Insights series / 09 August 2021

5 ways private debt managers can nudge corporates to make better ESG decisions

5 ways private debt managers can nudge corporates to make better ESG decisions

Led by investors and regulation, private debt managers are now faced with the challenge of incorporating ESG principles into their investment processes.

But what does ESG for private debt even look like, how much of these principles can private debt managers really be expected to implement, and can they really have an impact on the management teams of third party companies?

Though private debt managers do not generally hold board seats in the corporates they lend to, that's not the only way to influence the ESG strategy of a company.

We look at five ways in which private debt managers can effectively and reliably ask management teams to factor ESG into their decision-making processes.

Direct influence of capital

1. Direct influence of capital

To lend or not to lend: this decision in and of itself is perhaps the most obviously impactful, as whether to loan capital to a company seeking financing, gives lenders direct influence with management teams.

Companies that would fail a preliminary ESG review, for example, may be persuaded to change projects associated with the potential negative social or environmental impact that would lead to a loan rejection. On the face of it, management teams are incentivised to make such changes – especially if this is feedback they have heard more than once, perhaps from other lenders.

positive ESG

2. Link positive ESG to a reduced interest rate

Barings Bank took this approach in 2020, in a deal involving the listed company, Questel. 

Barings offered financing which included an annual review of the margin for the credit facility, based on the achievement of five pre-defined ESG criteria.

Because the test is annual, it requires the borrower to be committed to the ESG criteria throughout the year. Because commitment to the criteria directly correlates to a reduction in the cost of its capital, Questel is suitably incentivised to make good on that commitment consistently and the more ESG criteria the company meets, the larger the cost reduction. 

team up

3. Team up with others to grow your clout

Managers do not need to act alone. It’s possible for minority debt-holders to positively influence management teams by working with other existing or prospective lenders, equity holders or other major partners in the target business. Teaming up in this way can be a more effective way to prod management teams to make more positive ESG choices for their companies, compared to acting alone.

direct dialogue

4. Ongoing direct dialogue with management teams

Perhaps the most powerful tool in the kit: managers increasingly have a policy of direct dialogue with corporate management teams, in an effort to challenge or educate on pertinent ESG issues. The managers who use this particular route with good effect is too long to list, but it is worth noting that many find ongoing dialogue more beneficial for all involved than negative ESG screening. This is because negative screening does not allow management teams to make a change, where their firm fails a particular ESG criteria, whereas ongoing dialogue often encourages them to make a better a choice.

Filing burden

5. Take (most of) the form filling burden away from the corporate

It’s often said that low or unreliable data from portfolio companies hinder the ESG assessment process, whether before or after an investment is made, but it is especially true where information is needed on an ongoing basis - for KPIs that need to be monitored through the year or at particular intervals. 

However, finding the right partner to work with your in-house team can help alleviate this burden. Such partners can, for example, help fill out the required data collection forms on behalf of a company, based on their latest publicly released documents. Pre-filled forms can then be sent to the portfolio company for viewing, editing and eventual submission to your team. Once filled out, third party partners can cross-check the information on potential (or existing) portfolio companies against the ESG criteria of your existing investors.

Whichever path or combination of paths a manager chooses to take, what is clear, is that managers who are able to integrate ESG into their portfolios will undoubtedly be met with approval from investors around the world.

Related articles

02 August 2021 / Insights series

ESG in private debt