A Q&A with KKR’s Sustainability Expert Advisory Council

At the end of last year, KKR announced the formation of our Sustainability Expert Advisory Council (SEAC), a six-member independent council that aims to bolster KKR’s environmental, social and governance (ESG) expertise and capabilities and advance our firm’s strategy and practices in this area. We have already benefited from our members’ expertise and counsel on key ESG issues, including climate; diversity, equity, and inclusion; labor and workforce; governance and transparency; and data responsibility.

During our inaugural meeting, held in February 2022 at KKR’s New York office, we had the opportunity to openly discuss our ambitions and goals for the year ahead, including the development of a Charter that outlines roles, responsibilities, and expectations for SEAC members. I was inspired by the constructive nature of the dialogue and the diversity of opinions voiced.

During the meeting, SEAC members emphasized the importance of sharing best practices and learnings, as well as the role that private markets investors can and should play in advancing sustainability by mobilizing capital and bringing relevant expertise to investments. Additional topics of discussion that stood out to me included:

• The plethora of emerging climate innovations, from short-haul electric planes to zero-carbon hydrogen
• Why data privacy and cybersecurity are ESG issues, and the importance of responsibly handling people’s data
• The harmonization of ESG standards and frameworks and latest developments in the complex ESG reporting landscape
• The need to build the foundation for a future digital world that is safe and beneficial for all
• The role worker standards and human capital investments play in advancing the promise of stakeholder capitalism

Looking ahead, I am energized by the opportunity that we have to harness this expertise and thought leadership as we continue partnering with our SEAC members to help inform, critique, and challenge our thinking.

In an effort to share their thoughts more broadly, we asked our SEAC members a few questions about their work, outlook for ESG and what makes them hopeful. You can read the full discussion here:

DISCLAIMER

Q: When it comes to your area(s) of expertise, what are you most excited about? What are you most hopeful for?

Alexandra Reeve Givens (President and CEO of the Center for Democracy and Technology): In the technology sector where government regulators often struggle to keep up, corporate leaders have an essential role to play in establishing responsible business practices. The sector is maturing past the mantra of “move fast and break things,” and instead grappling with the outsized impact that social media networks, data-gathering technologies, and other tools have on our society. The responsible governance of these technologies raises hard questions, but I’m encouraged by the thought leaders across companies, civil society, and government who are focused on these priorities and working to get the answers right. Andrew Stern (Senior Fellow, Economic Security Project and President Emeritus of the Service Employees International Union): Although there has been an increasing amount of attention paid to environmental sustainability and governance issues, historically, issues relating to worker standards and their sharing in the success of profitable companies has often been more rhetoric than reality. Shareholder capitalism was too often a justification for an unacceptable level of economic inequality. People who work hard every day should not be poor. I believe this is a moment of potential change in public and investor attitudes on workers and ESG. Making that shift reality, not rhetoric, would be a big step forward.

Nat Keohane (President of the Center for Climate and Energy Solutions): Climate change is an area that needs some reasons for hope! This space is on the cusp of tremendous innovation. We have already seen dramatic gains. In the last decade, the average cost of generating electricity from solar power has fallen more than 80%, and from wind by more than half, making both now cheaper than coal in most places. Electric cars have gone from curiosity to marketing boon, with global sales doubling last year. But even that pales in comparison to the innovations on the horizon: batteries that store electricity for days or weeks to allow more renewables onto the grid, next-generation nuclear plants, short-haul electric planes, zero-carbon hydrogen that could fuel ocean tankers and power steel and cement factories, and technologies that suck carbon from the sky. We will need all of those technologies and more to avert the worst impacts of climate change. The good news is that there are brilliant, motivated people working on them—and huge opportunities for investors who back them.

Robert G. Eccles (Visiting Professor of Management Practice at Oxford University’s Said Business School): I’m excited about meaningful progress on corporate disclosure. In this context, I think the establishment of the International Sustainability Standards Board (ISSB) is an extremely important development. I’m hopeful that the EU will collaborate with it regarding its Corporate Sustainability Reporting Directive (CSRD). I was also very pleased to see the very sensible and practical proposed SEC ruling on climate disclosure for Scope 1 and 2 carbon emissions (with third party verification) and for Scope 3 emissions when they are material to a company’s strategy (without third party verification and with protection from legal liabilities). It is already anticipated that there will be lawsuits from various constituents, including business groups, which could go all the way to the Supreme Court. Not surprising in America today. But these lawsuits are on the wrong side of history and, ironically, against the long-term interests of those filing them. Climate change is indifferent to politics. I’m hopeful that the climate change deniers and ideologically-driven opponents of sustainability don’t try to get the U.S. Congress to pass a law that companies can’t report on climate. This would put U.S. companies at a global competitive disadvantage. I’m excited about the potential that the Private Equity industry has to take a lead in sustainable investing. I’m hopeful that it will do so. I see KKR’s SEAC and research by me and many others as being helpful in this regard.

Q: Sustainability is often referred to as the new digital revolution for business. What is your #1 prediction when it comes to what’s next for the sustainability “movement”?

