Kartesia: Private debt’s approach to ESG is evolving quickly

Private debt may have been later to embrace ESG than private equity, but industry approaches are evolving quickly, says Kartesia’s Coralie De Maesschalck.

This article is sponsored by Kartesia

The rise of sustainability-linked loans over the past year and the launch of several impact private debt funds in recent times are big developments for the asset class. But how can firms effect change in portfolio companies? And is this the start of a more widespread shift? We caught up with Coralie De Maesschalck, head of CSR & ESG at Kartesia, to find out.

What role do you believe private debt has to play in impact investing?

Coralie De Maesschalck

The role of private debt in achieving impact outcomes is often undervalued. The industry has grown significantly and is expected to grow further – some figures estimate an 11 percent annual growth rate of AUM in private debt over the next few years as LP allocations continue to increase. It has also become a valuable and valued source of financing for smaller businesses. All this means that if firms integrate impact into their investment processes, private debt can play a significant role.

We do face some challenges, however. Unlike with private equity, it can be difficult to gain access to data, especially ESG data. That’s partly because many companies don’t track ESG data but it’s also because we have less access to management than sponsors. We just have to find ways of addressing those challenges.

So how can you address these challenges?

There are a few ways we can do this. To compensate for the lack of data, together with Sustainalytics, we have built a model to estimate the carbon footprint for each portfolio company, most of which are too small to collect the actual data. The model is based on peer data and we apply it to each company and at a portfolio level.

Along with this, where we have access to management, we spend a lot of time engaging on ESG to help the team understand what best practice looks like, the benefits of using consultants and having a roadmap for improvement, and why carbon footprint data is so important. When we first started having these conversations, I thought it would be a tough sell to portfolio companies, but actually, we’ve found that they are asking for this support.

Management teams are becoming increasingly aware that they need to act on ESG to continue operating in five to 10 years’ time.

What are the best ways to engage with the portfolio?

We try to work in a way that means portfolio companies welcome our engagement. Having ESG fully integrated into all our processes means that I work alongside the deal team so that everyone understands the ESG issues involved in each case and what the risks are. That’s quite powerful and much more effective than if it is an add-on or just marketing.

We also adapt our approach to different products, so we’ll tailor engagement and processes according to whether the deal is sponsored or sponsorless, for example, or if it is a CLO financing. We explore the issues with the company and share information, taking time to explain why we are, for example, conducting a cybersecurity review of our entire portfolio.

We can then share best practice with companies. We recognise that we sometimes ask a lot of our portfolio companies, but we do our best to support them. We want to have a positive relationship, not a policing one. That really helps us gain trust.

Where is the impact market at the moment?

It’s a maturing market and it is starting to become easier to compare apples with apples. The EU’s SFDR regulations are pushing the industry along a little and helping to foster improved reporting. It’s also prompting the development of products from data providers for private debt specifically, including around ESG – it used to be that we just had to follow the private equity template.

Overall, this is helping to spur more impact investment in the asset class and the increased use of ESG ratchets that we’ve seen over the past year or so are really important in effecting change. But we’re also seeing a push from portfolio companies themselves. They recognise that it will become harder to attract financing and get insurance over the next decade if they don’t work on ESG. They are conducting full reviews of their business. That’s a trend I hadn’t expected.

How much of a game-changer is the SFDR?

It’s a huge game-changer. There is certainly a lot of work involved in interpreting it and it requires a significant amount of additional reporting. However, it’s very positive for private debt because it allows our industry to catch up on ESG – it has so far lagged behind other asset classes, including private equity. SFDR means that we can all now move forward at the same pace.

It will mean much greater transparency in the industry. All private debt players have to disclose information on their websites, their remuneration policy, KPIs and the sustainability profile of their funds. It also provides a definitive and complete list of KPIs across many different dimensions, from biodiversity through to anti-corruption.

They are really the only ESG KPIs that I could see as working for private debt globally and I hope the industry coalesces around these – they have real power, present a great opportunity for clarity and can be used to compare firms. This helps avoid greenwashing accusations and enable firms to evolve their sustainability approach. And for us as a firm, they are super-positive because they allow us to recognise the work we’ve done on ESG and to classify our current funds under Article 8.

D&I has become key for LPs. What do they want?

It has become a key item, but it’s still in the early stages and so the questions we get from LPs around this tend to be quite broad. At the moment, most LPs mainly want to see that we’re doing something on this. And for us, this is really important. We’ve been doing a lot of work to address this.

We started out with a review of all our policies to ensure they were inclusive, we’re doing D&I training and we’re now trying to inspire women to join the private debt industry, especially in investment roles. There are currently few role models to follow, so we’ve published a series of interviews with female employees. This has helped attract more female candidates when we’re recruiting.

What developments do you see on the horizon for private debt and impact?

More companies will seek out investors who can engage with them and support them to improve their sustainability. I see sustainability-linked loans growing significantly with ESG KPIs in the legal documentation. I think we’ll also see more genuine change, harmonisation of practices and less greenwashing, thanks in large part to regulation. ESG is moving fast.