Investors are calling on their private portfolio companies to start disclosing their environmental footprint, warning that a huge transparency gap between listed entities and private companies could derail decarbonization efforts
U.K. supermarket chain Morrisons' decades-long chapter as a listed company is set to end imminently, with two U.S. private equity firms currently vying for the company in a high-profile bidding war. The supermarket, which went public in 1967, announced Wednesday it plans to begin an auction procedure between its two suitors, SoftBank-owned Fortress and rival Clayton, Dubilier and Rice.
The imminent sale of the supermarket chain to private equity investors is part of a broader trend where global investment companies are snapping up public companies perceived to be undervalued in the wake of the COVID-19 economic downturn. The trend has been particularly apparent in the United Kingdom, where even before the pandemic companies had been buffeted by years of uncertainty related to Brexit. By August alone, there have been 39 bids completed or proposed for British companies from global investment firms, just two short of the total number of bids recorded in 2020, according to financial markets platform Dealogic.
However, the migration of public companies to private status carries major implications for the net zero transition. Unlike large publicly listed companies, which increasingly have to comply with high sustainability reporting standards, private companies typically face less scrutiny on environmental issues and pressure to decarbonize than their public counterparts. Yet these privately held firms are taking up an increasingly big portion of the global economy, with research from McKinsey highlighting that private equity net asset value markets have grown three times as fast as public markets since 2000.
In 2019, Morrisons was voted the U.K.'s "most environmentally responsible retailer" at the Responsible Business Awards, but, unfairly or not, any shift to private ownership would raise questions over whether environmental issues would continue to be regarded as a top priority. Many within the private equity space may resent the industry's reputation for asset-stripping and cost-cutting, but the stereotype is not completely without foundation.
In July, Morrisons wrote to its farmers to reassure them that regardless of any change in ownership it would honor its payment practices and commitments to sustainability and environment, after producers expressed concerns about the supermarket chain's future direction. Similarly, Walmart's decision to sell Asda to private equity firm TDR Capital and private investors the Issa brothers in late 2020 prompted fears about the potential erosion of the firm's climate governance practices.
More broadly, there are fears that the less stringent ESG reporting requirements on private companies could derail the pace of the net zero transition and counteract the work public companies are doing to reduce their emissions. Fears are widespread amongst policymakers and sustainable investor groups that in winding down their polluting activities, public companies will sell their high carbon assets to private companies whose environmental performance is less well scrutinized. Oil and gas giant BP's 2019 sale of its Alaskan oil and gas business to private firm Hilcorp Energy, for instance, will result in far less rigorous reporting requirements on a highly carbon intensive and controversial enterprise.
But among these foreboding financial trends, there is another that offers hope that more stringent environmental reporting standards could soon affect privately held companies. Net zero pledges have swept all corners of the investment industry over the last 18 months, with the Net Zero Asset Mangers initiative calculating that more than a third of total global assets under management worldwide are covered by a net zero pledge. Investors' long-term climate goals cannot be met unless they have access to comparable and comprehensive data on their portfolio companies' emissions performance, including privately held businesses.
It is against this backdrop that a group of influential investors have teamed up to collaborate with environmental disclosure platform CDP to create the first standardized environmental disclosure questionnaire for private companies. More than 1,000 companies have been requested to disclose environmental information through the scheme, across emerging and developed markets and a wide range of industries, including oil and gas, finance, renewable energy, tech, healthcare and manufacturing.
The investors, which manage more than $2.3 trillion of assets, have warned they will not be able to track and report progress towards their net zero financed emissions targets without better oversight into these firms' ESG practices. Consistent data is required to enable investors to understand and benchmark the performance of all the companies they invest in, not just publicly listed firms that must comply with higher reporting standards, they said.
A group of influential investors have teamed up to collaborate with environmental disclosure platform CDP to create the first standardized environmental disclosure questionnaire for private companies.
Adam Black, partner and head of ESG and sustainability at Coller Capital, one of the firm's taking part in the initiative, said the net zero transition depended on private companies being more transparent about their environmental performance.
"Encouraging more private companies to actively measure and disclose their carbon impacts, and also their water and possible deforestation impacts, is no longer a nice to have — it is essential to the low carbon transition," he said. "Moreover, it will better enable investors to make much more informed investment management decisions when it comes to the private markets."
CDP, which provides a platform for companies and cities to disclose their performance on carbon, water and deforestation, said it planned to compensate for anticipated gaps in the data collected through the exercise with emissions estimates. This would enable private market investors to calculate their financed emissions, it said. It should also ramp up pressure on firms that fail to disclose requested data to do so.
Clare Elsdon, joint global director of capital markets at CDP, said the high levels of support for the Private Markets Pilot highlighted the appetite among investors for "consistent, comparable and comprehensive" data across both public and private markets.
"To make this possible and support them in setting and meeting their own net-zero ambitions in the run up to COP-26, [investors] expect private companies to fully engage with TCFD-aligned standards on environmental disclosure and reporting," she said.
Elsdon added that the pilot was essential to ensure continued scrutiny of high carbon assets after they were transferred to private companies. "This pilot is essential to avoiding 'emissions leakage' between asset classes such as public companies selling high-carbon intense assets to private companies in a bid to avoid scrutiny and transparency," she said. "Stark warnings from the latest IPCC report that disastrous climate tipping points are nearing underline the urgency of this pilot's work."
In the U.K., most FTSE100 companies already mention the Task Force on Climate-related Financial Disclosures (TCFD) in their corporate reporting, and the government has announced it intends to make climate-related financial disclosures mandatory for large companies and financial institutions by 2025. Meanwhile, the G7 backed the idea of compulsory Task Force on Climate-related Financial Disclosures (TCFD) last June. But many of these initiatives focus on large companies or those listed on public stock markets and there is clearly work to be done to standardize reporting practices across all parts of the economy.
As such, the call from top investors marks an important moment in the push towards the mainstreaming of environmental reporting that is likely to prove crucial to the net zero transition and sustainable economic development. While progress to date has been driven in large part by government policy and pressure on publicly listed firms, last week's appeal marks the opening of a new front in the battle for more stringent ESG reporting standards across all sectors of the economy.