By Payton Dizney Swanson, Kaitlyn Fitzsimmons, Lara Gheriani, Tideline*
Introduction
Investors are increasingly recognizing their role in advancing the transition to a net zero economy, with many publicly committing to achieving net zero investment portfolios by 2050. However, the flow of capital to climate investments remains far below what is needed to meet the goals of the Paris Agreement, with annual climate investments needing to increase by an estimated $4.9 trillion per year by 2030 based on 2022 levels.[1][2] With the pace of transition activities significantly impacting the extent of physical and financial harm brought about by climate change, investors need multifaceted approaches to deploying climate capital at scale.
Context
To date, climate investors have primarily focused their strategies on financing climate solutions (entities or activities that directly contribute to the elimination, removal, or reduction of real-economy GHG emissions) while excluding or limiting exposure to high-emitting assets.[3] However, our economies rely heavily on industries that are currently carbon-intensive, such as power, materials, transportation, and manufacturing and thus cannot be ignored by investors. Since carbon-intensive activities account for around 75% of global emissions, they have the greatest potential to reduce emissions if real, verifiable transition strategies are designed and executed rigorously.[4] Many asset owners face limitations in fully divesting from these sectors as they make up a significant portion of the global economy, leaving portfolios exposed to high-emitting assets. Even in cases where exiting positions in high-emitters is possible, the result is decarbonization of portfolios, not necessarily decarbonization of the real economy (since the high-emitting asset tends to continue operating under different ownership).[5]
Many investors are beginning to believe that a more holistic climate strategy involves including “transitioning” assets in portfolios, i.e., investing in higher-emitting assets with robust plans for decarbonization. Data increasingly indicates a growing interest in this approach, especially from institutional asset owners. For example, a recent survey by Rede Partners found that three quarters of Limited Partners (LPs) are “open” to investments with the thesis of transitioning heavy emitting-assets.[6]
Climate finance groups are also increasingly encouraging financial institutions to recognize the impact potential of these transition investments. The Global Financial Alliance for Net Zero, (GFANZ) for example states that “the greatest emissions reduction may be achieved by directing financing and related services to – rather than divesting from – firms and assets that need to transition.”[7] In fact, not engaging with these businesses may contribute to the prevention of companies accessing critical capital to reduce their emissions. It is essential, therefore, for investors to understand how to approach investing in strategic, high-emitting sectors with an impact lens, focused on establishing clear intentionality and targets for carbon-reduction, providing the necessary technical assistance as a form of investor contribution, and instilling robust measurement and reporting processes.
Grey-to-green (G2G) investing
Emerging as an important pillar of climate investing is an approach known as “grey-to-green” (G2G) investing, which is most commonly utilized by private equity, private real estate and infrastructure investors. While not memorialized in regulation, the commonly accepted definition of G2G is intentionally investing in high-carbon-emitting assets with the goal of reducing their emissions over time to align with a 1.5°C pathway towards net zero.[8] Decarbonization of these assets is achieved through two primary approaches: 1) reducing the emissions of the core “grey” business or asset; or 2) pivoting the asset into new green business lines. G2G investments are often also referred to as “brown-to-green” or “transitioning assets”. Of particular note is the need to distinguish the terms “transition investing” or “transitioning assets”, including G2G activities, from the concept of transitioning the economy as a whole to net zero, which captures a broader range of activities including climate change mitigation (aligned with the EU’s concept of “transitional activities.”)
While public markets have a distinct and enticing role to play that is still coming into sharper focus (see: Climate Transition: The Essential Role of Public Markets), private market investors are particularly well-suited to lead G2G strategies due to their longer holding periods, greater investment control, and ability to implement structural change, including long-term decarbonization plans and business transformations. Moreover, impact capital managers are positioned to be leaders in this emerging field due to the magnitude of climate impact at play and the importance of implementing the core impact investing principles of intentionality, contribution, and measurement (see ‘Truth in grey-to-green impact investing’ below for further detail). Impact investors across numerous industries, asset classes, and risk-return profiles can engage with G2G investing as opportunities range from lower risk-return real estate retrofits, to higher risk-return fossil-fuel-to-renewable infrastructure transformation projects.
One example of a fund characterized by a G2G strategy is Argos Wityu’s Climate Action Fund. With a target size of €300 million, the fund acquires mid-market businesses in the EU with a mandate of reducing their carbon intensity. By “greening” or decarbonizing proven business models, the fund is targeting a 7.5% annual reduction in the carbon intensity of each of its portfolio companies, contributing to the advancement of net zero goals.[9] Alternatively, investors can create strategies with elements of both climate solutions and G2G to drive climate impact through multiple modalities while while expanding investable opportunities and creating potential synergies between portfolio investments. An example is Brookfield’s Global Transition Funds (BGTF) I and II, which invest a portion of their $15 billion and expected $17 billion raised capital, respectively, to transforming emissions-intensive energy and infrastructure assets into low-carbon alternatives, alongside investments in clean energy and other sustainable solutions, such as carbon capture and storage.
