Talking point: ESG loans must not just pay lip service

Investors have concerns about what is happening in the broadly syndicated loan space. The private debt market must learn the lessons.

The progress made by credit managers on environmental, social and governance issues is encouraging in many ways.

A new study from the Alternative Credit Council and law firm Allen & Overy found that 74 percent of fund managers are integrating ESG into investment processes. We’ll view that as a good thing, even if it does prompt questions about why 26 percent are apparently behind the curve.

But while there is willingness on the part of managers, investors need assurance that ESG advances are being made in the right way. ESG-related loans are still in their infancy in the private debt space, but a glance over at the broadly syndicated loan market – where they are more commonplace – reveals plenty of issues around the nature of the loans themselves, as well as around reporting and transparency.

Understanding targets

Investors appear to struggle to understand what the targets are for such loans, how key performance indicators are drawn up and assessed, and the structure of these loans, including how the mechanics of margin ratchets work. They also stress that reporting – the nature and frequency of it – is a key issue.

In a survey conducted by the European Leveraged Finance Association, as many as 96 percent of respondents said they wanted to see a standardised questionnaire that would help their discussions with borrowers about the provisions in green, sustainability and ESG-linked products. ELFA responded with the release of a document that will hopefully bring about greater transparency.

As with covenants and other aspects of deal documentation, what happens first in the BSL market will probably filter down into the larger – and even the mid-market – private debt space. The private debt market needs to learn from the concerns of investors and incorporate best practice.

Already, there are whispers that margin ratchets in some private debt deals are set at too low a level to have a material impact and that KPIs lack clarity or are too easy to achieve.

The last thing the asset class needs is accusations of greenwashing. The lessons from the BSL market must be taken on board.