The idea that a direct lender might reward a borrower with a reduced interest rate in return for making progress on gender diversity has gathered momentum in recent years. Gone are the days of lenders as passive bystanders on ESG policies – private debt managers are becoming increasingly creative in the way they factor gender diversity requirements into financing solutions.
Cécile Mayer-Lévi, head of private debt at Tikehau Capital, says: “Gender diversity among our borrowers is a focus of attention for us, but we can see that the mindset has shifted in the last two years. We no longer have to convince people that gender diversity is important; it has become a natural part of the conversation and that’s a real step forward.”
Tikehau has been among the pioneers of the use of ESG margin ratchets in Europe, rewarding issuers with margin reductions of between -5 and -25 basis points if they hit between three and five relevant ESG criteria and related targets. Often, those criteria will include some goals to increase gender diversity.
“The use of an ESG margin ratchet is a good way to accelerate progress on ESG KPIs and make sure companies stay on top of them,” says Mayer-Lévi. “Gender diversity, and specifically the percentage of women in management positions, is a key metric that we often look at because it is easy to measure at inception and then track its progress year-on-year.
“Usually, we have three or four KPIs that we track as part of an ESG ratchet, and gender diversity will be one of those for companies requiring some effort on that. If the workforce is already well-balanced and inclusive, then we are not going to put in a ratchet based on something that is already part of the corporate culture. In those cases, we may look at other KPIs to do with HR policies, training budget or retention.”
Tikehau has found sponsors to be broadly supportive of credit funds seeking to exert influence over portfolio companies.
Pauline Lloret, associate director in the acquisition debt financing team at pan-European private equity house IK Partners, says: “We have just shy of a dozen companies in our portfolio that have agreed sustainability-linked margin ratchets on their loans and a few of those have gender-related triggers as part of those mechanisms. The objective for us is to focus on the most relevant triggers for each company, so we decide on those based on discussions with management and with our lending partners.”
Examples of gender-related triggers in the portfolio include improvement of gender equality indices and an increased number and percentage of female managers throughout the ownership period, says Lloret. “At IK, we also have our own initiatives and endeavour to systematically have more female representation on our boards,” she adds. “There is an alignment with lenders and a shared interest in prioritising ESG topics, so offering marginal economic benefit as an upside for the implementation of certain criteria is helpful.”
According to Lloret, it is no longer an issue to find debt funds willing to embrace an ESG margin ratchet: “We have not encountered a situation where lenders could not offer sustainability-linked margin ratchets,” she says. “There is, however, limited time to negotiate these loans and sometimes it is not possible to have a productive conversation and agree on suitable metrics. The size of the discount on the margin that is applied may vary – usually 10 to 15 basis points.”
While becoming an increasingly popular tool, there remain challenges around ESG ratchets that mean they are not suitable for every loan.
Mayer-Lévi says: “The issue is always one of measurement – making sure that the way the data is reported can be reliable and make sense over time. Getting the data on gender is quite straightforward and does not require external consultants, so that can make it an easier place to focus.”
Lloret agrees that margin ratchets will not always be the best way to drive progress on gender diversity: “Lenders are in agreement with our iterative approach: this is not a tick-box exercise and the triggers are decided on a case-by-case basis and need to be both measurable and auditable, in some instances by third-party verification. Gender is particularly relevant for us in the context of companies that lack diversity, for example, but in other cases – like industrials – we might want to give priority to environment-related metrics.”
At mid-market European lender Kartesia, sustainability-linked loans are still under consideration and the firm’s head of CSR and ESG, Coralie De Maesschalck, says there are other ways to influence borrowers to act.
“The first thing we are doing at Kartesia is leading by example,” she says. “I’m head of CSR and ESG, and for me CSR is about the corporate level and ESG is about the portfolio, but they are completely linked and so we work on both simultaneously. It is hard for us to engage on D&I with our portfolio companies if we are not doing the right things ourselves.