Institutional asset owner demand for G2G products, particularly from large pension funds, is on the rise. Canadian pension fund PSP Investments, for example, invested $5.1 billion in “transition assets” in 2021 and aims to increase these investments to $7.5 billion by 2026, with a focus on helping portfolio companies instill robust transition plans and align with science-based targets for net zero.[10] [11] Similarly, CalPERS’ recent announcement of a $100 billion allocation to climate investments includes “transition” investments such as “helping a utility or steel or other manufacturing facility to lower its emissions.” [12]
Challenges
While compelling examples of transition in action are increasingly in the headlines, numerous perceived risks associated with G2G investing remain. Challenges include a lack of clarity regarding practical implementation on a large scale, specifically the required technical climate expertise, expected financial and environmental turn-around periods, and process for assessing risk-return accurately. Additionally, there is apprehension about the transition process for the high prevalence of older, less energy-efficient (‘legacy’) assets, such as industrial manufacturing facilities and outmoded transportation fleets, due to the elevated conversion costs, technological constraints, and time commitments required.[13]
From an allocator’s perspective, many LPs are concerned about misalignment between G2G investments and their public commitments to net zero goals or allocations to specific regulatory “labeled” funds. In contrast to climate solutions, which are inherently net zero aligned, G2G investments create an immediate, albeit temporary, surge in the carbon intensity of LPs’ portfolios. This is a particular pain point for LPs with explicit near-term net zero commitments, despite the significant decarbonization potential of G2G strategies. This uneasiness stems from the risk of not achieving targeted decarbonization goals and the difficulty in communicating the impact story of G2G investments to stakeholders, which can be more complex to convey than climate solutions.
As such, investing in transitioning assets through a G2G strategy requires flexibility and transparency around existing commitments. Some LPs are experimenting with portfolio “carve outs”, which involves specifically allocating funds for G2G opportunities without counting their emissions towards the portfolio’s short-term climate change goals.[14] For example, in its 2022 Annual Responsible Investing and Climate Report Ontario Teachers’ Pension Plan (OTPP) announced its plan to invest $5 billion in High Carbon Transition (HCT) assets defined as businesses with significant carbon intensity (around 10x the average of its portfolio carbon footprint) and with credible science-based decarbonization pathways. While HCT assets are included in OTPP’s broader 2050 net zero commitment, OTPP plans to track interim progress separately from its portfolio carbon-level targets, with metrics specific for each asset. Other investors may choose to articulate to stakeholders how G2G investments fit within their broader transition plans and the expected emissions impact over time.
Deep Dive: Regulation and Grey-to-Green
As an additional complexity, investors are grappling with how G2G investments fit within emerging sustainable investing regulation. Early versions of sustainable finance regimes often have limited provisions for “transitioning” activities, focusing largely on “green transition” or “climate solutions” in their taxonomies.
Under the EU’s Sustainable Finance Disclosure Regulation (SFDR), some investment managers focused on G2G transition are hesitant to label their funds as Article 9 “dark green” (products with sustainable investment as their objective) since high-emitting assets are seen as being at odds with the ‘Do no significant harm’ requirement at the point of investment. Additionally, most high-emitting transitioning assets are incompatible with the EU Taxonomy, with the exception of “renovation of existing buildings.” While EU Taxonomy alignment is not mandatory to be classified as a “Sustainable investment” under SFDR, it remains a primary pathway. Tideline will closely monitor the EU Commission’s reform efforts, which included a consultation on the regulation in 2023, and 2022 publication of options to extend the EU Taxonomy to include more transition activities.
Despite these complexities, some managers are marketing their funds with “transition” or “grey-to-green” investments as Article 9 products. Among investors that are not labeling as “dark green,” side letters may allow Article 9 LPs to commit to these non-Article 9 funds while adhering to required reporting standards.
In contrast, the UK’s Financial Conduct Authority has adopted a more flexible approach with its Sustainability Disclosure Regulation (SDR). SDR offers a “Sustainability Improvers” label for assets that are improving on social and environmental metrics, and “Sustainability Mixed Goals” for funds with multiple sustainable objectives. The law came into effect in July this year, and Tideline will continue to observe how G2G investors utilize these labels.
