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Private equity is committed to helping the world. Lenders want proof

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Private equity is committed to helping the world.  Lenders want proof

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LONDON – Words can be cheap on the loan market, now some lenders want to change that.

In recent years, borrowers have been able to obtain a reduction in their interest costs in exchange for meeting objectives linked to environmental, social and governance (ESG) objectives. That trend has been driven this year by private equity firms seeking a piece of the action.

ESG-linked loan issuance reached $ 87 billion during the first quarter, triple the amount during the same period last year, according to data provider Refinitiv.

As billions enter the market, some lenders are wary of taking borrowers’ word of mouth that they are meeting targets on everything from reducing food waste to promoting more women.

“The burden of proof will increase. Be prepared for it, ”said Mark Wade, director of sustainability research and management for Allianz Global Investors.

Three industry associations representing underwriters, law firms and asset managers in Europe, the United States and Asia reviewed their sustainability-linked lending principles last month.

They now say borrowers should get independent, external verification of their performance against targets, a shift driven primarily by the investors who buy the loans and the lenders who manage them, according to the London-based Loan Market Association.

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The change in orientation was due to developments in the loan market in general, but has coincided with the movement of private capital towards loans linked to sustainability.

Under pressure from their investors to show that their leveraged acquisitions are not just about earning returns, private equity firms, which often use sub-investment grade leveraged loans to finance acquisitions, have been responsible for the 95 % of emissions related to ESG in Europe. Junk-rated loan market so far this year, according to financial intelligence provider Reorg Research.

Disclosure has always been a challenge for loan investors and, in particular, creditors of private equity portfolio companies. Many are private companies, and unlike bonds or stocks, loans are not public securities, so they are not subject to the same disclosure requirements.

“The biggest criticism we hear is the problem of having data to assess the situation,” said Armin Peter, director of sustainable banking and global director of the debt capital markets syndicate at UBS.

LEVERAGED LOAN BOOM

It is unclear how widely and how quickly the voluntary guidelines will be adopted.

Some market watchers expect it to be an evolution, with independent verification of ESG targets eventually becoming the norm, as it has been in the government bond markets.

But in the short term, high demand for leveraged loans outpacing supply, plus booming demand for ESG products, means that borrowers often have the upper hand, allowing them to avoid third-party oversight.

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The issuance of ESG-linked leveraged loans this year increased 14-fold to € 19 billion in May compared to 2020, according to Reorg.

“The sheer amount of liquidity that is offered, compared to the amount of high-quality implementation opportunities, influences the terms that are achieved,” said Murad Khaled, director of EMEA leveraged financial capital markets at Bank of America, They have agreed on sustainability linked loans for businesses backed by companies like Carlyle and CVC.

ESG-linked leveraged loans allow loan cost savings of 0.05 to 0.15 percentage points if targets are met, while costs similarly rise if target is not met, according to Reorg.

Nearly two-thirds of deals do not require a third party to verify that ESG goals have been met, Reorg’s data showed.

Certainly not all targets may need external verification if data is available in a company’s regular disclosures, investors and bankers say.

But even within the private equity industry, the demand for supervision is growing.

Four months since the acquisition firm Carlyle Group negotiated a financing package of 413.5 million Swiss francs ($ 452 million) for the acquisition of the Swiss watch industry supplier Acrotec, it is still negotiating how to demonstrate to the lender key Blackstone that is meeting its sustainability goals, according to two sources familiar with the matter.

The loan arm of Blackstone Group Inc offered Carlyle a loan in which the interest rate falls if Acrotec reaches sustainability goals, such as limiting its energy use and recycling more.

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It also negotiated a revolving credit line whose borrowing costs are reduced if the funds are used for a project that has a “measurable environmental benefit.”

Blackstone wants an independent party to verify that Carlyle is meeting its targets, according to a source familiar with its position. Carlyle, on the other hand, wants the third party to be involved only in setting the targets and expects Acrotec’s management to certify compliance, another familiar source said.

Carlyle’s global director of impact, Megan Starr, said her companies’ self-assessment of sustainability goals was no different than how they report other data related to their debt covenants to creditors.

“They have a fiduciary responsibility to ensure that the data is accurate,” he said.

(Reporting by Yoruk Bahceli and Simon Jessop in London Edited by Greg Roumeliotis and Carmel Crimmins)

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In-depth reports on the economics of innovation from The Logic, presented in association with the Financial Post.

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