Sustainability

Green shoots in the private placement market

The “ESG revolution” is continuing in the private debt markets – a theme we flagged in our “2022 outlook” piece.

Investment practices

Strategies

There are no homogeneous ESG investment strategies in the PP market. The buyer base is at different stages of maturity: multiple mid- to larger-sized US accounts are lacking meaningful practices (mostly a qualitative part of investment decision), while certain, more advanced European and global accounts have already developed dedicated sustainable finance frameworks and investment targets. Particularly for investors managing third-party client money, it has been imperative to develop an ESG approach. In doing so, the general focus has been on proper integration, avoiding a simplistic “saint and sinner” list or to be seen to conduct “window-dressing” approaches.

Sector weightings

Several investors are finding ESG impact weightings between industry groups (such as reducing exposure to fossil fuels and cruise companies) and within sectors. One example: industrial real estate is easier than office real estate given the typically less energy-efficient nature of the current stock of the latter asset class.

Greenium

A broad-based reluctance remains amongst investors towards offering any meaningful greenium, and there’s indeed no evidence yet that this has filtered down from the public to the private market. Investors would generally prefer to see penalties for non-ESG compliant companies or offerings. This may not always be the case currently given the scarcity value of certain offerings (e.g. gas pipelines).

Themes

Transition finance

Several PP investors referenced an interest in wanting to support transitioning sectors. This could either be through financing with clear disclosure and reporting requirements, or “hard-wired” sustainability-linked target and coupon adjustments. The latter structure has its limitations however, as several transitioning borrowers noted that sectoral key performance indicators (KPIs) are still in development, and insurance investors don’t want to compromise the clarity of the PP returns given matched funding requirements.

Social

Various funds are being set-up to support affordable housing as well as SME lending in rural areas. Funds focused on the US market, typically include native Americans and veterans as additional target populations. When issuing PP debt, these typically offer minimum social reporting data.

Renewables

Infrastructure and project finance have, for a considerable time now, supported the development of renewable energy generation. Hence, the bullish outlook remains for this market segment, also based on the economic attractiveness versus some of the more polluting energy sources (e.g. coal).

Pre- and post-issuance

Due diligence

Amongst some of the largest PP investors there is now a drive to standardise the types of ESG questions they ask borrowers. The dedicated Private Placement Investors Association ESG working group was referenced by various market participants as a useful starting point in this regard.

Amendments

ESG-related investments are placing pressure on the credit profile of certain sectors, most notably real estate. To manage this risk, several borrowers have come to market for amendments looking to exclude retrofit and related environmental expenditures from the covenant calculations.

Macro drivers

US politics

The debate around the extent to which the Republican party control the Congress and/or Senate could reduce momentum behind ESG amongst US PP market participants. Even some speculation could become politicised the wrong way, such as for example Republican authorities withdrawing funds from “liberal” investment firms. The majority view, however, appears to be that ESG practices will increasingly become mainstream across the US capital markets.

Ecosystem

Data

The emergence of more accessible ESG data is likely to facilitate the embedding of greater sustainability transparency in private placement transactions. Several data providers already offer dedicated solutions for the market.

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