Understanding Carbon Exposure in Private Assets
Understanding Carbon Exposure in Private Assets
Written by Manish Shakdwipee, Executive Director, Head of Climate Change Research in ESG Research
Since the Paris Agreement, there has been growing scrutiny on carbon emissions by public companies, but it is much tougher for investors to evaluate their exposure to carbon from privately held assets.
Both private and public companies exposed to regions with high carbon-emission reduction targets are similarly vulnerable to regulations and policies aimed at reducing companies’ direct emissions.
For investors that have private companies in their portfolio, engagement might be more practical than for investors in public companies, as the group of private emitters is more concentrated than public counterparts.
Since the 2015 Paris Agreement, there have been a growing number of climate-related transparency regulations and initiatives focused on public companies and managers of listed assets. But private companies have not received the same level of scrutiny. How can investors in private assets calculate their exposure to carbon emitters in their portfolios, and what can they do about it?
This issue has become more pressing as the proportion of private assets has increased dramatically in institutional portfolios. For example, Willis Towers Watson’s Thinking Ahead Institute found that global pension funds’ allocations to real estate, private equity and infrastructure have more than tripled over the past 20 years, increasing to more than 26% from 7% [1]. But compared to the public markets, there is much less information available on how they are preparing for the transition to a low-carbon economy.
To gauge the potential climate-transition risk of private companies, MSCI estimated Scope 1, Scope 2 and Scope 1+2 carbon emissions for a nonrandom private-company set [2] using our proprietary carbon-emissions estimation model. We then compared the emissions of this set with those of public companies in the MSCI ACWI Investable Market Index (IMI) [3].
Private-Company Emissions Were Concentrated in Just a Few Sectors
Like emissions for public companies, emissions for private companies were clustered in three sectors: utilities, energy and materials. But the concentration in these sectors was lower for private companies, accounting for approximately 68% of total emissions, compared with approximately 82% of total emissions for public companies.4 Further, the three sectors accounted for only 12.3% of the private-company set by revenue, compared to 20.5% for the public-company set.
Sector Concentration of Carbon Emissions in Private vs. Public Companies
Data as of August 2021. The analysis is based on 9,225 public companies and 18,562 private companies. Source: MSCI ESG Research LLC, Burgiss LLC
Lower exposure to carbon-intensive sectors is a major reason for the lower overall carbon intensity5 of the private-company set (~172.8 of CO2 equivalent per USD million of revenue) compared to the public-company set (~249.1 CO2e per USD million revenue), as of August 2021.
When MSCI adjusted the datasets to examine only areas with high carbon-emissions reduction targets,6 the difference between overall carbon intensity of private and public companies was far less, declining by 85% (see exhibit below). This means that both private and public companies are similarly vulnerable to regulations and policies aimed at reducing companies’ direct emissions. The problem then becomes one of attention: Since private companies face fewer disclosure requirements, the market has paid less attention to their emissions.
Overall Carbon Intensity of Private vs. Public Companies
Data as of August 2021. The analysis is based on 9,225 public companies and 18,562 private companies. Source: MSCI ESG Research LLC, Burgiss LLC
Carbon Emissions Were Concentrated in Fewer Private Companies
While sector concentration associated with Scope 1+2 emissions was lower for private companies than public ones, we found the opposite pattern when we examined exposure to individual companies. For instance, the top 50 emitters in the public-company set accounted for approximately 40% of carbon emissions, compared to nearly two-thirds for the private-company set (see exhibit below). This higher level of concentration of emissions among private companies may help institutional investors who pursue engagement strategies with private companies, as they would have to engage fewer private high emitters than they would with their publicly held counterparts to address a similar level of carbon emissions.
Emissions Contribution of Top Emitters
What Can Investors Do?
As institutional investors recognize their exposure to carbon-emissions risk through private companies, they can think strategically about how to address them. After all, private companies are equally vulnerable to the growing number of regulations and policies aimed at reducing companies’ direct emissions.
As the first step, investors can ask portfolio companies to provide more comprehensive disclosures on the climate risk and opportunities they face. Investors could also assess the carbon footprint of their private-company portfolios and identify potential drivers of climate-transition risk in their portfolios. Carbon footprinting sets a baseline to inform future actions, which can range from reporting and engagement to decarbonization and risk management.
To date, institutional investors have been slow to act on the climate-transition risk associated with their private-company allocations.7 As allocations to private assets increase, the importance of addressing these exposures grows.