Climate change is undeniably one of the most pressing issues of our time. Alarm bells have become too loud to simply ignore, spurring increasing action on the part of policymakers and stakeholders to transition to a greener economy. Corporations and financial markets have not been immune to calls for climate action. Many shareholder or stakeholder initiatives and legislative actions now focus on the role that corporations and financial markets can play in the net-zero transition. Yet, the focus in these initiatives has so far largely remained on public companies, ignoring a large segment of the economy in the form of private companies.
In a recent paper, we argue that this focus falls short of providing a comprehensive approach to the problem of climate change. Similarly, in a recent post, we summarised our findings on why private companies matter in terms of climate action in the US and main policy implications in light of the recent step by the SEC to mandate climate-related disclosures. In this post, we turn to the relevance of private companies in other major jurisdictions and explain our findings from the perspective of the current developments in the EU and the UK.
Private companies have long been a substantial part of the European economies. Some of them are among the largest in their industry in terms of size and among the highest emitters of greenhouse gasses (GHG) (such as MSC Mediterranean Shipping Company, see here and here). Generally, under the EU emission trading system, energy utility firm EPH, a private company under Czech law, has been among the top three emitters since 2016. In Germany, which is by far the highest-emitting Member State, another private company (LEAG) owns four of the highest-emitting power plants.
Furthermore, as in the US, highly-polluting assets seem to increasingly shift from public to private players (mostly backed by private equity) both in Continental Europe and the UK, the so-called ‘brown-spinning’ phenomenon. Notable deals in this regard include, for example, those between TotalEnergies and Neo Energy, Ørsted A/S and Ineos, OMV and Siccar Point Energy, and Engie and Riverstone Holdings. We do not think that the public-to-private deals are per se harmful, but this phenomenon remains concerning as highly-polluting assets shift to private players that operate in shadow and are not subject to market pressure/discipline, at least not as much as public counterparts. According to a very recent report, ‘[oil and gas] [a]ssets are flowing from public to private markets at a significant rate. Over the last five years, the number of public-to-private transfers exceeded the number of private-to-public transfers by 64%. In every year during this period public-to-private transfers comprised the largest share of deals … Assets are increasingly moving away from companies with environmental commitments’.
As we identify in our paper, private companies lack several disciplining mechanisms available to public companies, including institutional investor engagement and activism, sustainability-linked pay or board structures, and sustainability disclosure requirements.
Yet, both the EU and the UK seem to have realized the relevance of private companies for climate change mitigation and the need for more transparency. Although the Non-Financial Reporting Directive’s disclosure requirements that are currently in place apply to ‘public-interest entities’ and thus do not cover most private companies, the newly-proposed Corporate Sustainability Reporting Directive extends disclosure requirements to all large companies (including private ones) and listed SMEs. It is hoped that the extended scope of application of the sustainability disclosure requirements persists during the legislative process and makes it to the final version of the directive, which has unsurprisingly attracted unfavourable lobbying efforts from the industry (e.g. here).
In the UK, the recently-launched Streamlined Energy and Carbon Reporting (SECR) framework requires large private companies to report (as a minimum) on their UK energy use and associated GHG emissions (with at least one intensity metric). However, the rules under the SECR framework for private companies are unjustifiably less demanding in comparison to those for public counterparts. Similarly, climate-related financial disclosures in line with the TCFD requirements have been very recently made mandatory only for very large private companies in the UK.
We welcome extending the sustainability reporting requirements to (large) private companies. The public/private divide in financial disclosure that has its roots in the securities regulation paradigm does not reflect the (potential) environmental impact of companies and thus should not be consequential in terms of sustainability disclosures. Furthermore, as the NFRD clearly acknowledges (in the double materiality concept), these disclosures serve a wider audience than (only) investors on public markets; instead, they are useful for stakeholders, media, NGOs and the general public, which suggests that these disclosures should not be considered only investor-oriented and thus should not apply only to public companies.
We argue that disclosure requirements for private companies would (i) serve as a nudge to improve environmental record; (ii) set in motion and facilitate social/stakeholder pressure as a disciplining mechanism; and (iii) provide information about the environmental impact of private companies in a standardized and comprehensive way, thus alleviating a sort of reputational and regulatory arbitrage that gives private companies incentives to acquire polluting assets from public counterparts (and vice versa).
In addition, we note that, despite their defects, direct environmental rules or carbon pricing, or indirect effects resulting from financial, reputational, or other factors could constitute a significant push for sustainability in private companies or could exert a certain discipline. In particular, banks are the conventional financing source for private companies in Europe. The recent impetus for sustainable finance both in the EU and the UK can affect banks’ financing of private companies’ polluting activities. For example, the requirement for banks to establish and divulge their environmental record, like the ‘green asset ratio’ in the Taxonomy Regulation (art. 8), and to better manage climate-related risks (like the ECB’s climate stress test in 2022) can cause (positive) spillover effects with private companies.
We are more skeptical however of the impact of corporate governance rules in private companies such as the duty to consider sustainability as part of directors’ duty of care under the newly-proposed Due Diligence Directive in the EU (art. 25). Under the low liability/enforcement environment in Europe for directors’ duties, directors will ultimately follow the interests of controlling shareholders in private companies, whatever the particular action their duties may require. Similarly, the UK introduced the ‘Wates Corporate Governance Principles’ to be applied by private companies on a ‘comply or explain’ basis. ‘Principle 6’ exhorts boards to consider the impact of the company’s activities on the environment. Given its soft nature, it is at least doubtful whether such counsel has any traction at all.
Overall, we submit that we cannot afford to ignore private companies in the net-zero transition and climate change adaption, and therefore need to adopt a holistic approach to the problem of climate change by bringing transparency to and amplifying certain disciplining effects on private companies.
Wolf-Georg Ringe is Professor of Law and Finance and Director of the Institute of Law & Economics at the University of Hamburg, and Visiting Professor at the University of Oxford.
Alperen A. Gözlügöl is Assistant Professor at the Law & Finance cluster of the Leibniz Institute for Financial Research SAFE.