Vai Patel, head of ESG at Alcentra, lays out his objectives for the year ahead:
What is your top sustainability priority for 2024? What will count as a success?
My top priority in 2024 is continuing to work with our borrowers and portfolio companies on ESG data, with a particular focus on climate data and transition plans. While as an alternative credit manager, we don’t have the same rights as equity holders, we are nevertheless focused on direct engagement with portfolio companies to better understand the state of their ESG & climate data, and how we can help improve their disclosures.
The climate data in particular will be crucial for our planned Taskforce on Climate-related Financial Disclosures (TCFD) report later this year, which in turn will form the basis of our preparation for the International Sustainability Standards Board (ISSB) standards. To that end, success will largely be defined by our ability to produce market-leading disclosures for our investors and stakeholders.
An example of this would include a TCFD report that prioritises quantitative disclosures (namely the Climate Value at Risk and Implied Temperature Rise) with implications for our strategy) – a point most asset managers have struggled with in their TCFD disclosures.
Where have you reached on your portfolio decarbonisation/climate journey? What is next on the to-do list?
I believe the economic impacts of climate change will be felt across industries and markets; however, at Alcentra we recognise that the magnitude and timing of these impacts remain varied. It is this variability that is grabbing the most attention in my to-do list. Namely, scenarios analysis that assesses both physical and transition climate-related risks and opportunities – and understanding how those might affect our portfolio companies’ business operations, strategies and ultimately financial valuations – remains the single biggest challenge faced by asset managers.
While Alcentra is at the earlier stages of this analysis, we are endeavouring to produce both qualitative and quantitative assessments as part of our TCFD reporting. This has been helped by the foundations that have been laid across the last two years ie increased engagement with portfolio companies on climate data disclosures and setting emissions reduction targets.
Wrapped around this is our firm’s commitment to set interim targets for 2030, for investment assets to be managed in line with achieving net zero by 2050 or sooner. This remains a substantial undertaking across our portfolio companies, but we see it this as us acting as responsible stewards of capital.
Do you think the industry has now reached a good place in terms of data frameworks?
In my experience, the sub-investment grade and mid-market companies are at an earlier stage of their ESG journeys, reminiscent of where larger investment grade companies were two to three years ago. The spread of voluntary and regulatory ESG data frameworks available to portfolio companies has given more options to companies and increased the quality and auditability of ESG data, but widespread adoption remains lacking. This stems from a combination of lack of internal resourcing and capacity at companies and the patchwork nature of the frameworks themselves.
However, we have started to see positive momentum – I see the future of ESG reporting being influenced by three perspectives: regulatory changes, industry coalescence around frameworks and inter-framework consolidation. All these perspectives indicate one major directional move: the harmonisation of ESG reporting frameworks. Of these, the one with potentially the most far-reaching consequences is the development of the ISSB standards.
ISSB builds significantly from existing reporting frameworks and standards, and the ISSB has pledged to enhance interoperability with other international and jurisdictional sustainability-related standards to better support adoption. Crucially, adoption by regulators across jurisdictions will likely enable investors and other capital market participants to make informed investment decisions by providing consistent and comparable information about companies’ sustainability-related risks and opportunities.
ESG data: Are you now finding ESG data (both your own and industry benchmark data) to be genuinely decision-useful for investment decisions?
Access to high quality ESG data remains the critical differentiator in decision-making. As things currently stand, the ESG data providers we have assessed provide reasonably good coverage of large companies (both listed companies and debt issuers) in developed markets.
However, the data provider market is much less developed for sub-investment grade and mid-market companies, and for asset classes other than listed equities and fixed income, reflecting the coverage and quality of corporate disclosure globally. These gaps in coverage limit alternative credit managers’ ability to make consistent investment decisions based purely on ESG data.
To bridge this gap, ESG data providers have focused on providing estimated data for such companies. At Alcentra, we remain highly sceptical of how useful estimated data can be in making investment decisions given that precise methodology used by the ESG data providers is typically opaque, with the estimated values likely just averages, calculated from a companies’ regional and sectoral peer groups. Instead of relying on ESG data providers, we have found direct engagement with portfolio companies on ESG data and management’s ESG strategy are far more useful for making investment decisions.
What is the next step in your ESG journey for human rights and supply chain risk?
The key next step for me is our campaign to increase awareness among our portfolio companies about supply chain risk, of which human rights is a core component. It’s clear that stakeholder expectations for companies’ awareness of their ESG supply chain risks are increasing.
In my view, to increase supply chain resilience, companies need to pay more attention to ESG risks across their supply chain. In particular, human rights due diligence needs to be integrated into the companies’ operations as current levels of visibility & control across the market remain limited.
More practically, we are encouraging our portfolio companies to focus on 1) risk identification and 2) risk management of their supply chains, and codifying policies that account for these risks (including key laws and regulations). Where possible, we are also encouraging our portfolio companies to look to provide an outline of aspirational standards or frameworks – such as the UN Global Company, OECD Guidelines for Multinational Enterprises; UN Sustainable Development Goals – that their suppliers could look to work towards.
What is the first item on your DE&I to-do list in 2024?
DE&I remains a constant focus for us as a firm and our investments in portfolio companies – we are committed to converting DE&I from an abstract concept to a robust, holistic approach within our industry. Fundamentally, we believe greater diversity leads to better investment outcomes. In 2024, we will continue our focus on embedding practical improvements for long-term improvements in DE&I.
Two examples come to mind to illustrate this point: 1. For our own operations, in 2022-23 more than 51 percent of all hires were women – this was supported not only by proactive hiring policies but also by casting the net wider and establishing programmes such the Returners Programme, which primarily targets women re-entering the workforce after an extended career break.
2. From a portfolio perspective, in our direct lending strategy, we have embedded detailed questions in our annual ESG questionnaire sent to all portfolio companies about their DE&I statistics, policies and strategy. This ensures we are able to act as responsible stewards of capital across our investments by tracking year-on-year improvements and identifying areas of engagements where needed.