MV Credit: Finding alignment on ESG

MV Credit’s Emilie Huyghues Despointes discusses how lenders need to collaborate with multiple stakeholders.

This article is sponsored by MV Credit

Over the past few years, private debt lenders have come under ever greater pressure from LPs to demonstrate their ESG credentials. At the same time, they need to build good working relationships with portfolio company owners (typically private equity sponsors) and their management teams to effect change.

Emilie Huyghues Despointes, ESG officer at MV Credit, tells us that a range of incentive schemes can help ensure that all stakeholders are able to align their interests when it comes to ESG. Helping companies to improve their ESG performance, she notes, will ultimately be a lever for value creation.

Why is it important to bring all stakeholders onto the same page when it comes to ESG?

ESG needs to be inherent to the business – part of everything we do. At MV Credit, we have fully integrated ESG throughout our existing investment procedures, and as an organisation, we follow the same ESG principles we expect of our portfolio companies. In the end, it helps to be fully transparent and to make sure all our stakeholders understand that we do what we say we’ll do.

How do you assess ESG when you’re making investments?

Emilie Huyghues Despointes
Emilie Huyghues Despointes

Our ESG investment procedures are fully integrated into our investment approach. We invest in transactions alongside private equity owners, so in the pre-investment phase our deal team will start by assessing the ESG profile of the private equity sponsor. The idea is to make sure we invest alongside private equity sponsors that are aligned with our values. We look at whether the sponsor is a Principles for Responsible Investment signatory or has made equivalent commitments – this should confirm that the principles are being followed throughout the life of the investment.

Then we have the screening phase. The deal team applies a negative screen via our exclusion lists. MV Credit does not invest in certain sectors, industries or activities. For example, the list excludes industries involved in weapons and fossil fuels. We also exclude some sectors based on our own strong convictions, as well as market standard exclusions. We have chosen not to invest in nursing or care homes because we think these businesses with vulnerable customers do not fit well with private equity ownership.

The next step is to perform a controversy analysis, which is performed by an independent expert that works with us and uses a proven methodology. The purpose of the controversy screening is to make sure that we have not missed an incident involving a company that may negatively impact the stakeholders or the environment. This could harm the reputation of the company, and ultimately affect its financial profile.

The deal team is also responsible for identifying, evaluating, and managing ESG opportunities and issues within each investment. For that, the borrower will fill in a proprietary ESG assessment questionnaire that we have co-designed with an external adviser. It includes 55 KPIs, covering E, S, G and stakeholder topics.

How do you incentivise borrowers to improve their ESG performance?

Roughly 20 percent of the transactions we see in the market include ESG ratchets in the structure. These sustainability-linked loans are designed to incentivise the borrowers to improve their performance against ESG criteria that are predetermined before the closing of the transaction.

It is not included in all our transactions, but it’s something we see more and more in the market. We offer these sustainability-linked loans to borrowers and will help the private equity sponsor and a company’s management team select the KPIs we want the borrower to focus on.

For ratchet mechanisms to be effective, we really need to have tailor-made structures and select the right KPIs. For example, if we invest in a company with a big workforce that has a lot of workers earning the minimum wage, then we’ll tend to focus more on the social aspects. We really try to adapt to the business itself.

Overall, these loans are a very good signal to the market that companies and investors want to do things the right way and go down the road of sustainability.

However, it is still early days. The ratchets down or up are still very low – normally between 7 basis points and 10bps on the margins. But these structures nevertheless put ESG front and centre for borrower management teams.

What actions do you take as an organisation to demonstrate a commitment to ESG?

We apply, as a firm, the same kind of requirements that we ask of our borrowers and partners. So, we are signatories of the PRI and other major initiatives. We are also active in supporting various charities. For example, we began a partnership earlier this year with a charity called Raise Your Hands. They act as a broker for smaller, local charities and our team spends volunteering days with one of these charities once or twice a year.

We are very focused on diversity and inclusion. Women represent more than 50 percent of the total headcount at MV Credit. Additionally, the percentage of women in senior executive roles is more than three times the estimated average for private debt (11 percent). We have 16 nationalities among 68 people working at the firm, showing that we really believe that diversity adds to our work.

Finally, we calculate our carbon footprint as a corporation, and take actions to reduce our negative impacts.

Do you agree that there is now greater collaboration between private equity and private debt firms on ESG?

Yes – in respect to ESG we have the same goals, so it’s always positive to work together. We used to hear that it’s not the place of the lender to engage the borrowers and try to provide support on ESG. But we typically have very good access to the management team of the company – certainly compared with listed equities, for example. We clearly have a role to play, alongside the sponsor.

I regularly meet with the four or five sponsors with whom we have the most transactions to discuss the portfolio companies and how we could better work together.

We all want to work closely with the companies and support them on their ESG journey. As such, it’s important we’re fully aligned to make the borrower’s life easier. We try to be clear and simple to reduce the number of requests the borrower receives. It would be tedious to send out our questionnaire and then two or three other lenders send theirs, as well as the sponsor itself – usually with all the same questions. So, we work hard to avoid multiple requests going out to the same company.

How is ESG regulation affecting your work?

We already have two existing funds classified as Article 8, and we are committed to ensuring all future funds will be classified as Article 8. Whether the Article 8 classification is important for LPs tends to vary depending on where they are based.

We find French investors are very focused on SFDR classification and some have already asked for funds to be Article 9. In the UK, investors are very focused on climate but may not place the same emphasis on the SFDR classification.

My opinion is that Article 8 will become a must-have, but we haven’t been down this road for regulatory reasons – it’s really by conviction. We believe in the positive  aspects ofESG on the investment side and the fact that it helps achieve positive outcomes for society and the environment. From an investor perspective, I strongly believe that ESG adds value. In the long term, the more sustainable a company is, the more profitable it will be.

Checklist record diligence

How do you ensure alignment with LPs?

We now get a lot of requests from LPs on ESG. Even just three years ago, we would only receive ESG questions from investors every two or three months – and these would be at the bottom of the list investors would send to us. Now, things have changed a lot. We can see that LPs are very focused on ESG.

We are fully transparent with our LPs. We provide them with a dedicated ESG report annually, in which we summarise everything we have achieved on ESG and set out our objectives for the coming years. We provide scorecards for each borrower and compare their performance to a benchmark.

The other mechanism we have developed for one of our latest funds is ESG-linked carried interest. This is a way to align with both ESG and the LPs, and it follows a similar approach to a sustainability-linked loan. We link some of the carried interest against three KPIs. The first one covers the percentage of senior women in the firm. The second KPI is the overall response rate to the fund’s annual borrower ESG questionnaire – which incentivises us to enhance engagement and transparency with the portfolio companies. And the final KPI is the fund’s overall ESG score; this is based on the questionnaire we send on an annual basis to each borrower.