Creating an environment that enables employees to develop their skill sets and perform to a high level is essential in driving strong returns.
Shared experiences are important, says Tim Schifer, managing partner at Twin Brook Capital Partners, adding that a positive working environment helped the firm navigate covid.
“Experience proved to be an important element on several fronts. Every period of disruption is unique, but I think the experience of working through multiple cycles definitely enhances your ability to effectively and efficiently assess, address and manage future situations,” he says.
“At Twin Brook, many members of our team have not only spent 20-plus years focused on this space but have also worked together for much of that time. I think that level of shared experience supported our ability to seamlessly transition to a remote environment, continuing to work as a team and serve as a reliable lending partner.”
Mentorship programmes are another way firms can invest in human capital, as such initiatives not only teach employees new skills but also offer a support network. Darnell Jones, global director of diversity, equity and inclusion at real estate investor Hines, says: “We know that a lot of times it is who you know and can learn from that really matters in terms of how well you progress, so it is very important to put more women and underrepresented minorities in front of the people that matter at the firm through these mentorships.”
Asset owners increasingly demand that their investments achieve more than financial returns, going even beyond the ‘do no harm’ approach of ESG. Achieving positive social and environmental impact is a top priority for a growing range of investors.
The market for impact investing has reached $1.164 trillion, the Global Impact Investing Network announced in October. This figure has grown rapidly in recent years – GIIN estimated the market size to be $715 billion in 2020 and $502 billion in 2019.
The private debt industry cannot claim to have been at the forefront of impact investing – but the asset class is catching up, partly in response to pressure from asset owners. “There is a growing trend for investors to demand impact alongside financial returns,” says Coralie De Maesschalck, head of CSR and ESG at Kartesia. “We have seen that quite strongly, especially since covid. I think the pandemic made everyone realise that we need to change the way we are living.”
De Maesschalck notes that the EU’s Sustainable Finance Disclosure Regulation, or SFDR, which created the Article 9 designation as a label to allow managers to differentiate impact funds, has helped spur investor interest. “The SFDR helps investors to understand which funds are actually offering real impact, making LPs more comfortable when investing into funds that have the appropriate labels,” she says.
Sustainability-linked loans (SLLs) offer one route to achieving impact – much as they can be used to incentivise progress on ESG criteria. De Maesschalck adds, however, that to truly incentivise impact, SLLs have to offer a margin discount of up to 50 basis points – far above the 5bps to 15bps discount more commonly available.
Another strategy is to lend to impactful businesses that typically struggle to access finance. In Africa, for example, impact investors that seek to improve healthcare often provide loans to clinics. It is typically harder for private equity investors to find opportunities to support small healthcare businesses.
“We don’t have that many companies that have that critical level where they are interesting for a private equity firm,” Vincent Lecat, head of impact and ESG at Development Partners International, told affiliate title Private Equity International in November.
As an increasingly wide range of asset owners begin to consider impact, more and more market actors will seek to refine their solutions. “Our intention is to push our sustainable loans range forward with a view to seeing our green products overtake our traditional loans range in the very near future,” Impact Capital Group’s founder and chief executive, Robert Whitton, said in August.
As debt funds hone their focus on ESG measurement, reporting and tracking, many are turning to the UN’s Sustainable Development Goals as a good basis for setting priorities. Goal 8 of the SDGs spotlights decent work and economic growth, with many funds getting behind the aim of promoting sustained, inclusive and sustainable economic growth, full and productive employment, and decent work for all.
While direct lenders may not have the same ability to influence job creation as their private equity counterparts, a number include it as one of their key ESG drivers. Permira’s PE business has been part of an initiative supported by the Institutional Limited Partners Association to agree a common set of metrics and definitions for reporting ESG data, identifying six priority areas.
Last year, Permira’s head of ESG Adinah Shackleton told Private Debt Investor that Permira Credit would prioritise those same six areas: “That makes a lot of sense because it means we should be more aligned with the equity sponsors of the companies we lend to when it comes the information we are asking of those businesses.”
A number of sustainability-linked loans have featured job creation metrics in KPIs as private markets emphasise job creation as part of their social remit. Invest Europe said in its Private Equity at Work report that PE and VC-backed companies employed 9.9 million people in Europe at the end of 2020, creating 2 percent more jobs versus a 1.6 percent fall in the broader job market.
Financial services and insurance companies, and biotech and healthcare businesses, recorded the highest employment growth in 2020: 7.7 percent and 7.5 percent, respectively. Creating productive employment opportunities for all women and men, including young people and persons with disabilities, is another element of Goal 8, with DE&I efforts moving up the agenda for all credit funds – both across their portfolios and in their own teams.
Sharadiya Dasgupta is the founder of Blue Dot Capital, which partners with investment management firms to create their ESG programmes. She says: “Whenever we are looking at any asset management firm’s ESG programme, the framework that we use is to look at materiality considerations at both GP level and portfolio level. Diversity and inclusion is perhaps the only topic where there is unanimity that it is material across GP and portfolio levels.”
The need for ESG talent is also driving job creation in funds themselves. Jan Wade, chief people officer at Arrow Global, says: “Having ESG expertise in-house to advise investment professionals is essential, as is the upskilling of origination, underwriting, portfolio management and servicing teams to ensure a sustainable approach to investments is pervasive throughout an organisation’s DNA.”
The need for harmonisation around industry-wide approaches to KPIs is becoming more apparent as lenders increase their focus on ESG metrics for due diligence and ongoing reporting purposes.
François Lacoste, managing partner in private debt at Eurazeo, says: “We are seeing an increasing number of sustainability-linked loans in private debt as they become more mainstream. It is crucial for the industry to aim for the harmonisation of the methodology – around the number of KPIs and the need to be aligned with the Paris Agreement, for example – as well as the harmonisation in the calculatsion of the KPIs.”
Eurazeo will push strongly for the use of the SBTi – Science Based Targets initiative – methodology for carbon footprint measurement and reduction trajectory.
Many managers are getting involved in efforts to foster harmonisation. Michael Kashani, head of ESG Credit at Apollo Global Management, says the availability of quality ESG data continues to challenge investment managers, particularly in private credit. “The recently launched ESG Integrated Disclosure Project is designed to help address this by encouraging transparency and consistency for private companies and credit investors through a voluntary standardised format for ESG disclosure,” he says.
“A harmonised approach that increases the availability of ESG information for both LPs and GPs is also beneficial to borrowers by helping to reduce the burden of different ESG KPI requests from prospective lenders during underwriting and due diligence.”
Laure Villepelet, head of ESG at Tikehau Capital, highlights the need for accountability: “A primary source of ESG data results from organisations making ESG disclosures that are based mostly on self-assessment, with varying degrees of audits. The alignment of the International Sustainability Standards Board and the EU’s corporate disclosures will be key for defining a robust global baseline.”
Lenders are also working hard to enhance the credibility of the KPIs they are focusing on. Salma Moolji, European ESG lead at Ares Management, says: “Working in close collaboration with a company on target setting helps make sure we establish objectives that are business-relevant, purposeful and meaningful. Specific and measurable targets, for example, focused on carbon intensity reduction, improvement to health and safety management or ethics, can work well.”
The big advantage of reporting KPIs is that borrowers are treated more favourably throughout their financing processes, says Neale Broadhead, partner at CVC Credit: “Borrowers must make every effort to report, monitor, control, and improve upon these KPIs to minimise regulatory, financial and reputational risks.”