Readers of affiliate title Private Equity International will be well aware that demand for NAV financing – a form of fund finance in which a fund leverages its assets – has skyrocketed recently. The market could grow to $700 billion by 2030, up from $100 billion in 2022, according to fund finance provider 17Capital.

Given this growth, the question of how sustainability practices apply to the area comes into focus. Private credit in general has lagged other asset classes when it comes to ESG, though there are signs that this is improving. Whether it’s new data platforms – such as the one launched by MSCI – or disclosure frameworks like the ESG Integrated Disclosure Project, the asset class is moving in the right direction.

But NAV financing is not like most other forms of private lending.

For one thing, even though a NAV lender is providing financing to the fund manager, in practice most of the ESG risks occur within the underlying portfolio. Hence it is at that level that the real data gathering work needs to be done. The trouble is that lenders have no direct relationship with the companies within the portfolio. As a result – for 17Capital at least – managers must take a more qualitative approach to data gathering, says head of ESG Claire Hedley.

There is a further complication. When a lender is engaging with a borrowing sponsor, it may not even know exactly how the proceeds of the loan will be used. “If you have a direct lending transaction, you know that you are lending money to a specific portfolio company, and you know what that specific portfolio company is likely to do with that money. [But] We finance the whole fund, and the money could be used in multiple ways,” as Pavol Popp, a managing director in Pemberton’s NAV team, told NPM this week.

More advanced data collection processes and the wider adoption of ESG disclosure frameworks will no doubt improve the ability of lenders to assess sustainability risks at the portfolio level. However, uncertainty over use of proceeds presents lenders with an ongoing ESG challenge.