Turn off the lights

Although officially known as the Carbon Reduction Commitment (CRC), a new UK government order scheduled to come into effect next year has been called other things – including “bureaucratic nightmare” and a “blow to entrepreneurs” – by industry members. It will also likely impose extra financial and time constraints on many managers.
 
The proposal, part of the UK Climate Change Act of 2008, will require private equity funds to register with the government’s Environment Agency if individual portfolio companies’ electricity consumption exceeds 6,000 megawatt hours per year. The agency is already creating a unit of about 50 auditors and inspectors who will have the authority to access company property, demand energy bills from utilities without the knowledge of those being investigated, and view power meters.

Anywhere from 5,000 to 20,000 companies could be pulled into the scheme at some level: private equity firms will have to collect data and do analysis exercises to determine whether they and their portfolios will be caught by the CRC. Those fund managers who do find themselves embroiled will have to take on extra administrative tasks.
 
In addition, private equity funds themselves may have to pay cash allowances to cover the emissions of their portfolio companies. Such funds will be paid into a central pool, which will be recycled back as bonuses to funds that best reduce their emissions and electricity usage over time, while those that don’t will be assessed further penalties.

These kinds of considerations, including the timing of the cash flows and potential penalties, and how the purchase of allowances will be funded, will likely prove challenging for private equity funds, according to Angus Evers, a partner in the planning and environment group of SJ Berwin. “A fund is typically not geared up for that kind of compliance,” he said. “You’ve got certain issues like how do you get money out of the portfolio companies for buying allowances? How do you allocate [a bonus] back to the portfolio companies? Or do you take money from your investors and recycle payments back to them?”

Failure to adequately comply would also trigger a range of civil and criminal penalties. Firms that don’t register with the Environment Agency will be fined £5,000 and hit with a penalty of £500 for every day they do not register, while failure to surrender efficient allowances by year end will result in a fine of 40 pounds per tonne of carbon produced. Actions like refusing to cooperate or falsifying reports could also lead to jail time.
 
The effects would also not just be limited to the UK; a company based in the US that has subsidiaries in the UK would be caught up in the scheme. The cost of compliance in the first year is expected to be around £4,000, along with hundreds of thousands of pounds in eventual allowances that may be returned to the fund. For an organisation with tens of millions of pounds that should not be too onerous, but for a smaller firm it could be a significant cost.

“What is probably more significant are the administrative costs of putting in place systems to monitor your energy consumption and report to the Environment Agency, take part in trading if you are going to buy and sell these carbon allowances and all the general compliance obligations you have to do,” Evers said. “That is going to be particularly complex for private equity funds.”

Although the CRC is scheduled to go into effect in April 2010, industry groups like the British Venture Capital Association (BVCA) are lobbying to mitigate certain effects of the current draft. In the meantime though, industry members said during the SJ Berwin seminar that while the cost related to preparing for the CRC’s introduction may seem high, failing to do so will result in greater pain down the road.