As seen in this year's PDI US Report, September 2021.
Credit has been behind other asset classes on ESG, and the US market has lagged behind Europe and Asia, but now is the time to engage in the conversation, say Keith Miller, global head of private debt, and Karlien de Bruin, global head of ESG, at Sanne.
Keith Miller: The debt product has been behind other asset classes due to the size of the market and the nature of the assets, and the US has been behind Europe and Asia on the ESG conversation. In the last 12 to 18 months, many US private debt funds have come from a pretty unadvanced position to really move this up the agenda. The fact that other asset classes and other regions are driving this has increased the interest in North America, and we definitely see more discussion taking place.
In general, issues like climate change are getting more airtime in the US thanks to the change in administration and more awareness. It is also clear that the investor base is global and across products, and is ultimately going to drive this discussion and behaviour. Everyone wants to be doing the right thing on this rather than just waiting for regulation. So, while the conversation is still in its infancy, people are talking to businesses like ours to see what support is available.
Karlien de Bruin: There are some industry bodies working hard on things like standard ESG due diligence questionnaires, such as the Loan Syndications and Trading Association, which has been working with the Loan Market Association to develop best practice. We have also seen the Principles for Responsible Investment committee bringing out specific asset class guidance, and that really helps people think about what’s possible.
If you look at regulation globally, a lot of progress has happened in the last year, whether that’s new regulations going live or new regulations out on consultations. Many of these regulations and guidelines are expected to come into force in the next 12 to 18 months. It is important for investment managers to understand the requirement to prepare in advance.
KM: From an institutional perspective, people are making sure they hire ESG specialists to drive the conversation internally and help build this out. There’s a large education piece and conversation about getting up the curve, but we are seeing more focus on this among managers. The focus on the investment stage seems to be more on the due diligence side, pre-investment, at the moment. Information is more accessible at that point, allowing investment decisions to be made in line with ESG principles. We haven’t seen much yet where there are ESG-linked covenants on an ongoing basis, or ongoing reporting, because that ongoing data is a bigger challenge.
KDB: The pre-investment screening processes and bringing ESG principles into credit analysis is where investment managers have traditionally spent a lot of time anyway. Due to data constraints, it is much harder to do that analysis on a continuous basis.
KDB: The challenge for private debt is where they sit on the capital structure, which means they don’t have leverage to demand ongoing reporting. Plus, the data they need to do that ongoing reporting is not always there, because target companies are smaller and they are often engaging with the CFO who might not have that information at their fingertips. Private equity has more leverage to demand metrics over time and do a periodic analysis. There’s a big drive in Europe now to get the information, with the ‘big guys’ getting that and creating momentum that will spill over to smaller investment managers. There is still a lot to be done on what kind of data needs to be collected and what metrics investors want to see on an ongoing basis, but only once target companies know that it won’t be a problem. They already have to collect data for financial reporting so this will just be an additional element.
KM: The biggest challenge is data. Some of that depends on the type of investment, the size of investment and where it sits on the debt spectrum. Smaller investment managers are probably lending to smaller corporates where it is likely that there will be less sophisticated reporting capabilities. The challenge is to raise awareness with the borrower on the data that they need to gather and why it is important.
KDB: There seems to be a deliberate move towards uniform standards. Through our annual reporting to the PRI and CDP (formerly the Carbon Disclosure Project) we could already see the incorporation of the Task Force on Climate-Related Financial Disclosures recommendations. It is a good sign that institutions are converging. We also see ESG rating agencies and reporting frameworks working together to get a global system in place. We don’t know how long that will take, but everyone is trying to work towards a uniformed approach. That helps investment managers to start seeing what needs to be put in place in order to comply with ESG frameworks. The International Financial Reporting Standards foundation is also looking to bring sustainability requirements into accounting standards. It is still a moving machine, and we are still far from a single global standard but things are moving in the right direction.
KM: US credit managers are often marketing globally so they have to be aware of European regulations and those of other jurisdictions. The Securities and Exchange Commission has made some noise about introducing ESG requirements, and with the change of administration it is probably only a matter of time before US managers need to deal with more local rules.
KDB: ESG is a broad topic, impacting all jurisdictions and all asset classes. Investment managers will need assistance. We are doing a lot of advisory work around the regulations and the steps investment managers need to take to meet those requirements and investor demands. We are helping clients identify the data they need, which metrics makes sense for their specific fund and how to improve their ESG impact.