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ESG insights for private companies

Why climate change matters in private markets

Multiple authors
2024-10-31
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only. Past results are not necessarily indicative of future results. For more information, read our appendices on questions to consider, suggested readings, and key definitions below.

How are climate-related risks and opportunities considered and integrated into your corporate strategy? Have any of your company’s sites or key vendors faced climate-related incidents? Who oversees the assessment and management of climate-related risks? In our view, private company managements and boards must be prepared to answer these questions and more from their investors.

We believe climate change is one of the defining investment challenges of our time. Increasingly severe climate events can cause widespread disruption across many industries, while solutions to mitigate and adapt to emerging climate risks present an array of new opportunities. All of this holds the potential to significantly impact your company’s financial performance.

In our view, companies across all sectors and stages should develop and maintain thoughtful approaches to building climate resilience into their business models. These strategies should consider both the accelerating transition to a low-carbon economy and the worsening events exacerbated by climate change. This impacts a broader range of companies than one might expect, for example:

  • A consumer products company’s manufacturing facility is in an area that experiences extreme, sustained heat (as was the case across much of the US during the “heat domes” of 2023). Working conditions during these types of heat events result in reduced productivity, higher employee recordable incident and absentee rates, and the need to consider new capital expenditures to upgrade the facility’s cooling system.
  • Data center operators and substantial data users experience higher operating costs and lower margins due to rising electricity prices from higher carbon prices in some operating regions. Capital expenditures are required to offset these costs over time by procuring on-site renewables or securing power purchase agreements.
  • To accelerate progress in meeting its greenhouse gas (GHG) reduction targets and respond to consumer preferences, an international hotel chain invests in new technology vendors to automate both energy efficiency initiatives and data tracking at its properties.

Many companies overlook and/or underreport climate-related risks and opportunities that can be material to disclose to stakeholders. However, we expect disclosure scope and quality to improve in the coming years. In our view, these considerations are particularly relevant for private companies as they approach a public offering. Notably, disclosure expectations are rising in private markets, and the material business risks and opportunities presented by climate change warrant consideration at all phases of a company’s life cycle.

Evolving climate regulations

Climate disclosure requirements are evolving globally as regulatory regimes increasingly view them as a tool to promote well-functioning markets. For instance, the European Union’s (EU’s) Corporate Sustainability Reporting Directive (CSRD) requires large companies to disclose their policies around environmental protection, and the European Commission has published guidelines on climate-related information. Jurisdictions like the United Kingdom and New Zealand have also implemented new mandatory climate reporting requirements for listed companies in 2022 and 2023, respectively, while other markets such as Hong Kong are actively considering similar standards.

New California climate regulations could impact private companies

In the United States, at the state level, California signed two new climate regulations into law in October 2023. Senate Bill (SB) 253 and SB 261,1 known as the Climate Corporate Data Accountability Act and the Climate-Related Financial Risk bill, respectively, are set to take effect in 2026. The bills would require all companies (public or private) that “do business in California” to disclose:

  • SB 253 – Scopes 1, 2, and 3 GHG emissions where total annual revenues exceed US$1 billion
  • SB 261 – Climate-related financial risk, in accordance with the Task Force on Climate-related Financial Disclosures (TCFD) framework, and measures to mitigate or adapt to that risk where total annual revenues exceed US$500 million

Nationally, the US Securities and Exchange Commission has proposed a rule to require public companies to report on — and seek assurance for — material climate-related risks, GHG emissions, and net-zero targets or transition plans. If adopted, the onset of these expectations will be phased in based on company size and filing status.

Finally, while not a regulatory requirement, the Paris Agreement outlines the international community’s commitment to limit global warming to well below 2 °C compared to preindustrial levels. To meet this goal, GHG emissions must peak as soon as possible to achieve net-zero emissions by 2050. Each signatory country submits a climate action plan with levers to address its highest-emitting industries. Public and private businesses located within signatory countries are increasingly being asked by stakeholders to provide detail on how their operations will support the path to net zero. The ESG Data Convergence Initiative, the leading standard for ESG data collection in private markets, also recently announced that it’s adding a new metric on net-zero commitments and decarbonization efforts to its standard data collection template beginning in the 2024 reporting cycle.

Market support for climate disclosure

There is also growing awareness across the globe that climate change and the strategic transition it necessitates matter for returns and the stability of the financial system. This is exemplified in initiatives such as the Net Zero Asset Managers initiative, the International Sustainability Standards Board, the Institutional Investors Group on Climate Change’s Paris Aligned Investment Initiative, the UN PRI’s Net-Zero Asset Owner Alliance, and the Race To Zero Campaign. Importantly, commitments to decarbonization extend across asset classes, so we think investor expectations for disclosure by private companies are likely to catch up to public companies.

