Q&A: PAI Partners' Cornelia Gomez

Q: How did the International Climate Initiative (ICI) come together?

A: The most advanced French GPs kicked off on climate in 2015, testing different approaches to carbon footprint measurement. It has only become more of an industry approach in the last two years with the TCFD [Task Force on Climate-related Financial Disclosures] and when the PRI [Principles for Responsible Investment] started to get involved. The PRI issued a climate change module, but at first it wasn’t compulsory, which was a good move because it allowed the most advanced GPs to test themselves against it. What happened in France five years ago was the GPs asked how we could build a scale initiative around the Paris Agreement and make sure private equity has a voice. We wanted to share best practices, carbon footprint measurement, and find out the best way to conduct scenario analysis. By 2019, we had 39 French signatories and we decided to take the initiative international. We partnered with PRI and we are now the ICI and two weeks ago we founded the UK chapter. We would be interested in creating an Asia-based network as well.

Q: What are the challenges in measuring the carbon footprint of a portfolio?

A: You must ask where most of the carbon emissions come from and whether they are direct or indirect emissions. If it’s scope one or two you could call up the CEO, tell him he has two years to reduce his carbon footprint by 20-30%, and talk about how to achieve this. However, if it’s a garment retailer or a pharmaceutical company, most of the emissions are scope three, so you must look at the suppliers. We started measuring our full carbon footprint in 2016 but we were only confident of the data only in 2019. Even then, the emissions factors we were using came from a French methodology. We are an international PE firm, so we changed our measurement system to follow the Greenhouse Gas Protocol.

Q: Why did it take so long to get comfortable with the calculation?

A: I wasn’t satisfied because we were asking way too many questions. We were trying to obtain a perfectly accurate carbon footprint, which means pushing down 50 indicators to portfolio companies. We own an ice cream company, so we were asking how much milk powdered milk, palm oil, coconut milk, cream was being used. What are you going to do with that? You have a super-accurate carbon footprint, but you’ve exhausted the company with questions, and you haven’t really built any awareness. We decided on an 80% materiality threshold and the number of indicators fell to10-15. You ask about electricity usage, about gas, about the top three raw materials they are buying. By asking fewer questions but better questions, the data you get is more accurate.

Q: What other underlying metrics do you track?

A: Since 2014, we have been tracking water consumption, waste management, and energy efficiency. If you want to reduce emissions on scope one and two, energy efficiency – consuming less water and electricity for the same number of units of production – has the biggest impact. This might be easy to track if you have just one manufacturing site and in a country with reporting regulations. For many small to mid-cap companies, it is hard to put reporting systems in place. You might be asking them to pull out all the water and electricity invoices for every site.

Q: How widespread is carbon footprinting among GPs?

A: Of our 39 French signatories, a majority have measured their carbon footprint. It’s really a case of how accurate you want to be and what you want to achieve. I think the next frontier is private equity firms becoming fully carbon neutral – the investment manager and the portfolio. For an investment manager, you measure your carbon footprint and then invest in a project, often a forestry project. PAI wants to do this by year-end. I don’t think we are ready to do it for our investments yet; that would require significant carbon offsetting projects. It also depends on what PE firms are investing in. If they are targeting privatizations of listed companies, those businesses might already be compliant. They report to CDP, they partner up to become carbon neutral, or they are required by their clients to measure the carbon footprints of the products they sell.

Q: What should people be looking at beyond carbon footprinting?

A: The real question is risk. Transition risk, which covers legal, policy, reputation, business, sector risk; and then physical risk, which involves knowing where sites are located and assessing the risk of fire, drought, and hurricanes and loss of real assets. You want companies to understand how they are impacted by climate change and mitigate the risk.

Q: Where does scenario analysis come into this?

A: If a company has maxed out scopes one and two, it must attack scope three. You can only work on it if you do scenario analysis, and it’s costly – at least EUR10,000-15,000 ($12,000-18,000) and sometimes up to EUR25,000-30,000. Smaller GPs with only one person covering ESG struggle with their budgets. Everyone is waiting for advances in open source tools. That said, when we sell a company, I get questions on risk, not on carbon footprint. They want to know whether we have evaluated the physical risks of the asset. If a company has four sites in coastal areas where the sea level is expected to rise by one meter, how is that being mitigated? We have a company that is Europe’s number one producer of organic food. Coffee and tea are among the key products. During due diligence, we looked at the sourcing and found that arabica plantations will be severely affected by global warming. How do you adapt your business model to that?

Q: Are you running scenario analysis on companies to assess the impact of specific global warming levels?

A: We have 21 portfolio companies and we are running scenario analyses for two. It means doing a deep dive into the business model, locations, and supplies, mapping out the risk, and asking by how much you should reduce emissions to maintain the company under that scenario. You have to talk to a lot of different people. One of our companies is bottling business and the endgame is not a scenario analysis, but a lifecycle analysis for the product. We want to understand the overall impact of producing bottles made of recycled PET, virgin PET, Tetra Pak, and glass. We already have a climate risk analysis and we will run that against a 2-degree Celsius scenario. We want the company to set a target – for example, reducing scope two by a certain amount by reducing the amount of water or energy used at three sites. One of the challenges of buying recycled PET is it costs 30% more than virgin plastic. Companies like Coca Cola, Danone, and Proctor & Gamble are buying up 10 years of capacity to ensure they can live up to the promises they’ve made to consumers.

Q: What makes these analyses difficult, apart from cost?

A: Every service provider has a different view on it; there are too many methodologies out there. You have to choose a partner you want to work with, who is knowledgeable and has experience with corporates, and you want them to come up with a methodology that’s simple enough to be understood by management. Then there are lots of new regulations. The European Commission is due to issue a green finance directive in September and it is reviewing the non-financial reporting directive, specifically lowering the threshold, which would mean more companies have to report on risk. There are also carbon tax regulations in France and the UK. If carbon taxes or quotas are introduced, we will have to reengineer our scenario analysis. Right now, the financial impact is very unclear; we don’t know how much we can save by reducing emissions. If you are a B2B company, it’s a positive, but you won’t get a premium on exit because you did a scenario analysis or reduced carbon footprint.

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• Topics
• Europe
• GPs
• Regulation
• ESG
• PAI Partners