Leveraging ESG for growth

Speaker A: Welcome to money. Multiple sustainability is rapidly becoming a cornerstone in private equity, shaping not only how UH firms manage and grow portfolio companies, but also where they choose to invest. With increased attention on environmental, social and governance issues, PE firms are facing rising expectations from investors, regulators and consumers to embed sustainability into their strategies. This shift isn't just about compliance. It's creating opportunities for new business models and investments in areas like renewable energy, circular economy innovations and sustainable agriculture. Private equity is channeling capital into companies and technologies that support a more sustainable future, fostering impactful change across industries. Beyond green projects, firms are implementing ESG metrics and reporting standards to track and drive sustainable outcomes across their portfolios. As UH sustainability becomes central to value creation, the question arises, how can private equity maximize impact and returns while adapting to these new models? To explore this interesting and important topic, I'm joined by Sourabh Dhingra, EY's Asia Pacific strategy and transaction sustainability leader Saurabh. Welcome to the show.

Speaker B: Hi Luke and thanks for having me here today.

Speaker A: So Saurabh, to set the context, we understand the increasing importance of global warming and climate change. Can you help us understand the key industries that generate emissions?

Speaker B: I think it's very important to set the base here. When we talk about the emission levels we are actually talking about greenhouse gases and the gases which are relevant here are carbon dioxide, methane and ah, nitrous oxide. And just to give you a bit of context, overall the world has seen a significant increase in these uh emission levels, uh, by around 60% over the last 25 years. And to answer your question about the key industries, as you would wonder, power generation and electricity are definitely one of the largest contributor about 30% of the global emissions emission levels followed by agriculture and manufacturing both contributing 20 plus percent and then transportation which is around 15 odd percent and then building and construction which around 6%. Of course these numbers vary by geographies and the maturity of different markets.

Speaker A: So clearly certain industries account for quite a significant percentage of emissions. Let's talk about what sustainability lever should be prioritized for investments in these areas to increase investor and shareholder value.

Speaker B: As I mentioned, the emission levels obviously vary from different sectors perspective and therefore we should focus on the sectors which are the largest contributor to these GSG emissions. Let's look at electricity or power generation. As we all know there is a significant shift that is required from the fossil fuel based energy to uh, renewable energy. We are seeing new initiatives and investment opportunities arising in this space, but particularly the move to large scale renewable energy sources such as solar, wind and Hydro. Of course there are differences in terms of the maturity of the technology. Particularly we've seen significant progress made under the solar panel as well as battery storage systems. The other area where we seeing big initiatives and opportunity of investments is energy uh, efficient projects such as carbon capture and fuel blending. Similarly, we are seeing significant investment opportunities across manufacturing and industries. In industries, the two largest subsectors which are contributing the emissions are steel and cement. And we are seeing opportunities to invest into green steel as well as certain industrial practices to improve the way green steel can be generated. So moving away from the conventional blast furnace based production to more uh, electric arc furnace based production. When we look at cement, we are looking at new industrial practices coming in to make it much more sustainable, both from the carbon capture and storage perspective, but also looking at the supplementary material that's used to manufacture cement. The third sector which I spoke about earlier is agriculture. Multiple initiatives have been driven globally and therefore create investment opportunities from the buyer's perspective. First and foremost around sustainable farming practices such as precision farming techniques, uh, using new technologies, GPS sensors, analytics to really be able to drive the reduction in the inputs such as uh, fertilizers, which are one of the largest contributor of methane gas. The second area where we look at from opportunity perspective is carbon soil sequestration which has really helped to reduce and improve the quality of the crop and therefore be able to drive towards more sustainable farming practices. Third area, which I would say is also quite meaningful, especially in the west, is around livestock management where we are looking at new feeding practices to improve the usage and production of methane. The other sectors, especially transportation, we are seeing large investments going into electrification and production of EVs both for commercial as well as personal usage. In aviation industry projects such as sustainable aviation fuel blending would be quite interesting to follow in the coming years. And we are seeing electrification of the commercial vehicles such as trucks using battery electric trucks. Now coming to the last sector which is around real estate building and construction, I would say there are investments being made in the bio based materials as well as looking at solutions such as insulators and uh, smart ventilation systems. Those will create good investment opportunities for the buyers.

Speaker A: That's fascinating if you look at the rate of change in each of these industries. For firstly all of these changes and this evolution requires a significant amount of capital. I think private equity plays quite well to that. But also you're talking about potentially a lot of new talent, a lot of innovation as you mentioned, and potentially a lot of new business models which might even converge certain industries. So maybe let's unpack a little bit the aspect on business models. Can you give us some examples on good business models that you've seen implement some of these sustainability levers?

