Responsible investing: On the minds of ESG leaders

Our panel

Vincent Lemaitre
Head of ESG for private debt, Tikehau Capital

Kevin Magid
President, Audax Private Debt

Rita Mangalick
Global head of ESG, Blackstone Credit

William Needham
Managing director, KKR

The world is racing to meet net-zero targets by 2050. Can private debt deliver?

Vincent Lemaitre: The ongoing societal shifts magnified by the current environmental, societal and health crises have provoked recognition that finance has a responsibility to act. Private debt is well positioned to play a role because of the inherent long-term nature of the investments, which allows for a deeper relationship. Private debt investors have the ability to convince management to embrace better sustainability practices.

Rita Mangalick: At Blackstone, we believe that the companies racing to meet these targets will need financing to do so. Blackstone is uniquely positioned to contribute: we see an opportunity to invest $100 billion in the energy transition and climate change solutions across all of our businesses over the next decade – much of which will come from private credit.

William Needham: Private debt investors have the most influence right before a transaction is signed. So, while lenders currently face significant challenges expecting borrowers to set net-zero emission targets, we believe we may be able to encourage them, for example, through active engagement, and support them through sustainability-linked loans focused on carbon emission reduction targets.

Kevin Magid: We believe private debt has an integral role to play alongside our private equity partners in delivering on net-zero targets. By working collaboratively to support companies with actionable, measurable net-zero strategies, we can push the mid-market ecosystem to adopt sustainable practices.

What is the most common question you get from LPs?

WN: ESG management comes up in almost every conversation we have with our LPs and clients. The type of information they are asking us for is getting increasingly more sophisticated and rigorous. The focus is often on how we think about climate risk in our investment strategies and how we integrate ESG considerations into our overall investment process. Questions around data collection challenges and new and upcoming ESG-related regulations, such as the SFDR, are also becoming increasingly common.

KM: LPs routinely ask us about integrating ESG factors into our investment process (including engaging with our PE sponsor partners), the ESG framework and standards we utilise, and the metrics/KPIs we track (both now, and going forward, as standards evolve). LPs are also focused on understanding our commitment to DE&I, both at the firm level and in our investment practices.

VL: It depends of course on the nationality and culture of the LP. If I have to pick one, it would be: “What are the firm’s ESG-related policies and how do ESG factors influence its investment beliefs?” LPs want to know that ESG is embedded in the firm’s investment processes, not just an attempt to check some boxes in an agreement or due diligence.

RM: I’m often asked about our ESG resources across the firm and how we collaborate across teams. I’m proud to say that we have a deep bench of over 30 dedicated ESG professionals, including our new global head of ESG, a chief sustainability officer, and dedicated business unit heads of ESG for private equity, BAAM, credit and real estate.

Besides net zero, what other big ESG-related challenges are asset owners facing?

RM: One of the biggest issues within private credit is the lack of ESG-related data from companies. I’m excited that we’re working with trade groups such as Principles for Responsible Investment, the European Leveraged Finance Association and Loan Syndications and Trading Association to standardise requests from lenders, and working with companies directly to identify relevant data to report on. What is measured is tracked, and what is tracked is reported by companies.

WN: Private debt has a key role to play in the corporate ecosystem but the pace of dealmaking means there are many competing demands on sponsors’, borrowers’ and deal teams’ time. With ESG topics representing both risks and opportunities, the lack of data, and good quality data in particular, presents a significant challenge. An outside-in ESG diligence approach, while necessary, is naturally limited, so having strong relationships with management and sponsors is critical to facilitating engagement.

KM: We have seen firms and professionals analyse how they will balance supporting sustainable practices with generating investment returns. With that said, even in a competitive deal environment, giving ESG factors their proper place in the investment process will, in most cases, lead to stronger returns over time. We believe that sponsors and lenders with an appropriate focus on ESG can set themselves apart from other firms that struggle with thinking holistically.

VL: Obviously, avoiding greenwashing that may run the risk of ESG being reduced to a marketing exercise with only modest achievement. Finding out which GPs are talking the talk and which ones are taking concrete action is far from simple in this fast-growing environment. It can be sometimes challenging to demonstrate the impact of the underlying investments because of the inherent subjectivity of ESG and lack of data. Fortunately, regulation is driving transparency, alongside industry efforts to standardise.

What is the role of sustainability-linked loans in the move towards a sustainable global economy?

RM: We think sustainability-linked loans are a key tool that credit can use to track and measure ESG value creation. Through our SLL structuring process, we aim to support borrowers in their efforts to drive meaningful improvement within their sustainability strategies and ensure that the KPIs and the sustainability performance targets are appropriate and clearly defined so that all stakeholders’ incentives are aligned.

WN: The danger is that SLLs fail to achieve the change that they’re capable of delivering by becoming a tick-the-box exercise. We believe that KPIs and SPTs need to be material and capable of being objectively assessed. Easy wins may sound good, but they won’t move the needle.

KM: It is our belief that sustainability-linked loans will play an increasing role in the US mid-market, as sponsors and lenders evolve to match what we are seeing in other markets. We expect LPs will help drive this evolution by continuing to ask lenders and sponsors how often they are using those loans in the market. It will, however, take time for sustainability-linked loans to become more commonplace.

VL: It is a very effective transition debt instrument. They are meant to generate positive outcomes on specific points of transition to support borrowers/issuers building a more resilient business model from an environmental or social standpoint. The borrower is incentivised to do something that they otherwise would not necessarily have done. In return, it can benefit from a lower credit spread to adequately reflect the credit risk.

What does the future hold for sustainability in private debt?

WN: Whereas today it might be possible for a company or a private debt provider to get away with not focusing on sustainability or to get a reward for proactively addressing it, in the future we think the reverse will be true: companies that don’t prioritise ESG topics will suffer a premium when raising debt and similarly, lenders who fail to address ESG factors may struggle to raise capital.

RM: I think we’ll see an increased use of SLLs to drive change. As it becomes clearer that ESG drives value, we’ll also see more engagement with companies around their ESG commitments. Our team has even created guides for our borrowers to calculate their carbon footprint and develop an ESG policy.

KM: We are at an inflection point in the US mid-market, where we (and our peers) are investing substantial time and resources into ESG initiatives. We are excited to be among those firms promoting sustainability, best practices, and related KPIs, and driving the returns that come from those initiatives.

VL: According to research from PwC in 2021, sustainability AUM could reach between €80 billion and €120 billion by 2025 in the private debt market in Europe. This demonstrates that the industry is at the beginning of a substantial structural shift.

Why are ESG factors gaining importance for private debt funds?

RM: Today, it’s clear to us at Blackstone that ESG drives value, leading to stronger, more resilient companies that can potentially drive increased profits and benefits for our stakeholders.

WN: ESG considerations are critical, not only to building a sustainable global economy but also to assessing the creditworthiness of investments. We believe that companies that focus on ESG topics often perform better, can access capital more easily and are better positioned for success.

KM: We have always found addressing ESG factors central to our ability to deliver attractive returns. As private debt investors, we carefully identify material ESG factors early in the underwriting process and continue to monitor these factors during the holding period of the investment.

VL: The EU’s Sustainable Finance Disclosure Regulation has been one major catalyst but not the only one. Sustainability investing has become a critical element of portfolio construction for LPs. Capital providers view ESG factors as a way to mitigate financial risk and boost investment performance. ESG strategies particularly outperformed during a period of intense volatility, which is highly relevant in the current context.