Claudia Zeisberger (Professor of Entrepreneurship and Family Enterprise at INSEAD and founder of the Global PE Initiative): Looking ahead, the Sustainability movement is bound to expand from Private Equity to Venture Capital, with some arguing that ESG should really be esTg; the ‘t’ being for Technology. And given the power VC investors wield these days – in 2021, startups raised a record US$ 621 billion from VCs – surely one can ask for responsibility. And indeed, institutional investors have started to ask VC partners to implement ESG (environmental, social and governance) principles in their investment mandates, similar to what they have demanded of private equity funds in recent years.

But AI – artificial intelligence - is arguably the most important vertical where scrutiny is needed. AI creates enormous value potential and in turn, the opportunity to achieve outsized returns. But it also poses substantial risks. We need to build today the foundations for a future digital world that is safe and beneficial for all. It is time for VC investors and founders to work together to develop meaningful tools to measure and assess the risks of AI-based business models, track the development of startups, and continue to iterate to arrive at a widely accepted standard on “Ethical AI” practices.

Roy Swan (Head of Mission Investments at the Ford Foundation): I predict that investors, policy makers, elected officials, and the public will realize that the identification and quantification of negative and positive externalities are essential to sustainable capitalism and society. Investors will incorporate the value or cost of externalities into their investment modeling. Policy makers and elected officials will require companies to stop dumping hidden costs on society and taxpayers, and force companies to internalize such costs or change their behavior. The public will reward companies that produce positive externalities and avoid companies that produce negative externalities. When that happens, the objectives of ESG and impact investing will be met, and a new era of capitalism will be born.

Q: What ESG issues haven’t historically been in the spotlight but are expected to rise in importance that investors should keep on their radars?

Givens: Business owners and investors need a far greater focus on data - cybersecurity vulnerabilities; how companies respect and protect their users’ information; and what steps they take to responsibly and ethically manage AI. This is an ESG issue because, while data can produce new insights, it can also give rise to discrimination, exploitation, and abuse. Loose data practices - like poorly developed AI, or sharing users’ sensitive information with third party data brokers - can bring companies reputational and legal harm. A company’s interactions with government can raise concerns about surveillance and human rights. And, of course, we’re seeing cyberattacks and ransomware target all sectors of the economy, threatening customers’ privacy and security. With growing momentum for regulation in the U.S., EU, and around the world, investors need to ask tough questions about companies’ data practices and hold them accountable for answers. The use and misuse of people’s data is one of the major corporate responsibility issues of our time.

Stern: I think younger investors, public pension funds, the presence of catastrophic climate events and vast inequality, coupled with successful impact investment strategies, have the potential to accelerate ESG considerations in investments. Across portfolios, we need to manage not only ESG performance but also sustainability outcomes. Investors who do that will be well positioned to succeed in the market while driving positive societal impact.

Keohane: Climate change is already in the spotlight, but it’s still worth underscoring how its importance will grow in discussions around corporate responsibility and investing.

The key thing to understand is that concern about climate is a one-way ratchet, driven in large part by the tangible impacts of extreme weather events that are becoming increasingly visible by the year. We have seen a rapid shift in just the last two years in how investors, employees, and others think about climate. As climate impacts become more frequent and severe, those stakeholders will continue to demand more of companies in setting ambitious emission reduction goals and delivering on them.

The implication is that as investors and asset managers make decisions today, they need to anticipate how fast the conversation is changing. A good example is natural gas. While gas still has a near-term role to play in driving out coal and oil, provided methane emissions are kept to a minimum, opposition is growing to any new infrastructure that could lock in unabated fossil fuel use over the longer term. To be credible, future investments in natural gas must have a pathway to zero carbon emissions (for example, through conversion to hydrogen or carbon capture).

Eccles: A few years ago, I would have said “biodiversity” but that appears to be high on the agenda of the EU’s ESG regulation. Diversity, equity, and inclusion (DE&I) is also getting a lot of attention. While not quite yet in the spotlight but where much work is going on is the issue of income inequality. Large universal owner investors understand how this contributes to system instability. Some feel it will bite us harder and faster than climate change. These are related. Climate change will have its worst impacts on those least able to bear it. Conversely, if income inequality isn’t addressed it will be difficult to get the political will to address climate change. What makes income inequality more difficult than climate change from an investor point of view is what they can do about it. Like, how does one invest and engage from an income inequality thesis to create value for shareholders and address this problem?

Swan: Most of us know that without emphasis on “E” there is no habitable planet. What investors, boards, and CEOs have begun to see is that without emphasis on “S” and “G” the economy and society deteriorate.

A Quality Jobs private equity strategy that seeks superior operational design and superior human capital investment is an excellent way to advance “S” and “G” profitably. MIT Sloane School Professor Zeynep Ton, author of “The Good Jobs Strategy” and co-founder of the Good Jobs Institute, has collected data and drawn a roadmap on how companies can outperform through operational and employee investments. Harvard Business School Professor and innovation scholar Linda Hill has shown that the best innovations come through business culture that embraces open communications throughout the entire organization. The success of KKR’s Pete Stavros’s broad-based employee ownership strategy provides practical evidence that good things happen when rank and file employees feel like owners and have a stake in their companies. When companies acknowledge all employees as partners, cost savings and productivity emerge through lower attrition, better customer service, and higher engagement.