As Asia’s private credit markets mature, widespread involvement of European and North American institutional investors alongside increasing participation by global private equity sponsors and private lenders means debt funds are having to get quickly up to speed on ESG.
For many managers in the region, ESG policies remain focused on excluding participation in certain sectors and seeking to identify and address key ESG risks. “Our LPs are cognisant that we are, at the end of the day, a credit fund and therefore our ability to influence the borrowers is limited,” says Eddie Ong, deputy CIO and head of private investments at Singapore-based SeaTown Holdings.
“They do ask us what we are doing on the ESG front, and we have a framework, we stay clear of certain excluded sectors and we have an ESG department within our firm. That generally satisfies most, if not all, of our LPs.”
For international GPs building their credit businesses in the region, ESG is a priority. Shane Forster, head of Barings’ Asia-Pacific private finance group, says: “It is fair to say that ESG in Asia is a few years behind where it is in Europe. As a firm, we operate global platforms and policies so we have had rigorous processes around ESG for years. But it is a mixed bag here and there are a lot of managers that don’t have a particular ESG focus, and ESG aspects are not considered by many lenders.”
Sustainability-linked loans, which have become widespread in other parts of the world as a means for private debt funds to influence the behaviour of their borrowers by offering margin discounts in return for good progress on ESG, have not yet become common in Asia-Pacific.
Forster says: “We were one of the first movers on sustainability-linked loans in both Europe and the US; and in APAC, we have included that language on a couple of deals. The loan documentation is basically constructed to allow us to put something in place that makes sense, but we have yet to take that next step. I’m aware of one deal in Australia with an ESG ratchet, but it is certainly not commonplace.”
At European asset manager Allianz Global Investors, in which German insurer Allianz is a big investor, there is a similar story. Lead portfolio manager for Asia-Pacific private credit, Sumit Bhandari, says: “Most managers in Asia are still following an exclusion approach, where they would not fund companies involved in thermal coal, weapons, tobacco and so on.
“Above and beyond that, we follow a stringent approach, grouping companies into low-, medium- and higher-risk ESG categories and then looking into those businesses to identify ways of reducing things like carbon footprint, water consumption and improving social and governance related aspects.
“We are not only investing heavily in the energy transition sector but also engaging with companies that may, as part of their processes, have opportunities to reduce their environmental impact and agreeing plans around that which are incorporated into our credit agreements.”
While frameworks may not always be as sophisticated or widespread as they are in Europe, the result is the same, in that the availability of private credit to heavy polluting companies is increasingly challenged.
Bhandari says: “We think we are a little bit ahead of the curve but the direction of travel is very clear. There are not many lenders that can finance thermal coal, but while you might be able to do those deals today, in two years’ time the number of people that will be able to refinance your loan is going to be far fewer, so people are taking a huge amount of back end credit risk in doing those deals.”
In the most developed credit markets in the region, the spotlight on energy transition is even more apparent. In Australia’s commercial real estate credit market, GPs are paying a lot of attention to the ESG risks associated with assets.
Robert Hattersley, group head of capital at Australian real estate lender MaxCap, says: “ESG is a focus for us as a business because we believe in the future of green lending, particularly as office makes strides to recover and we see value, subject to corrections, playing out in the potential to participate in brown to green asset upgrades.”
MaxCap recently announced a partnership with the Clean Energy Finance Corporation, Australia’s green bank, with access to more than $30 billion from the Australian government to invest in the transition to net zero. That deal will see MaxCap manage commitments of up to $75 million to target commercial offices, hotels and retail assets for green refurbishment, providing senior debt finance for building owners to improve the sustainability performance of assets and reduce emissions.
Bruce Wan, head of research for MaxCap Group, says: “When we take a global perspective, the Europeans are very much the leaders in thinking about sustainability on both the equity and credit side. The European investors are asking those challenging questions.
“Where Australia is today is probably at the forefront of the Asia-Pacific region – we are asking more questions and we are talking about the green premium with the ability to show better occupancy and better rents for those assets, drawing on European evidence. We are very confident we will see that conversation gaining ground in Australia over time.”
“We rate all our borrowers with an ESG credit risk rating”
Metrics Credit Partners
At Metrics Credit Partners, a leading non-bank lender in Australia, managing partner Andrew Lockhart says ESG has to be front of mind. “It’s very much embedded in everything we do,” he says. “If you have any expectation of being able to run an asset management firm while not having a very stringent approach to ESG, you are not going to be terribly successful.”
The focus is on taking proactive steps to improve the environmental and social impact of companies in which the fund invests. Lockhart adds: “We rate all our borrowers with an ESG credit risk rating and then we use that as a mechanism to create action plans to see how we might engage to make changes over time.”
While sustainability-linked loans were attracting a lot of attention in the market 18 months ago, he says things have shifted since. “The regulator has recently been much more active on disclosures as those relate to greenwashing, so there has perhaps been reluctance on the part of some market participants to make claims that are hard to substantiate. That has taken some momentum out of that.
“We should get to a point where poor ESG outcomes are going to limit companies’ ability to access capital, as opposed to us giving out discounts in return for progress. This should become business as usual – that is really where the market is going.”
Lockhart says a critical issue is that lenders cannot ask borrowers to take actions on ESG if they are not demonstrating leadership themselves, and as such Metrics has established a dedicated sustainable finance team to both originate sustainability-linked opportunities and advise the firm at corporate level.
“The extent of the information requests we get on this from investors is really quite significant now. It is not something any of us can ignore.”