Changes have been made to the UK’s Carbon Reduction Commitment (CRC) – which goes into effect next April – in response to concerns from private equity firms. However, even under the revised rules private equity will still feel a number of negative effects.
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 any individual portfolio company’s electricity consumption exceeds 6,000 megawatt hours per year. The agency would then have the authority to access company property, demand energy bills from utilities without the knowledge of those being investigated and view power meters.
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, while 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.
For instance, 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 per tonne of carbon produced.
Before the changes to CRC were made, an individual business was not subject to CRC if it fell below the 6000 MWh threshold. However, if that business were part of a group that did in aggregate exceed the 6000 MWh threshold, then all group members would have been obliged to participate in CRC, according to law firm Slaughter and May.
The firm said one of the concerns private equity managers had was that in a diversified fund, businesses that are functionally unconnected with one another, and which individually fall below the 6000 MWh inclusion threshold, would potentially be caught up by the CRC solely because a majority interest is held in them by the same private equity fund.
However, according to Slaughter and May, the government also introduced a limitation that greatly reduces the scope for a private equity parent to use SGUs to escape participation: a parent cannot separately register an SGU if that would result in the parent and other subsidiaries falling below the 6,000 MWh threshold and therefore falling outside CRC.
As it stands the measure still poses numerous potential headaches for private equity funds, including regarding the timing of the cash flows, potential penalties and how the purchase of allowances will be funded. As a partner with SJ Berwin noted last summer, funds are typically not geared for that kind of compliance, which could lead to questions 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?”