Speaker B: As you mentioned the there's significant investment that needs to go into this space and we are seeing very good innovation both from the technology developments that are happening and also there are entrepreneurs who are coming with very innovative business models. Most of the models are trying to move away from a more capital intensive solutions to greater accessibility and lowering the cost of adoption. So what we have seen, let's take the power generation and electricity as the first sector where we're seeing emerging models from renewable perspective and how those models can drive better adoption of renewable energy. There are examples such as community solar projects where the companies are developing large scale solar farms and allowing customers to be able to lease the solar energy at a much cheaper and a much accessible cost perspective. Similarly, we have seen models such as solar as a service where some innovative entrepreneurs are able to come up with installation of solar panels on both the commercial and residential buildings and be able to offer these in a much cheaper as a fee based model. We have seen significant support also from some of the governments as well as the development banks, especially on the sonal energy space. Now if I continue that thinking into the other sectors, we have seen some similar models that emerge in the building space as well. Similar to solar as a service, we are seeing energy as a service solution being offered by some of the largest technology infrastructure companies who are looking at energy efficient solutions and really bringing them as a service to both the businesses and individuals and that will really allow them to be able to look at a much more cost efficient solutions. In fact, we've seen space where some of the companies are offering guaranteed cost savings and therefore be able to really embed the better adoption of these solutions. Another area I can talk about is from the transportation perspective where we're seeing EV charging as a service as well where certain companies have started creating a network of EV charging stations and be able to generate revenue through subscription models rather than a capital incentive model. So I would say in all I think a lot of solutions are coming to the market that are trying to reduce the usage of upfront capital required and therefore it's a great space to look into. Maybe if one more area I can talk about which is as we all know we are increasingly moving towards increase in usage of AI and quantum computing, although these solutions are much more energy intensive and will go a little bit against the whole sustainability initiative. But we are seeing green solutions such as green data centers being developed, which will hopefully be able to solve these requirements in the coming year. So an interesting space to look into, although the technology is still maturing slowly.

Speaker A: Thanks. You've actually covered quite a lot of ground there. What I wanted to do was uh, shift tack a little bit to talk about how private equity is incorporating sustainability into their own business and there's probably two or three lenses to that. So clearly one big area is around and it links to what you just said where private uh, equity actually enables a lot of sustainability investments. But we also invest in a lot of businesses across sectors where they need to incorporate sustainability practices into these companies. So maybe let's start with that. How do you think the industry is doing incorporating sustainability into their own investment workflow and practices?

Speaker B: So I think we're seeing significant progress that's been made in the whole investment cycle right from the LPs to the GPs. From our recent survey we have seen that 90% of the respondents from the LPs are saying that they have incorporated uh or embedded sustainability into their evaluation criteria for looking at gps. So progress has been made there. However, when we look at from a GP's perspective, only 2/3 of those respondents have said that they are looking at sustainability as a uh criteria when they're taking decisions on their investments. When we speak to the various GPs, we have seen most advanced GPs have already developed their own evaluation frameworks looking at sustainability as one of the key criteria for evaluation of portfolio companies. However, the area where we still feel that there's further development or progress required is really following through the post transaction cycle where the P's should start looking at ah, our sustainability as a core driver of value creation and guiding their portfolio companies.

Speaker A: So I guess in your view private equity is doing a good job at the moment in incorporating sustainability agenda into their workflows and uh, in a way they are quite uniquely positioned to lead the charge in helping companies to transform.

Speaker B: Of course there's been uh, development but there are areas where private equities can further play an important role in driving this agenda. There are few different strategies they can potentially follow. First and foremost developing uh, more specialized sustainable funds which could take a form of either focusing on a particular sector and especially the some of the sectors we discussed earlier in the conversation or could be very thematic based such as looking at climate tech or let's say sustainable agriculture or even circular economy. We have seen some development in this space but I think PE funds can definitely push more on that agenda. The second part I would say is to also start integrating sustainability in a much more holistic way across the whole investment life cycle. As I mentioned earlier, PE funds have started looking at sustainability from their diligence and investment decision perspective. But what we really believe is P funds can do that even at an uh onset from a deal sourcing as well as the opportunity identification perspective. And also there's significant room for improvement or push from really working closely with portfolio companies. From planning uh, value creation as well as the monitoring perspective I think PE can play an important role in setting the right sustainability targets for their portfolio companies. Provide them the right guidance, expertise. Given the excess that a uh, private equity player would have uh versus a portfolio company I think they can play a much more hands on role and really looking from a long term value perspective. Now the third area where I feel that we can further push the boundaries is by building a broader partnerships and alliances. Ah, some of the large GPS can working along with their LPs can actually work with the development banks as well as the global organizations such as World bank and IFC to form partnerships to look at some of the long tenor projects which are heavily capital intensive. Hope that gives you a bit of perspective of where private equity can further push the agenda.

