Last year US-based private equity firm Frontenac selected HSBC to finance its acquisition of Newterra, a provider of water and wastewater treatment solutions. In doing so, Frontenac became the first firm to receive a private equity loan in Canada under Green Loan Principles1 that require loan proceeds to be allocated to sustainable projects. HSBC has pledged to provide between USD750bn and USD1trn in financing and investment to support green companies and projects by 2030. “Executing sustainability need not be mutually exclusive with attractive investment performance,” says Ron Kuehl, managing director at Frontenac.
Environmental, social and corporate governance (ESG) practices are gaining traction among private equity firms, due in part to heightened societal focus, increased investor demand and potential growth. HSBC research shows that companies focused on climate change or ESG outperformed their counterparts in the early weeks of the covid-19 pandemic. According to investment research and management firm Morningstar, 57 of its 65 ESG indexes (88%) outperformed their broad market equivalents for the five years to the end of 2020.2 Respondents to a 2020 survey of 50 private equity executives by consultancy Environmental Resources Management indicate that ESG will offer significant value creation and investment opportunities in the next three to five years.3
Frontenac owns 14 middle-market companies that each have varying degrees of ESG policies in place. “In each investment opportunity, we evaluate sustainability and other ESG-related topics,” Mr Kuehl says. “Our interest in Newterra was driven by its ability to provide highly engineered solutions to complex problems facing the water industry. Legacy infrastructure issues, increased awareness, government focus, and inevitable future demands are going to drive this industry for years to come.”
While publicly traded companies and large investment funds have formally outlined their net-zero ambitions, most privately held middle-market businesses are still trying to figure it out, says Jamil Ibrahim, HSBC’s commercial and corporate banking market head for Eastern Ontario. “Finding the balance between setting sustainability goals and strategies and funding the cost to implement them is the largest concern we see middle-market business facing,” he says.
Costs are a key challenge, often cited as a significant pain point in meeting net-zero goals. Yet the pressure to think sustainably will continue to trickle down to family-owned private businesses, as they are likely to be part of the supply chain of larger organisations. In some cases, it is not so much the absence of funding as the difficulty in accessing what is already available. “HSBC’s transaction with Frontenac opens up a new segment in the Canadian financial market for private equity sponsors interested in green assets,” Mr Ibrahim says.
Without financial support and incentives, however, organisations are reluctant to take on the risks that the shift to net zero entails. Mr Kuehl recommends making incremental improvements and using whatever government incentives are available now, even if such an approach is a piecemeal one. Several of Frontenac’s food manufacturing businesses, for instance, recycle their own waste;another has a zero-wastewater facility; and one company generates its power via solar energy. “Incremental changes and achievable goals are rational first steps on the road to making a difference,” Mr Kuehl says. “If more and more small and mid-sized companies were to make seemingly insignificant changes, together, the positive impacts could be substantial.”