ESG and private debt: The power couple in a post-Covid world?

Gautier Despret, Head of Private Debt, IQ-EQ Luxembourg. (Photo: 360Crossmedia)

Gautier Despret, Head of Private Debt, IQ-EQ Luxembourg. (Photo: 360Crossmedia)

Environmental, social and governance (ESG) is no longer a concept for hippie investors or millennials. It has become a new way of doing business, and if you don’t join the bandwagon now, you will miss the party – or, more specifically, the fundraising party.

It is true that companies have been, even until recently, largely evaluated only on their financial parameters, such as price-to-earnings ratios or earnings growth, to determine whether they would make for a strong investment prospect. However, ESG has risen firmly to the fore – driven by both investors and regulators, particularly in the wake of Covid-19 disruption – and is now actively being used as a yardstick for judging investment returns while also bringing greater transparency to the alternative investment sphere.

This surge in ESG-focused investing encompasses private debt, which has also been bolstered by the pandemic and is emerging as one of the fastest growing categories of alternative asset. In fact, private debt is projected to increase 11.4% annually, from US$848 billion at the end of 2020 to US$1.46 trillion by the end of 2025, according to a survey by Preqin on the future of alternative assets.

There is immense potential for private debt to grow in this current economic situation. Private debt strategies usually thrive during an economic downturn. Looking around us, we see that banks have significantly restricted loan access to retail customers and smaller companies in light of enhanced regulatory requirements and as defaults increase amid the pandemic. Here, private debt has a crucial role to play by providing an alternative to the banking industry. Indeed, it’s interesting to note that 80% of corporate loans in the US are provided by individuals and only 20% by banks. In the EU, meanwhile, these figures are currently the other way around, which highlights that the potential is immense.

Embedding ESG into private debt can help in the democratisation of private funds and will likely be a key part of the post-Covid economic recovery.

Embedding ESG into private debt can help in the democratisation of private funds and will likely be a key part of the post-Covid economic recovery.
Gautier Despret

Gautier Despret,  Head of Private Debt,  IQ-EQ Luxembourg

ESG allows private debt managers to reduce risk and add opportunity. For instance, an ESG assessment can lower downside risk and allow investors to invest in structural themes linked to climate change, energy transition, the environment and inclusive growth – impact-oriented sectors that have garnered global attention amid the pandemic. Factoring ESG considerations into investment decisions can also foster more active asset ownership, thereby further reducing risk.

Not only will ESG considerations help the private debt managers in the reduction of risk, ESG is fast becoming a ‘must-have’ instead of a ‘nice-to-have’. The EU’s recently implemented Sustainable Finance Disclosure Regulation (SFDR), which relates to the publication of information from financial market participants (those managing and raising funds in Europe) on the sustainability of their investment decisions, has put the onus on all asset managers to have and disclose ESG policies and procedures. The Loan Market Association and the European Leveraged Finance Association have also developed their own set of ESG disclosure topics.

It is also interesting to note that subscription credit facilities linked to ESG metrics are fast becoming a new trend with market giants such as EQT, Carlyle and Eurazeo, having all used an ESG sub-line over the course of last year. This is a trend which is set to grow with a number of sponsors willing to commit to a more sustainable approach to investing by putting their margins at risk.

Private debt has an important role to play in the recovery of the economy in a post-Covid era. Embedding ESG criteria into the private debt structure will not only tick the compliance box but will significantly help create further transparency and mitigate risks in private debt structures.

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