This article is sponsored by Bridgepoint Credit
ESG is currently one of the most rapidly evolving areas in private markets. How do you approach it at Bridgepoint Credit?
Hamish Grant: As a firm we are very focused on this. We held a townhall meeting last year when our managing partner stated that ESG is our single most important non-financial priority, so there is real senior management support and commitment.
On the private equity side, where we have greater opportunity to lead the agenda, we are looking at the carbon footprint of every company in our portfolio and supporting them in establishing appropriate carbon reduction plans as part of the firm’s broader plans to support the transition to a low carbon economy.
At the management company level, our goal is to be carbon neutral by the end of this year. When it comes to credit, as a lender there are obviously more constraints, but nevertheless we aim to be one of the leading investors on ESG.
We see this as a four-legged stool, with the first leg being screening and due diligence. We start with a pre-screening process based on some pretty rigorous exclusions, then in due diligence we have a detailed ESG questionnaire that we send to potential portfolio companies. We discuss answers with management, using fact sheets that we have developed alongside the European Leveraged Finance Association. Overall we go through a thorough process of assessing at the outset whether a company is addressing ESG appropriately and where the risk factors are.
The second element is the investment process; during our investment committee meeting there’s always a very important discussion on the ESG aspects of the opportunity. We think ESG risk is fundamentally credit risk because an asset that isn’t well aligned with moving in the right direction on ESG has risk and is one that we don’t want to be associated with.
Next is the deal process, where we now put ESG-performance linked margin ratchets in all our loans, in direct lending and increasingly in our credit opportunities fund. Finally, post-transaction, one thing we love about those ratchets is that they give us a platform to discuss ESG with management. That makes ESG a much more fundamental part of the deal monitoring and discussions with management.
That’s where we are today, but we want to go a lot further. For instance, we would like to be able to get into the same level of granularity on things like the carbon footprint of portfolio companies as our private equity colleagues do. We are focused on unlocking that.
How easy is it for credit investors to get good quality ESG information from borrowers?
Cathy Wang: It’s tricky. Often, there’s a lack of understanding or knowledge of ESG data, especially when we are investing in a smaller enterprise value company. We see ESG typically split across various functions, so the HR team might be looking at the S, while the CEO looks at the G and the COO looks at some of the operational aspects relating to the E, for example. There is often no central overseer of ESG and there can be a lack of strategic direction at company level – the concept of a “head of ESG” is still new.
There are ways to improve that and change the company approach to get better data, and one way is to embed ESG in the mindset of the investment team. It is about focusing on it as a priority – the more companies are questioned regarding ESG by different stakeholders, the more it moves up their agenda.
What happens if you do not get the right level of information from borrowers?
CW: We are lucky to be able to draw upon our internal ESG team. We have an internal best practice guide that sets out sample KPIs for portfolio companies, which the equity side of the business has adopted across the portfolio. That includes concrete examples of things that companies should be thinking about.
We also use limited ESG information in due diligence as an opportunity to engage more with management and develop an ongoing dialogue on the topic.
Finally, we extensively use external experts. For instance, earlier this year we launched a collaboration with ERM, a leading ESG consultancy, looking at how we can bridge gaps in our data points, particularly on environmental risk. We are able to draw on their team of ESG experts to help us benchmark companies, giving us an opportunity to assess what the high-level environmental risk of a credit might look like.
We have seen an increase in ESG-linked financing deals in the leveraged loan market in the past year. What is your view on this?
CW: Overall, this is definitely a positive trend, because sustainability-linked loans are becoming market standard and that means ESG is becoming front of mind for investors. Investors want to incentivise companies to improve ESG performance and one way is to tweak the margin, which has a financial impact.
The key risk is greenwashing. That’s something we have discussed at length as an industry, and ELFA recently published sustainability-linked loan principles to lay out best practice.
What you want to see in loans that have this construct is an improvement in KPIs because you’re incentivising companies to do something that they wouldn’t otherwise have planned to do.
Across the industry we have seen two approaches, with some managers using an ESG rating provider to generate a rating for the company versus its peers, and others preferring to list out specific KPIs that they want to see the company improve. We prefer the latter approach, largely because it allows us to engage with the borrower and set clear and ambitious targets on relevant ESG aspects of the business that we think could be improved. This is something we introduce on all our new primary deals.
Turning to fund financing, why are subscription lines embracing sustainability?
CW: From a Bridgepoint Credit perspective, since we are asking companies to improve on their ESG metrics, it makes sense that we should be doing the same, as a business and a platform. We recently closed an ESG-linked subscription line for both our credit funds, which we believe shows our commitment to embracing this for ourselves, rather than just in the companies we invest in.
The KPIs we came up with and agreed with the banks are ones that we as a team believe are important. The first one is about improving diversity and inclusion within the team, and especially within the investment team. The second is increasing the number of ESG-linked loans that we have in the portfolio. And the last one is assessed from an external view, looking at becoming a top-tier credit fund with a focus on sustainability.
We believe these ambitious targets demonstrate the firm commitment we have to furthering sustainability goals. While this has been done on the private equity side by various fund managers, we believe we are one of the very first credit managers to have entered into an ESG-linked subscription line.
Finally, when it comes to diversity and inclusion, what do you think LPs want to see from fund managers?
HG: If you look at the investor community, there’s the same breadth of focus on D&I as there is on ESG. ESG has become a big topic for a lot of investors and diversity and inclusion is a key part of that.
Diversity is a broad topic, with gender probably the easiest element to talk about in terms of statistics and the biggest macro theme in terms of enabling women to have the same opportunities in our industry as men. We have been focused on it for some time. In Bridgepoint Credit we have six levels of professionals and we’re pleased that in the first four levels we now have 50/50 representation of men and women. We have come a long way, but obviously our goal is to reach 50/50 across the board.
We recently promoted our head of investor services, Carlota Sanchez-Marco, to the partnership as our first female partner in the credit business. We also have a lot of talented women in the next level, with many future female partners emerging. And we are pretty diverse in terms of nationalities, with 19 different nationalities represented in our team of about 60 people.
So, we are making good progress. In order to really achieve diversity, and for it to be sustainable, the focus has to be on the underlying culture and how we operate and socialise as a team. We have introduced a number of formal and informal policies to promote diversity across our business, but for me the ultimate focus is on the E and the I. Our goal is to ensure our culture is one that treats everyone equally and makes everyone feel included. When that is fully in place, diversity will follow as a natural consequence and people of all backgrounds will feel comfortable and welcome.
What is your approach to impact investing?
HG: There are three types of funds: those where the impact of the fund on the environment and society is the central priority; those where the qualifying threshold is not doing harm, but the priority is the financial return; and those where ESG is not on the radar. At the moment, we are in the middle category. We are focused on this and very thoughtful about ESG and have significantly ramped up the focus and granularity of ESG in our investment process. But at this stage we are not an impact fund.
Currently, our investors have asked us to prioritise returns over impact given their fiduciary duty is to get the best returns for their underlying clients, who are often pensioners. ESG is then a very important secondary consideration for them. As a consequence, we manage an Article 8 fund, not Article 9, but we will definitely look to manage impact funds in the future for investors that want it.
Hamish Grant is deputy managing partner and Cathy Wang is investment director at Bridgepoint Credit.