Private capital, politics, and the Paris commitment

Current political uncertainty is a threat to ESG engagement. The private sector has an urgent responsibility to provide strong leadership, writes William K. Reilly.

Traveling to London to speak at the PEI-PRI Responsible Investment Forum at the end of May, I couldn't help but reflect on the stormy political weather on both sides of the Atlantic. The US and UK face uncertain civic and economic futures as a result of a highly polarised election in the US and, in the UK, the looming possibility of a “Brexit”. In these volatile conditions, issues of global significance, particularly environmental, social, and governance (ESG) concerns, can be overlooked. This creates an opportunity-and a responsibility-for the private sector to lead and continue to show progress in ESG engagement. 

A recent report by the Institute of European Environmental Policy concluded that the UK's environment would be highly vulnerable without EU regulation. Similarly, the ability of sustainability legislation in the US to survive partisan crossfire is questionable. 

The framework of ESG regulation may prove to be unstable, yet international agreements have been made -at the United Nations Climate Change Conference in Paris last November, the US committed to a 26- to 28-percent reduction in greenhouse gases by 2030, including new regulations to rein in CO2 emissions from automobiles and power plants as well as methane from fossil fuel production. The US has not, however, identified the means it will deploy to achieve a third of the promised reductions.

The Paris commitments are even more fragile when it comes to fast-growing emitters in the developing world such as India, Brazil, Indonesia, and South Africa, where economic and political turmoil often take precedence over ESG concerns. Developing countries made promises to implement massive new wind and solar power generating capacity. Without renewable energy additions at such a scale, we have no prospect of keeping global warming from reaching catastrophically disruptive levels, but, as the 'Shaping Energy Transitions' 2016 report notes, the investment necessary to finance these initiatives is an estimated $2 trillion over 15 years. We can be certain that there is not that kind of money in government funding or the international aid and development community. 

Much of the capital necessary to realise the COP21 commitments worldwide will have to come from the private sector. The commitments are explicitly contingent on receiving financing, and fulfilling them is thus contingent on the desirability of the investment opportunities they present. Investors may have good intentions, but deals must still be profitable. 

We are going to have to get serious about eliminating barriers and implementing the investment criteria, regulatory systems, and transparency that will make these opportunities attractive, at a very large scale, to investors with access to capital.

Fortunately, the private sector has, in recent years, stepped up to meet social obligations as never before. A decade ago, private equity firms had no dedicated professionals responsible for the ESG policies of their portfolio companies. TPG, a leading global alternative investment firm where I am a senior advisor, now has four. Other major firms – KKR, Carlyle, Goldman Sachs, and others – now have similar priorities and professional oversight. 

Until the COP21 conference, major UN environmental gatherings were populated by government officials and nongovernmental groups, while business representation was notably absent. In Paris, that changed. Major banks, investment funds, and business leaders were active, making headline pledges to help finance the commitment to keeping the world's temperature increase at or under two degrees Celsius.

This follows a well-established tradition of private enterprise going where government will not or cannot go, helping fulfil the need for sanitation, quality public education, reliable electricity, roads and ports, and transparent, corruption-free regulation. 

I used to run a fund that invested in water companies in developing countries to offer services that government did not: drip irrigation in India, clean water for beverages in Russia, water filtration and household storage in Mexico. We standardised accounting, best practices for pollution control and workplace safety, and rigorous transparency. Private equity often plays this role in developing countries, and it is a major contribution to economic innovation.

It is also a crucial factor in creating opportunities for further investment, which will be key to helping meet the COP21 commitments. Private equity can invest in a struggling company and improve business management, bringing it to a condition in which it can be sold on the international market and attract investments that would not have otherwise been made.

What's more, the market is changing, as are priorities for the millennial generation, in ways that give the private sector a powerful incentive to invest in sustainability. ESG concerns were once relatively marginal to the income-generating outlook of a company. Now, they are central, understood to be directly related to the bottom line.  

When I was EPA Administrator under the first Bush Administration, I once pressed Procter & Gamble CEO Ed Artzt about his good efforts to reduce waste by trimming non-essential packaging.  He said: “We're not doing this for you. Our customers are demanding it.” Likewise, when Walmart stopped purchasing seafood from unsustainable fisheries, then-CEO Lee Scott said very plainly that it's not because the company is trying to “go green”, but because they want to make sure that in five years they still have seafood to sell. Private investment in businesses' ESG initiatives now has the power to change production procurement and market-facing design, with enormous influence on work practices, waste, and ethics in China, Vietnam, Bangladesh, and India.

I urge major investment institutions to convene formally and regularly, exerting leadership in setting goals and timetables for climate-friendly investments. They should not simply wait to receive proposals to help countries honour their Paris commitments, but actively pursue investment opportunities that will advance carbon reduction on a global basis. As a sector, we have the capability, and therefore a duty and a responsibility, to help build the foundation for a sustainable future around the world-a foundation that can withstand any political tempest.

William K. Reilly was Administrator of the US Environmental Protection Agency from 1989 to 1993.  He is now a senior advisor to leading global private equity firm TPG. Reilly will give the keynote interview at the seventh annual PEI-PRI Responsible Investors Forum in London May 25-26, 2016. The Forum is the largest and most influential international conference dedicated to responsible investment in alternatives.