The lack of standardized definitions and labeling for transition finance complicates the regulatory landscape. Various types of institutions are encouraging market organizers and regulatory regimes such as GFANZ and the EU Taxonomy to develop consistent definitions and criteria for “transitioning assets”, including guidance on transition plans and transition pathways. These developments are expected in future versions of regulation and guidance.
Truth in grey-to-green impact investing
Similar to other impact themes, impactful G2G investors distinguish themselves from other investors in responsible decarbonization strategies based on the degree of intentionality, contribution, and measurement they bring to their approach (for additional background, see Tideline’s Truth in Impact Framework and Truth in Climate Impact Framework).
Intentionality: Where responsible investors may include decarbonization in broader responsible investing policies, G2G impact investors develop outcomes-based theories of change centered on the decarbonization of strategic industries and businesses. Their investment process is designed to drive emissions reductions in high-emitting assets. In contrast to broad commitments to reasonably limit portfolio emissions, G2G investors set specific quantitative transition targets, such as Argos Wityu’s 7.5% per annum reduction target, to ensure decarbonization is quantifiable and time-bound. Accountability may be further strengthened through mechanisms such as carried interest being tied to the achievement of decarbonization targets.[15]
Contribution: Impactful G2G investors bring differentiated capital and capabilities that enhance emissions reduction. They allocate capital specifically for transition activities, often taking significant ownership stakes and influencing business decisions through board representation. Due to the complexity of transitioning higher-emitting businesses, investors must pair technical and operational expertise in the targeted sectors with knowledge in transition planning and climate measurement to efficiently execute transition plans, facilitate structural business changes, and direct new market entry. Additionally, their network of peers, high-skill talent, and scientific experts are crucial to support investees and fill knowledge gaps. Lastly, unlike traditional 100-day value creation plans, G2G investors actively manage investments throughout their holding period, and take precautions when exiting to ensure transition activities are locked-in to the business model.
For value creation, some G2G investors utilize the “transformation” approach outlined in Tideline and Impact Capital Manager’s New Frontiers in Value Creation framework. As defined, “transformation” value creation activities involve pivoting impact-agnostic businesses to become impact-aligned, often with the broader goal of catalyzing or accelerating similar transitions within the market. The report includes case study examples of business transformations by impact managers.
Measurement: Measurement is a heightened focus in G2G investing, where failure to meet decarbonization targets results in continued environmental harm. At a minimum, investors measure scope 1, 2, and 3 emissions of each investment regularly and assess performance against emissions targets set at the fund-level and/or at the time of investment. As distinct from solely backwards-looking measurement, which is more common in responsible investing approaches, G2G investors use this emissions data to continuously update transition plans and strategic goals. Importantly, these targets and measurement of impact must align with globally recognized frameworks, such as the Carbon Disclosure Project (CDP), Science Based Targets Initiative (SBTi), or Greenhouse Gas (GHG) Protocol, with third-party impact verification often employed to ensure a lack of bias and enhanced credibility.
Conclusion
Tideline sees the market increasingly embracing G2G strategies alongside climate solutions as part of a holistic effort to bring the power of capital markets to tackling climate change. While healthy skepticism is warranted, and work continues on market infrastructure such as aligned definitions and capacity-building, investors would be remiss to overlook G2G investment opportunities, which will be critical to meeting global climate goals.
For readers interested in exploring grey-to-green investment strategies, please contact [email protected] and explore the resource guide below.
Resource Guide:
European Union Platform on Sustainable Finance, ‘The Extended Environmental Taxonomy: Final Report on Taxonomy Extension Options Supporting a Sustainable Transition’, 2022.
Focusing Capital on the Long Term (FCLT) Global, ‘Grey to Green: The Opportunity for Private Equity to Decarbonize Assets’, 2023.
Glasgow Financial Alliance for Net Zero (GFANZ), ‘Financial Institutions Net-zero Transition Plans’, 2022.
Tideline, ‘Truth in Impact’, 2021.
Tideline, ‘Truth in Climate Impact’, 2022.
Author bios:
Payton Dizney Swanson
Payton Dizney Swanson is an Associate at Tideline leading impact management, measurement, and reporting engagements with a focus on climate. Payton brings prior experience as an investment consultant for institutional asset owners as a Senior Analyst at RVK, Inc.
Kaitlyn Fitzsimmons
Kaitlyn Fitzsimmons is an Associate at Tideline, where she is focused on supporting clients with the development and implementation of impact management and reporting strategies. Prior to joining Tideline in 2021, Kaitlyn was an ESG Investment Analyst at Gitterman Wealth Management.
Lara Gheriani
Lara Gheriani is an Analyst at Tideline, having joined in 2024 from her postgraduate studies at the University of Oxford. With a background in economic development and climate resilience, she now supports investors in integrating environmental and social impact considerations into their activities.