Speaker A: It certainly does Saurabh. So thank you very much, that was very insightful. Let's talk about a slightly different topic and maybe unpack some of the challenges that are faced in integrating sustainable finance principles. Would you want to comment on what key challenges companies face in incorporating these?

Speaker B: So Luke, I think while we know that there is a very strong correlation that exists between the investment performance and sustainable practices but there are still a lot of dependencies that exist in the macro environment which create challenges for embedding sustainability into the overall investment principles. And I would say there are three key areas where I believe the uh, challenges exist. The first and foremost is from the policy and the regulatory environment. The second is in terms of the financial challenges such as the tenors and the returns and so on and so forth and thirdly is from the availability of data and the reporting requirements. So let's look at the policy and regulation challenges. I think significant progress was made I think five years ago but we have seen a little bit of a pullback from governments across different parts of the world, especially post Covid as well as the inflationary pressures that the economies have felt. So which has slowed down some of the policy changes that were required across the globe. And some of it is also driven by the short term nature of the governing offices, limited amount of capital available as well as the industriously lobbyist that are quite active in certain parts of the world. Secondly, as I said, financial challenges, which is given the nature of the project and the scale of the investments these projects require, it will require uh, larger partnerships from the public and private perspective. Some of these technologies are still unproven and therefore have a much higher perceived risk leading to higher cost of capital. Therefore we see limitations from the capital perspective will probably require better public private partnerships to come with new solutions such as blended finance where we have seen some progress, but I think a lot more can be done. The third challenge is around really the availability of the standardized data as well as the reporting requirements. As we all know the reporting requirements are still evolving and fast changing across different geographies as well as different industries. And then that really hinders the transparency that it can bring from a buyer's perspective, not just from a uh, evaluation at the investment stage, but also during the monitoring phase. So those are the three big challenges I would say that still need to be solved here.

Speaker A: And are you seeing good models to where people work together to overcome some of these key challenges?

Speaker B: It requires a concerted effort from industry as well as the key stakeholders in the whole value chain. First and foremost would be the public private partnerships. And where certain governments and states come together with large industry players to be able to fund these long tenure, large capital intensive projects. Governments can play a very important role from providing the right sort of guarantees, subsidies and other incentives to be able to fund these long dated large scale projects. Some of the examples are also uh, working with development banks such as World Bank ADBs who have come forward and are trying to cover the long tenor part of the funding required. These structures are very important to really drive this agenda forward. The other area where we've seen at least the development is where the large industry players have come together and start forming large uh, collaborative alliances to really drive the agenda in terms of developing new technologies as well as pushing the project from a long term perspective. I think one good example of that would be Oil and Gas Climate initiative where some of the largest oil and gas companies globally have come together to solve the problem of carbon capture and storage and are trying to fund that collectively with working with some of the government agencies as well. Third area where we are seeing at least some right progress being made is from the policy and the regulation perspective where the governments and regulators are coming together at least from a regional perspective and start defining some standards. For example, ASEAN has come together to standardize the reporting requirements and hopefully also the data requirement that will be very important to drive the agenda forward.

Speaker A: So things are moving forward and certainly since the Paris climate Accords there's been a lot of focus on this topic. I think there was a lot of momentum as well. How is that momentum today? Is it still at that breakneck pace? Has it kind of calibrated in a certain direction? If we can have your comments on that.

Speaker B: As you said, when the Paris agreement came into foray, the first couple of years were definitely slow, but we had seen a very strong momentum, let's say four, five years ago, especially led significantly by EU and support from the rest of the Western markets. However, we have seen some deviation or a distraction from the overall sustainability agenda post Covid, particularly given the high inflationary environment we have been operating over the last few years. If I take a view from Asia perspective, I think Asia has always sort of been looking at west from the guidance and in the last couple of years we have seen a lot of commitments being made by the government agencies and the uh, respective economies to drive the agenda. So I would say Asia was always a little behind the curve compared to the European economies, but over the last couple of years we've seen a very good push, especially in asean.

Speaker A: Saurabh, we've covered a lot of ground. Thank you so much for sharing your insights. What would be your advice for private capital investors?

Speaker B: We have seen a direct correlation between ESG factors and the performance of the portfolio companies. Private equity funds have started making a significant progress of embedding sustainability into their journeys and I think PE funds have a very unique position given they can directly influence the entrepreneurs as well as access to both the financial as well as sustainability data and visibility into the performance. PE funds can take a long term view as compared to the public traded companies therefore have a significant impact. What I would recommend as a parting note to the private equity funds is to embed thinking around value creation into the overall life cycle of your transaction right from the onset when you are looking at the opportunities and evaluating opportunities to look at ESG as a value creation lever. Another area where I think PE can do a greater job is to really work with their GPS as well as the broader ecosystem to be able to drive sustainability as a core agenda and embed into the investment life cycle.

Speaker A: Sourabh, thank you very much for joining us.

Speaker B: Thanks for having me.

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