The Australian bushfires that tore through an area the size of South Korea over the past several months, destroying thousands of homes, killing at least 33 people and wiping out an estimated one billion animals were a stark reminder of the unpredictability and destructiveness of the global climate crisis.
They should also be a catalyst for action.
The past six months has seen a tipping point in the financial arena when it comes to discussions of the risks and opportunities climate change presents.
“We are on the edge of a fundamental reshaping of finance,” BlackRock CEO Laurence Fink wrote in his annual letter to chief executives in January, in which he announced several initiatives to “place sustainability at the centre of our investment approach”, including exiting investments that “present a high sustainability-related risk”.
BlackRock is a $7 trillion asset manager. It doesn’t matter anymore whether you believe in climate change; if you continue to do business as you’re doing it now, you’re betting against the biggest shareholder in the world.
Speaking on a panel at The Economist’s Investing for Impact conference in New York last week, Joseph Lake, chief operating officer at climate risk analytics firm The Climate Service, put it thus: “Regardless of where you think we are in this journey, we’re definitely going in one direction, and there’s no turning back.”
For private equity fund managers, some powerful limited partners are driving that train. Private Equity International’s latest annual Responsible Investment report showcases several LPs formulating climate change policies for the asset class.
“There is growing awareness that climate change is the key risk to investment performance and long-term financial success,” Sean Collins, service manager (pensions) at Oxfordshire County Council told us. Fund managers should expect more climate-related questions from their LPs.
Or, as Lake put it: “Climate risk is in every investment decision that you’re making, and so if you don’t understand what you’re doing there, then you’re absolutely mispricing that risk.”
As we explore in this year’s Responsible Investment report, risk is very much front and centre of the private equity industry’s discussions around climate change (as one investor put it to us, “there’s real potential for the destruction of equity value”).
But on the flipside, opportunities abound, particularly around energy transition.
As Lake pointed out on last week’s panel, the transition to the low carbon economy is going to happen “very quickly and it’s going to be completely messy and unmanaged” with “asymmetries of information”. In other words, exactly the kind of situation in which private equity – a long-term asset class where success is predicated on market inefficiencies and information asymmetries – should thrive.
What’s more, in a world in which most are measured quarterly and compensated annually, private equity has the luxury of time. Fund managers can implement initiatives that may take several years to come to fruition – which is appropriate, as they’ll be selling the asset into a market that will likely value such initiatives even more highly than it does today.
We will be revisiting this subject more frequently and in greater depth. How is your firm thinking about climate change and its portfolio? Could the industry be doing more, or is it not in investors’ interests? We’d love to hear from you.