The ESG battle rages on
The anti-ESG stance being adopted in some US states is considered in this month’s cover story. What it draws attention to is competing narratives.

From states where there are traditional energy industries to protect comes the argument that investors should only be considering potential returns when making investments – anything else is an irrelevant distraction. From the pro-ESG side comes the attempt to frame ESG considerations as a crucial element of risk management.

This week, the UK Sustainable Investment and Finance Association – representing banking heavyweights such as Barclays and JPMorgan – urged the UK government to provide clearer guidelines around the role of fiduciary responsibility in ESG considerations. This followed a PWC survey that revealed 74 percent of investors cited the management of ESG risks and opportunities as a critical factor in their decision-making.

ESG is an area where further regulation is supported by those in favour of consistent standards, the minimisation of liability risks and the implementation of responsible investing practices. It would help to cement the status of ESG as a vital part of the investment decision-making process, regardless of the growing backlash.

BoE careful
The Bank of England has issued a warning over the proliferation of private credit and more esoteric financing strategies within the private markets, according to our colleagues on Private Equity International.

In a Monday speech at UK Finance, published on the central bank’s website, executive director Nathanaël Benjamin said that “any adverse macroeconomic outturn” in the US could be felt across all asset classes and products in some way, particularly within private equity and private credit.

“We are mindful that as interest rates have risen and traditional leveraged financing markets have stuttered, a clear trend toward illiquid private equity financing and private credit has emerged,” he said. “Some firms are growing rapidly in this space, and with that has come a significant increase in complexity, as firms not only lend to portfolio companies, but also to fund investors, underlying funds, asset managers and everyone in between.”

Benjamin said the BoE sees a risk that firms underestimate their aggregate direct and indirect exposures to underlying counterparties and connected collateral. “[That is] not a good place to be should credit conditions begin to deteriorate, or should those counterparties be feeling the squeeze of the tighter monetary environment through tighter access to liquidity,” he said, noting that the bank intends to “closely monitor private asset financing”.

The bank’s warning feels particularly timely given PE’s burgeoning appreciation for facilities such as NAV financing, which this year are increasingly being relied on as an alternate path to liquidity at a time when many LP coffers are bare. Private credit firms also are seeing this year as an opportunity to gain ground in sponsor lending, as traditional lenders retrench in some markets.

It seems Benjamin’s advice won’t be falling on deaf ears. Panellists at our Seoul and Tokyo forum last week noted that private debt managers, for their part at least, were having difficult conversations with sponsors about the appropriate use of leverage, and becoming more strict on covenants. They did note, however, that there was still room to improve for deals on the larger end of the spectrum.

Tough credit conditions in Europe
S&P Global Ratings predicts in a report (login required) that the European speculative grade corporate default rate will rise from 2.8 percent in March 2023 to 3.6 percent in March 2024 as tightening credit conditions reduce access to, and increase the cost of, speculative grade issuance.

The rating agency said that, so far this year, two-thirds of speculative grade issuance has been by higher-rated ‘BB’ issuers – indicating that weaker issuers are already struggling to access markets.

“The contrast between the highest and lowest rated corporates could not be starker, and worsening credit conditions will have an unequal impact on European corporates,” said Paul Watters, head of corporate research for Europe at S&P Global Ratings.

Credit conditions have tightened as central banks seek to bring inflation under control and restore price stability, which is not expected to happen in the Eurozone until 2025. With more restrictive rates, banks will become more risk-averse, funding costs will rise and the focus on credit quality from investors and lenders will increase.

The report noted that the economic cycle is also weakening, although a deep recession is not expected in the Eurozone.

Essentials