KKR, Carlyle Group and private equity's sustainability evolution

KKR, Carlyle Group and private equity's sustainability evolution

Despite its private nature, private equity has evolved in the way the industry approaches sustainability and environmental issues.

At first glance, private equity does not appear to be a natural pairing with sustainability.

But for an industry known for its secrecy, large private equity firms are showing a gradual evolution in the area over the past few years.

This evolution began in 2006, when the United Nations Principles of Responsible Investment (PDF) (UNPRI) released a framework for how private equity firms should incorporate environmental, social and governance criteria into their investments.

"The industry overall is lagging other parts of the financial services industry," said John Hodges, managing director at BSR. "Nonetheless, there has definitely been an upswing in the past couple years."

Initially, six private equity firms signed on to the framework in 2006, but six years later in 2012, there were over 1,000 signatories from firms that had $30 trillion in assets under management.

The jump in signatories came about as investors increasingly started recognizing sustainability and environmental risks as financial risks, and began demanding more ESG information from private equity firms.

Roadblocks ahead

While private equity firms have made progress in recognizing the need to focus on sustainability, many firms still are not releasing an annual sustainability report, and a number of inherent challenges lay ahead in enabling the industry to focus on sustainability.

Private equity firms have different strategies for enhancing capital, but often firms purchase either private companies or distressed mature public companies with the intent to delist them.

Then, the private equity firm restructures the companies where it expects to return a profit in three to seven years.

"They have a holding period that is long enough, where they could actually see results, but they haven’t figured a good way to quantify those results," said Hodges. 

But long-term sustainability initiatives such as carbon neutrality, or mitigating climate change, often can be inefficient and costly, and the return on investment can take longer than four to seven years.

In addition, private equity companies that are not publicly traded are not required to disclose information on the progress of their sustainability initiatives, and because of the inherent private nature of these companies they often abstain from reporting on this information.

Some large publicly traded private equity firms such as KKR and Carlyle Group have made their sustainability initiatives publicly available on their website and are slowly changing the way the industry talks about sustainability.

Carlyle Group's approach

Washington D.C. based-Carlyle Group, which is the largest private equity company in the world and has $178 billion in assets under management, released its first set of guidelines on responsible investing in 2009.

Two years later, it began applying this guideline to the companies it had under management and released its first corporate citizenship report the same year, after the company saw more demand from investors, particularly from Europe.

"Probably about a third of our investors are active in this area and are watching it and monitoring it," said Carlyle Group's chief sustainability officer, Jackie Roberts.

Roberts became Carlyle’s chief sustainability officer in 2015, after working at the Environmental Defense Fund for 17 years as the director of sustainable technologies and as the senior director of the climate and energy idea bank.

She said at first, the focus with sustainability for Carlyle Group and private equity firms was on cost savings, but now that focus has shifted beyond savings as companies are seeing more value in sustainable products and services.

"Now I see that the conversation is different if we can say, 'OK, well, there is cost savings,'" said Roberts. "'But there is also an opportunity to do something that we know is of interest to your customers, and your sales team can start marketing it.'" 

The Carlyle Group, like KKG, releases a sustainability report that shows the sustainability profile of some companies it has under management.

It showcases the way companies have improved in operational efficiencies, reducing greenhouse gas emissions and improving sustainability reporting. 

One company Carlyle highlights in its report is Veyance Technologies, a manufacturer of engineered rubber products.

Veyance Technologies replaced two boilers under the Carlyle Group’s ownership at an Ohio facility, reducing its carbon footprint by 14,000 metric tons and accounting for $3.5 million in annual savings and $25 million in total savings. 

The question remains, however, how much of this change is due to Carlyle Group’s emphasis on ESG and sustainability issues, and how much is a result of either necessary replacements or something the company already was concerned about.

Roberts said it sometimes can be difficult to show this distinction between Carlyle Group and a company under management.

"It’s a hard nuance to say exactly where Carlyle’s role finishes and where companies may come in," said Roberts.

She said that by emphasizing sustainability, it shows companies Carlyle is willing to invest capital in these projects and will take these issues to the board of directors for consideration.

"We’ll definitely have companies that have started sustainability initiatives before we buy them," said Roberts. "However, we’ll come in and support those companies and say, ‘We want those (initiatives) to be continued.’"

The disclosure dilemma

In the U.S., there are few standard disclosure regulations for private equity firms, meaning that firms are largely not required to report on ESG issues, and private equity firms tend to be opaque in their investments.

This makes it difficult for firms to talk about their sustainability initiatives. It also challenges how serious private equity is taking sustainability if it is not able to disclose these initiatives so that the information is publicly available.

Hodges said private equity firms often will let investors know about their sustainability initiatives if asked in private in a questionnaire, but still refrain from disclosing it online or in a sustainability report.

"The proof is really whether or not they are saying that it in the public,” said Hodges. "That, to me, is much more credible than what they (private equity firms) say in a questionnaire."