Four private debt allocators walk into a (virtual) room…

... and tell Andy Thomson how they view the industry's progress on ESG. Views range from the sceptical to the optimistic.

As part of our December/January cover story, we canvassed a select group of investors for their thoughts on key themes as we head into 2024. One question was whether private debt has its house in order when it comes to ESG.

‘More could be done to create impact’

“As investors start to have more appetite and understanding around ESG & DEI matters, this has paved the way for genuine SFDR 9 funds that are allocating capital to companies and projects that have measurable impact on various sustainability goals,” said Timo Hara, founder and partner of Finnish fund investor Certior Capital. “At the same time these funds are still mostly ‘selection-based’: i.e. they provide capital to selected companies that fill their targets ex-ante rather than creating structures that would both incentivise and penalise borrowers that do or do not improve their sustainability.”

“This means there are more and more opportunities for sustainability-minded investors, but still more could be done to create impact – in particular with companies that have improvements to be gained, but are not straight out ‘sustainable companies’,” said Hara.

EU regs have shaped approaches

“Historically, private credit funds mainly followed a generalist investment approach. In recent years there has been a shift towards sustainability in private credit motivated by EU regulation (and policy-implementing entities such as the EIF) and LP appetite,” said Priscilla Schnepper, investment manager, private debt fund investments at the European Investment Fund. This has resulted in the emergence of “specialised sustainability-focused funds (sustainable thematic and/or climate impact funds)” and simultaneously the emergence of “a sustainability mindset in generalist funds which incorporate ESG characteristics, as part of risk analysis”, she said.

The private debt ESG tool kit

“In addition to the requirement to follow relevant reporting and disclosure requirements, private credit lenders have a unique set of tools and opportunities to incorporate ESG and sustainability into the investment process,” said Schnepper. “While exclusions and ESG scorings are also available to other asset classes, sustainability-linked loans and sustainable loans (with a sustainable purpose of finance) characterise the unique toolbox for credit, thus contributing to dedicated financing to close the green and transition financing gap, as well as address social targets (such as diversity aspects or labour conditions).”

‘Less uncharted territory’

“There is a lot that remains to be done for private debt in the ESG & DEI space,” said Marc Smid, senior portfolio manager at Allianz Global Investors. “Compared to the situation about five years ago, progress has been made and there is less uncharted territory when it comes to the consideration of sustainability criteria in private debt investments. However, there is broadly a need for improvement in private debt. Investors like us have clear requirements with regard to ESG & DEI and managers that do not improve and keep up on expected standards will fall behind.”

‘Old school’ = un-investable

“From my perspective most of the active private debt houses have clearly done their homework,” said Dominik Thienel, head of private equity and private debt at German pension fund WPV. “As ESG has come into clearer focus during the last three to four years, market participants have built up internal infrastructure (e.g. awareness through ESG committees, focus within due diligence, side letter veto rights for critical assets), mostly driven by governmental requirements and LP/market demand.

“Nevertheless, even though there is immense fundraising competition nowadays, some GPs still stick to ‘old school’ style, putting them in position to be ‘un-investable’ for some LPs,” continued Thienel. “So, there is still room to improve further.”

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Our cover story asks key investors what they think about a range of issues – something that will be a regular feature of Private Equity International’s NEXUS 2024 event in Florida on 6-8 March.

For example, in a discussion on day two, our own director of research and analytics, Dan Gunner, will be quizzing Jennifer Choi, chief executive officer of the Institutional Limited Partners Association, and Andrew Palmer, chief investment officer of the Maryland State Retirement and Pension System.

That’s just one example: you’ll find many others by taking a look at the agenda here.