In addition, the Sustainable Finance Disclosure Regulation (SFDR), the new requirements in the EU for sustainability‐related disclosures in the financial services sector, will create mounting market pressure for enhanced disclosure by companies. This progress will be necessary to enable asset managers to measure investments on a range of climate dimensions, including climate solutions, for funds sold in the EU. Since this directive is based on fund domicile, European investor pressure will likely flow to global companies that are not directly subject to the parallel CSRD requirements.

Wellington’s commitment to climate change research

Wellington is dedicated to expanding our climate research capabilities across public and private markets as we believe climate change presents risks and opportunities that materially affect company financial performance. With this financial materiality in mind, we continue to pursue an aggressive research agenda on the physical and transition risks of climate change and its direct application in our investment processes. In addition to industry initiatives, our ongoing collaborations with Woodwell Climate Research Center and the MIT Joint Program help to deepen and broaden our understanding of the intersections between climate change and capital markets — including through new developments like our climate mapping tool. In our view, these capabilities make Wellington a strong partner for private companies as they consider climate-related risks.

Bottom line on climate risk in private markets

We believe it is critical for companies to consider climate change as an enterprise risk and to prepare for the opportunities and risks it presents. Furthermore, firms must be ready to meet the related disclosure requirements that are likely to increase from both regulators and consumers, especially as they approach a public offering. In our view, companies that demonstrate a high-integrity and principled approach to climate change will be better equipped for these challenges.

To aid in this effort, we have put together a series of resources for our portfolio companies to consider, including questions to expect from public-market investors, suggested reading, and a list of key terms. For portfolio companies looking to get ahead of future GHG disclosure requirements, we can also facilitate introductions to carbon accounting firms such as Watershed.

Appendix A: 10 climate questions to expect from public-market investors

Every company — whether a consumer company with supply chain risks or a data-intensive IT company with carbon costs for electricity use — faces its own climate-related risks and resulting oversight and disclosure requirements. We believe boards of directors and management teams will be expected to answer the following questions with the appropriate level of ESG expertise, particularly when climate-related issues arise.

Climate risk oversight and disclosure

  1. Who is responsible for assessing and managing climate-related risks? Does the board have explicit oversight? How do you ensure that these dedicated resources have sufficient expertise?
  2. Have you adopted the recommendations of the TCFD or an equivalent global reporting standard?

Physical risks

  1. Has any company site experienced a climate-related incident? What damage occurred physically and financially? What capital projects have been undertaken since the incident, particularly with respect to resilience planning?
  2. Can you explain the company’s business continuity planning? Do insurance policies cover both property and casualty (P&C) and business disruption?
  3. Do you anticipate that physical climate change will impact the growth or margins of your business as a result of supply chain shocks or changes in end-market demand?
  4. Do your products/services have the potential to help customers adapt to the changing climate?

Transition risks

  1. Do you measure and disclose your carbon footprint, including Scope 1, Scope 2, and material Scope 3 emissions? What challenges have you encountered in this process?
  2. What is the company doing to mitigate its own GHG emissions? Are there reduction targets and if so, how do you evaluate year-over-year performance against those targets? How do you measure the business impact of these initiatives? How do you assess the best internal and external levers to achieve reduction targets?
  3. What is your strategy for aligning your business with the global low-carbon transition toward net-zero emissions?
  4. What products/services do you offer where customer demand related to the low-carbon transition can serve as a sales driver?

Appendix B: Suggested reading and resources

Climate disclosure

Assessment of climate risk exposure and management tactics

Appendix C: Defining key climate terms

  • Transition risks versus physical risks: Transition risks relate to the cause of climate change — emissions in the atmosphere — and the remediation of the cause, referred to as mitigation. Physical risks relate to the effect of climate change — acute and chronic climate events — and lessening the impact of these on societies and assets, referred to as adaptation.
  • Carbon emissions “scopes” 
    • Scope 1: Direct from operations, such as factories or vehicles owned by the company
    • Scope 2: Emissions associated with electricity consumed by operations
    • Scope 3: Indirect emissions associated with the supply chain and full life cycle of products/services. Measuring Scope 3 helps companies identify opportunities for collaboration and influence across industry verticals and for investing in innovation to evolve product lineups. There are 15 subcategories, divided between two categories:
      • Upstream: purchased goods (think materials, transport, and waste of production inputs/costs of goods sold)
      • Downstream: use of sold products (think automobile emissions post sale), investments
  • Life cycle analysis (LCA): Measurement of the full life cycle of GHG emissions of a product, including raw materials, manufacturing, transportation, storage, use, and disposal. The results can create competitive advantages by enabling better product design, increasing efficiencies, reducing costs, and responding to customer demand for positive environmental impact.
  • Science-based targets: Targets set to be in line with the Paris Agreement, which should follow the principles set out and ideally be verified by SBTi. The requirements differ by sector in terms of the emissions scopes that must be included and the pace of decarbonization.

1 Source: The Hill, “Newsom signs landmark emissions, climate risk disclosure laws,” 9 October 2023.

Our approach to sustainable investing

Experts

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Drew Morales

Associate Director, ESG, Private Investments

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