This article is sponsored by Ares Management
ESG is clearly a hot topic these days across all industries. How has ESG evolved for private market investment managers over the last couple of years?
Adam Heltzer: Describing ESG as a hot topic almost underestimates what’s happened in the last two years – we’ve seen an incredible explosion in interest. There was a long period of time when investment managers viewed ESG largely as a policy. Now, we are seeing a systematic and scaled approach that brings out an asset manager’s full
On the one hand, all this interest is great, and as a multi-strategy platform we feel that from all angles and welcome it. On the other hand, you have the greenwashing issue where managers feel compelled to communicate their leadership credentials before they’ve actually achieved them. As a result, there needs to be a focus on measurement, substance, systematic reporting and accountability. Every manager now needs to have a plan, a story and an approach that can be well substantiated by actual numbers.
ESG engagement was typically expected from those who control assets, private equity for example. In your view, is that changing?
AH: For a long time, this was a private equity exercise and, candidly, when I joined Ares in early 2020, part of the appeal was that ESG in credit was less developed and Ares as a marquee name was demonstrating leadership in the space already. The old industry attitude was that there wasn’t much to be done if you didn’t own the asset, but if ever there was a place to turn that on its head, it was at Ares.
The fundamental question for every asset class is: “what levers of influence do we have and how can we use them to achieve our ESG objectives?” In direct lending, LP expectations are now much higher and include stewardship, engagement, data collection and reporting. One benefit of this is that it leads to closer partnerships and collaboration with borrowers and sponsors.
Can you briefly discuss the importance of ESG to Ares direct lending and to your LP base?
Blair Jacobson: ESG has utmost importance for all stakeholders at Ares. We are taking it very seriously and striving to innovate. As one of the largest global direct lenders, it’s incumbent on us as a market leader to set an example for the industry.
That’s not just because LPs are asking us to do it, but because we really believe it is win, win, win. Our LPs want it, we think it’s good to build Ares into a business that gives back in many ways, and we believe companies that embrace ESG become better and more valuable as a result. We also partner with many private equity firms who are aligned with us on this mission.
How have LPs’ ESG expectations of private credit managers evolved in recent years?
BJ: ESG has always been a part of how we evaluated investments, but that’s developed quite a bit. We raised our third European direct lending fund in 2015 and that was the first time we had a specific diligence questionnaire about our ESG policies. It’s accelerated significantly since then and when we raised our fifth fund this year, we had ESG discussions with every investor and many LPs wanted follow-up sessions to go into more detail. LP expectations have continued to scale and what started in the Nordics is now a focus for everyone.
How should private credit investors approach ESG?
Carl Helander: We believe it needs to be front of mind. Many Nordic sponsors now have dedicated ESG resources driving their efforts in portfolio companies and many are looking for sustainability-linked loans. Direct lenders need to take this seriously if they want to be an important player not only in the European market, but the global market as well.
BJ: We believe we have a lot of influence, and probably more than we think. In a typical transaction we will often have as much capital at stake as the sponsor, and that means we can exert real influence over the business. We also lend to many small and medium-sized companies, while we ourselves are a large, sophisticated, global business with a strong ESG programme. In recent years our mindset has shifted and we now appreciate that we are in a position to help these businesses make real progress on ESG.
How has Ares approached ESG within its global direct lending portfolio?
CH: We have had a dedicated ESG team at Ares for many years, but in 2019 we took several steps forward and developed very comprehensive ESG due diligence for direct lending. When Adam joined in early 2020, we formalised it even further, creating a global direct lending ESG integration plan. It is a process that begins before we make a loan, through the life of that loan, right up until the exit. It has been a journey and we continue to enhance this process because as Blair mentioned, improved ESG is a positive for all stakeholders.
How does Ares integrate ESG throughout the life of a loan?
CH: We start by screening a transaction. There are a number of sectors we will never invest in, and others we are quite cautious about. If it’s one that we are cautious about, it gets reviewed and approved or rejected by the ESG team. If there are still questions related to the transaction, it moves to a discussion amongst the partners for final
During diligence, we have an online tool that divides global industries into various sectors and allows us to look at the key ESG issues for each of those sectors. We also use an AI tool to scan media outlets for reporting on a particular business, so if it has been involved in any ESG-related incidents like environmental violations or governance issues, those are flagged. We also increasingly ask sponsors to do their own ESG due diligence and report their findings.
Next, we have discussions with management teams on the ESG risks we identified and that is consolidated into an ESG rating that goes into our final investment papers. High-risk companies are tracked very closely.
Once a company is in our portfolio, we collect ESG data points that we track over the life of a loan and report them to our investors.
Does integrating ESG into the underwriting process impact credit selection?
BJ: There are so many instances where it has impacted credit selection in a negative way, but it does also positively impact selection. On the negative side, I could provide plenty of examples of companies that we chose not to be involved with because we didn’t like the culture or some of their practices. On the other hand, those companies doing the right thing on ESG are building better companies and are therefore attractive to us as lenders. ESG can be a really powerful differentiator.
Can you provide a recent example of how you’ve influenced a borrower on an ESG-related matter?
CH: One of our UK-based portfolio companies was creating its first ESG plan. We connected the company with Adam, who was a valuable resource to them, advising on how best to develop, scale and implement their newly formed ESG strategy.
Here in the Nordics, a sponsor wanted to produce a gender policy for a business and asked us for advice and guidance on how other companies in our portfolio had addressed that. We introduced them to Indhira Arrington, our global chief DEI officer, who guided them through this process.
We are also beginning to see a real impact from sustainability-linked loans. I believe we’ll see more and more of these in the market as sponsors and managers get more familiar with the idea, the process and the benefits.
How do sustainability-linked loans play into your current ESG efforts? Can you briefly discuss your recent transaction with RSK Group?
BJ: In order to work well, the target KPIs on these loans have to be real, measurable, quantifiable by a third party and it can’t be a one-way option. In addition, once the company executes on what it said it was going to do, any savings should go to a good cause.
RSK has evolved from an environmental consulting business into a solutions provider that helps clients accomplish their ESG goals, employing around 6,000 people around the world. They are growing rapidly, and we got involved about three years ago to provide capital to fund growth.
RSK is a great candidate for a sustainability-linked loan because it already realises that doing the right thing is beneficial to all stakeholders. We committed £1 billion ($1.35 billion; €1.18 billion) to help RSK achieve its growth ambitions, and together we identified four different sustainability targets, from emissions reduction targets to inclusivity and diversification and employee safety.
If they meet the targets, we will give them a break on the interest rate. If not, the rate ticks up. If they are able to achieve cost savings, at least half must be devoted to a sustainability-linked initiative or charity.
Where is private credit ESG headed in 2022?
AH: Managers need to clearly define what they’re trying to achieve with their ESG programme and what specific steps they’re taking to achieve it.
Data collection and reporting then becomes so critical because all stakeholders – internal and external to the manager – need to have confidence that the manager is following through with its commitments. ESG data will propel the growth of sustainability-linked loans, which in turn will drive more engagement with portfolio companies and sponsors.
The last point is on collaboration, because we all need to participate in broader discussions across the ecosystem. I’d advise people to get out there and socialise to share ideas on how to take ESG initiatives to the next level.
Blair Jacobson is Ares co-head of European credit; Carl Helander is partner in the Ares Credit Group and head of ESG for European direct lending; and Adam Heltzer is global head of ESG.