“We will use sustainability-linked loans in order to factor D&I metrics into financing solutions. We don’t do it yet at Kartesia, but we believe lowering financing costs in exchange for ESG progress is efficient and it’s important as a means of incentivising companies to hit diversity targets.”
“Even where people are starting from a low entry point, what is most important is to focus attention and make progress”
De Maesschalck argues that alongside an ESG ratchet mechanism should come other levers to help achieve long-term change: “For instance, next to the mechanism itself we believe it is important to ensure deep ESG due diligence is done prior to investment in order to set up relevant KPIs. That is particularly important for gender diversity because most of that data isn’t audited.”
She adds that understanding the sponsor’s approach is also important, as they too should lead by example and have clear views on diversity and inclusion. “Plus, we need to think about how we bring the company to the next level on sustainability. Usually there are two or three KPIs to reach in these mechanisms and I’m not sure that’s sufficient to really bring the company to the next level,” she says.
“We believe in creating a full development plan that is drawn up with the company and might include, for instance, rolling out D&I training or setting up new policies. In our current funds, we are focused on proactively engaging with our portfolio companies on D&I and supporting and encouraging them with that journey.”
Debt funds will often insist on a board seat at portfolio companies, which can be used to push the diversity agenda. Completing and reviewing ESG questionnaires on a regular basis is also a common approach.
Leading by example
Another organisation seeking to lead by example is mid-market private equity and private debt firm AEA Investors, which in April announced a joint venture with Amateras Capital, a women-led investment platform focused on junior capital solutions across private credit and equity. The joint venture is led by Amateras co-founder Alexandra Jung, who is now managing partner of AEA-Amateras, head of private debt funds and a partner at AEA Investors.
“When we underwrite a business as a lender, we are thinking about key credit metrics and one of the first things we evaluate is the board’s and the management team’s capabilities to lead and execute on the business plan,” says Jung. “We want to lend to sustainable businesses that will generate sustainable profit and growth, and we know that diverse teams outperform and lead to better profitability. So, diversity is a core part of our credit evaluation process.”
Lenders are now looking closely at specific metrics including board diversity, what the management team looks like, the diversity and inclusion policies in place, the employee base, the training procedures and the goals that have already been set, says Jung. “There are very specific measurements that large public companies have led the way on measuring, and we can learn from that and make those metrics a core element of our evaluation as a lender.
“How can we move the needle on this? First, we have to ask the questions and start that process of accountability. Then we have to set out our expectations as lenders, including the softer expectations that we talk to companies about, where over time we will move towards more measurement and tracking of performance.”
“You can’t create a diverse management team or investment committee overnight”
Amateras Capital and AEA Investors
The joint venture employs a solutions-based approach to investing, seeking to create outperformance by bringing diverse thought. Portfolio companies have access to a distinct female advisory network and it runs leadership development programmes to build the next generation of investors and operating executives.
“We have partnered with sponsors from an Amateras perspective to leverage the power of female investment and operating talent as a value-add partner,” says Jung. “When you have an investment team that is leading an investment that has diversity to it, then you are bringing that perspective to your borrowers.
“This is something we can bring that may not be part of the toolkit of the borrower or the sponsor because you can’t create a diverse management team or investment committee overnight. This is something we can do to help the industry evolve and start thinking about DE&I as a value generator and a performance generator.”
More and more lenders are factoring gender diversity into their financing decisions and taking steps towards meaningful engagement with borrowers.
“Gender diversity is part of a company’s ESG journey, so when it doesn’t necessarily translate into a ratchet, it is still always part of our due diligence and something that we monitor on a continuous basis through our annual ESG questionnaire,” says Mayer-Lévi. “Even where people are starting from a low entry point, what is most important is to focus attention and make progress.”
Sustainability-linked loans may have a big role to play going forward. “Often, we see IT consulting firms or software companies starting out with around 22 percent of women in management positions, and those women are primarily working in support functions. The metrics we set may require those firms to go from having females in one-quarter of management to one-third, across three or four years, and across all business functions globally,” adds Mayer-Lévi. “It is not too high to reach, so people are not deterred from trying, but real progress can be made.”