfolio companies where they have less influence.
In private debt, the adoption of net zero practices can be seen as a risk management tool, as well as a value add in relationship management. Engagement plays a massive role in building that understanding between all stakeholders. We encourage the use of a “three-way” engagement model whereby private debt general partners should consider engaging both with their portfolio companies but also the private equity sponsors where applicable.
What are the main similarities and differences between stewardship practices in private and public markets?
A key difference is that a strong enabling environment, such as regulations around climate disclosures, has emerged in public markets but not yet in private markets. IIGCC wants to close the gap by helping investors integrate climate change risks and opportunities into private markets investments. Our aim is to enable investors to act in a more standardised way, much like the Taskforce on Climate-related Financial Disclosures (TCFD) did in public markets.
As industry norms and regulation evolve in both private and public markets, certain concepts are likely to converge over time. For example, public markets-focused NZIF criteria and Climate Action 100+ indicators may one day become embedded in private markets. Until then, investors can follow best practice guidance that is specifically tailored to the nuances of private markets.
What are the main challenges of engaging in private markets?
In many jurisdictions, data, regulation and decades of established best practice have significantly improved transparency and climate-related engagements in public markets.
Private markets, on the other hand, generally have less transparency, less regulation and, crucially, more bespoke engagement strategies.
This is why our approach to private markets engagement – focusing on levels of influence and expectation along the financial value chain – aims to treat private markets as they are, rather than change them to fit public market conventions.
That said, one thing public and private markets have in common is the need for more and better quality data. Such data helps investors measure a company’s progress against targets and can help orient them on the most relevant topics to engage on. Ideally, data should flow from portfolio company to general partners to limited partners every annual reporting cycle. General partners and limited partners should also report progress towards established net zero targets.
How would you summarise best practice for private market engagements?
We believe that communication, dialogue and partnership are the cornerstones of successful engagement in private markets. The integration of climate change considerations into investment strategies and processes is crucial for both value creation and risk management in a world in transition. So, when investors exit private markets investments, the portfolio companies they have worked with will be better aligned with the changing world in which they operate.
