Private equity’s TCFD challenge

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On the list of more than 100 asset managers signed up as official supporters of the TCFD, only around a handful are organisations purely active in private markets. While it would be a leap to suggest this indicates private investors are clueless about TCFD — organisations across various sectors are certainly working on TCFD reports without being official supporters — many private investors are behind on climate risk reporting and feel the TCFD reporting “was made for listed investors”, as one PE director put it. 

In fact, of the private investors on the TCFD supporter list contacted by RI for this article, most did not reply to interview requests and one firm said it was too early to comment on the topic: “We are currently formulating which parts of what [our firm] already does that is TCFD compliant and what further things we need to do,” a director at the investment firm said: “We may use external consultants to assist us. I would prefer to delay any comment until we have reached that stage – probably early next year.” 

This firm will not be the only private investor accelerating its climate risk reporting efforts in 2020. 

Phil Case, director, PwC UK, who specialises in sustainability in the private equity sector, confirms he is seeing “climate risk as a topic increasingly important to PE clients”. “This is a systemic risk in portfolios,” he says. 

There are three key reasons why private markets investors feel they need to get their heads around climate risk reporting: Limited partners (LPs) are asking for TCFD-aligned reporting; discussions about making TCFD reporting mandatory are increasingly taking place in a number of geographies, and – perhaps most pressingly – the PRI will from next year require signatories to respond to its climate risk reporting segment, which is partly based on the TCFD’s strategy and governance indicators. 

With regards to the latter, Case says it will likely be enough for private equity investors “to say where you are, how you’re planning to improve and get to the next level – I think that’s ‘job done’ for year one”. But he highlights that firms will need to improve their climate risk reporting going forward as “this isn’t going away.”

Some of the PRI climate risk indicators to become mandatory from 2020 include “indicate the documents/communications the organisation uses to publish TCFD disclosures” and “indicate whether there is an organisation-wide strategy in place to identify and manage material climate-related risks and opportunities”. 

The term “organisation-wide” is a sticking point for private investors. There are concerns that the strategic, company-level reporting the TCFD is encouraging will not reflect what private equity firms are doing to address climate risks in each individual company they own. 

“We’re comfortable with risks to individual holdings, so we’re well-equipped on a bottom-up level, but practicable and insightful portfolio analysis is a challenge,” says Therése Lennehag, head of sustainability at Swedish private equity firm EQT. “What do LPs and other stakeholders need to know? And will the results be different than on the individual company level?” 

“The TCFD guidelines were designed for a broad range of diversified asset classes [and] recommend a broader analysis of climate issues from PE firms and therefore bring several challenges,” says Candice Brenet, Managing Director and Head of Sustainability at French private equity and infrastructure investor Ardian. “For example, as we invest in non-listed companies that do not necessarily assess climate metrics, we need to raise awareness among companies’ management teams in order to implement data collection and management processes.”   

This is no mean feat for most private investors, Alison Hampton, founder of advisory firm Alma Verde Advisors and previously general counsel at HgCapital – where she headed up the PE firm’s responsible investment initiative – says most private equity investors “are actually small-to-mid market – they don’t have a lot of internal resources”. 

In particular, private investors are struggling with the risk management pillar of the TCFD framework. “In non-listed markets, risk management is quite basic,” says Isabelle Combarel, deputy CEO, French private markets investor SWEN Capital Partners. “But the TCFD is very dynamic, and unlike in the listed markets, we don’t have stochastic modelling – it’s unusual for us,” says Combarel. 

So, how are some of the early movers in private investing preparing for TCFD? SWEN Capital Partners made its first draft of the TCFD report attempt this summer, followed by a gap analysis, Combarel says. The firm aims to complete its first TCFD report in the first quarter of 2020, and is considering to potentially merge it with its Article 173 reporting under France’s disclosure requirements on ESG, she adds. 

The firm is, for example, attempting to leverage on the higher volume of data available in public markets. Consequently, SWEN has worked with a public data provider to use carbon footprint data from listed companies to create a proxy for its portfolio. “We’ve got exposure to more than 1,700 portfolio companies through direct and indirect investments – how do we measure their carbon footprint? Due to its complexity, we need to rely on a sectoral proxy from the public markets,” she says. “It will not be exact, but  it’s the best estimate we can get today.”

Ardian has tested the TCFD framework with one of its portfolio companies and has encouraged it to consider different climate scenarios. “Building the scenarios helped them manage risks and identify opportunities, and this has led them to build a new three-people team to focus on innovation to leverage these opportunities,” Brenet says. 

But working to educate portfolio companies about TCFD is exactly the time-consuming and challenging task a lot of other funds might be unable – or unwilling – to do, however. And many portfolio companies will themselves not have the resources to get their heads around a complex reporting framework. “It’s not yet well understood in private companies – I think the TCFD is still reserved for an audience that is already knowledgeable about climate issues,” says Combarel. For now, she believes SWEN can produce a first TCFD report without requesting additional data from its portfolio companies.

And while private investors aren’t catered for by as many climate and ESG service providers in the listed space, some guidance and advisory services are available. Case at PwC UK explains it has, for example, a toolkit for scenario analysis and advises private equity on various climate risks. Brenet at Ardian highlighted that the France-based Initiative Climat International – an industry working group for private equity players – is in the early days of implementing TCFD guidance. 

Therése Lennehag, EQTLennehag at EQT also speculated that the TCFD itself is likely working on becoming more asset class specific. A TCFD spokesperson declined an interview request for this article and was not available to comment on email before the article went to press. 

“The PRI has a central guidance role to play – considering their international reach – and we may expect that [its] action will accelerate the use of the TCFD framework within reporting practices in private markets,” says Brenet.