Can private credit/debt have an ESG impact?
On the 17th June, on a hot day in London, we were joined by eight clients for a roundtable lunch including some of the largest private real estate debt funds. We were there to discuss how private credit/debt can effectively progress ESG objectives when these products do not have the same level of control and stakeholder engagement as equity investment funds.
When there is such a significant need for transition funding, shouldn’t lending have a significant part to play in the decarbonisation of buildings, in adaptation, in health and wellbeing, in nature conservation?
It was clear from the outset that there were some strong differences of opinion – perfect conditions for a rich discussion.
At the root of these differences was a deep sense of ambiguity about regulations and an overwhelming lack of standardisation in investor preferences and data reporting requirements. This is compounded by the fact that banks and non-bank lenders have different viewpoints and appetites for risk, as well as the EU and US seeing ESG and financial risk from different perspectives. Even within the EU we see different country regulators transposing the rules in differing ways.
Pricing ESG risk (and opportunity) into debt is a clear point of differentiation – with some lenders seeing sustainable development objectives as requiring a higher cost of capital, whilst others see the benefits and are offering discounts. Some revelled in the challenge of a reduced borrowing universe whilst others remained concerned about how distribution could be made more complex by ESG. Some see the first-mover advantage as already passed whilst others see that first movement as a challenge, particularly under the shadow of an increasing number of greenwash accusations.
Plotting a way through this uncertainty takes time and effort without there being a clear endpoint in sight for the evolution of sustainable finance. An unintended consequence of the regulations flowing from the EU Action Plan for Sustainable Finance is that it has created some market inertia due to the fear of incorrect interpretation in their application, particularly in Alternatives.
Everyone expected the momentum behind the ESG agenda to increase, even after the broadside from Stuart Kirk at HSBC and from other commentators. However, Kirk’s comments on a 6-year time horizon (or less) has struck a chord in financial services, even though the delivery of this message was poor. The lending term or an investment hold period does make a difference when considering one’s fiduciary duty.
Over lunch, there were strong positions advocating for morality, for risk prudence and for a traditional interpretation of fiduciary duty that can’t compromise on financial returns. Could we reconcile these different points of view?
Despite the need for competitiveness and differentiation in this market, there was a clear desire for collaboration in certain areas. Data standardisation being one. A clear regulatory pathway being another recognising the challenge of transitioning legacy assets and the significant capital already deployed against these assets.
If financial market regulators were able to set out minimum standards now, for Art. 8 funds as an example, and a roadmap for how they could ratchet up over time, this would allow debt providers to plan and cycle their portfolio in the right way.
Those who have begun to screen borrowers on ESG, observed that the response from borrowers has been very positive, both from large and small companies. Which suggests that gathering the right data is possible. The challenge being that investor DDQs were often different, which is time consuming throughout the financial chain. There was agreement that there is nothing in the market that meets this needs for standardisation at this time.
Our discussion showed that this is a rich vein of conversation with a need for real action to move the debt market forwards. EVORA will continue to support the evolution of the market by engaging with the top debt providers and their investors.