Sabrina Fox: Private debt is on the verge of a seismic shift in how it views ESG

What are the biggest challenges for debt funds?

The challenge for private debt is quite similar to the challenge for other types of debt in leveraged finance, which is how to effectively obtain information on a company’s ESG profile, particularly with covid’s quite significant impact on due diligence.

A lot of companies are early in their ESG journey and do not know exactly what investors are looking for, so education is needed. That’s what our ESG initiative is based on: we know investors need to get disclosure to do this analysis; we know ESG means different things to different people; and we know from companies that they are willing to help investors, they just need to understand what they should be disclosing. That must be sector-focused, because every sector is different.

The other challenge is being able to impact the trajectory that a company is taking, because we are not yet at a point where we see standard industry KPIs on ESG that will support green loans and impact financing.

What ESG initiatives is ELFA currently working on?

Our focus is on improving information flows in ESG, and we have been engaging with different stakeholders to make sure investors are getting the information they need. Private equity has been very willing to engage, and they understand that they are often the gatekeepers of that information. Even the interests of the broader lending group tend to be well aligned, because everyone wants to alleviate downside risk and help companies achieve better outcomes. What we need in ESG disclosure is revolution, not evolution. Usually disclosure is slow to respond to new developments, but we need it to move much faster. We need to bring hearts and minds together and agree what ESG means in different sectors – what we are looking to achieve on a sector-by-sector basis is the publication of ESG disclosure checklists for companies, which can be presented to all potential investors at the outset. We are seeking buy-in from all the stakeholders involved: private equity, private debt, law firms, arrangers, credit rating agencies and so on.

What sort of innovation are you seeing in ESG?

There’s definitely appetite to incorporate more ESG-type KPIs into loans, which is when you start moving towards blended sustainable finance products, but it is still bespoke. Private debt is renowned for being able to move quickly and offer nimble financing solutions. I’m not sure how much companies seeking sustainable finance are looking to private credit investors for that, or whether it is a different value proposition. We are seeing the first signs of convergence.

How do you expect ESG behaviours to evolve?

By next year, I think more private debt funds will have an ESG policy that they have incorporated from top to bottom into their businesses. That is what is starting to happen: a seismic shift towards thinking about philosophies, values and how those translate into ESG policies. By next year, those conversations will have been fleshed out.