The stage is set for a private equity decarb revolution

“If I wasn’t doing this, I’d want to be raising a private equity decarb fund.”

This was expressed to New Private Markets earlier this year by an investor in climate VC funds. Coming from someone in one of the hottest areas of investment, this is a strong indictment of a potentially exciting, emerging area.

While it is not yet a clearly defined strategy, there is a handful of firms that have identified the decarbonisation of mid-market companies – let’s call them the real economy – as a compelling opportunity. One such firm is Argos Wityu. The Paris-headquartered private equity firm has raised €120 million for Argos Climate Action, a €300 million-target vehicle that will invest in small and medium-sized businesses and use decarbonisation as a value creation lever. It is targeting a 7.5 percent annual reduction in carbon intensity for its portfolio.

In the words of Jack Azoulay, senior partner at the firm and co-head of the fund, while capital has started to flow to green infrastructure, climate tech and large corporations, “there’s a lot less to transform in everyday life SMEs – companies making our chairs, chemicals, windows or food, or transporting goods around; all sorts of things that we’ll still need in 10, 20 or 30 years, but that will need to be produced in a far less carbonised way.”

Concerns that regulation – EU SFDR specifically – could hamper the development of such funds by not allowing transition strategies to be classified as Article 9 also seem to be dissipating. The Argos Climate Action fund is Article 9 on the basis that “article 9.3 specifies that one of the ways for [funds] to be sustainable is if they have as a main objective to mitigate climate change, namely by reducing carbon emissions”, Azoulay told NPM earlier this year. This is “exactly in the spirit of article 9.3”, he continued. The UK’s yet-to-be-introduced Sustainable Disclosure Regulation will allow for decarbonisation strategies within its “improver” classification.

What about differentiation? We know that financial sponsors are starting to think about – and measure – emissions across their portfolio companies. Projects like the ESG Data Convergence Initiative are helping to make this standard practice. It is a short logical step to assume, therefore, that part of all good PE firms’ ESG toolkit will involve improving emissions data over time (or start facing difficult questions from investors). Some are implementing their own reduction targets.

But while we expect and hope emissions reduction will become a recognised part of the PE value creation playbook, we also expect specialist strategies, which target specific assets where the reduction can be material, and link carried interest to the achievement of this goal, to remain differentiated and grow in relevance.

They should also be received favourably by investors. One in five respondents to a BlackRock survey released this week said they would like to see more private equity transition products in the market. The industry will hopefully answer this call.