ESG-linked credit facilities begin to show mass appeal

A series of sustainability-focused deals in 2021 gave fresh significance to a relatively young market.

The proliferation of ESG-linked credit facilities has been on the PE agenda for some time – a trend that accelerated this year.

These vehicles are increasingly seen as a way for firms to align their financial goals with socially conscious objectives. By placing environmental, social and governance-focused responsibility at the forefront of their investment decisions, they can both improve their public profile and promote transparency between their investors, lenders and other financial sponsors.

Several structures are in place to make this approach more appealing. For example, whenever certain KPIs are met at predesignated checkpoints over the duration of a credit facility’s lifespan, the manager will often receive a discount to the market margin. On the other hand, penalties may be added if those indicators are not met on time.

“Senior management often want to focus the deal guys on the things they care about. How do you incentivise your deal team?” Tom Smith, a partner at law firm Debevoise & Plimpton, told Private Equity International at the beginning of the year. “One way is to have a capital call facility that allows them to make savings at an institutional level if you improve ESG. That effectively institutionalises this focus.”

One of the first firms to enter the world of ESG-linked credit this year was ICG, which said in February it had secured a £550 million ($729 million; €645 million) revolving credit facility linked to carbon emissions targets. ICG told PEI at the time that it had spent six months working with an external adviser to develop a climate risk assessment tool, with the aim of integrating climate risk into its investment decisions.

“For strategies where we have more influence and access to management, we’ve developed climate-related KPIs to track by industry,” said Eimear Palmer, a managing director and responsible investing officer at the firm. “We also took the decision… to ban any direct investments in companies that generate a majority of revenue from coal, oil or gas across all our funds.”

And the trend has continued over the course of 2021. In October, Baring Private Equity Asia made headlines with an ESG-linked credit facility to support its PE platform. This was due to its size – up to $3.2 billion, according to the firm – and because it was the first of its kind in Asia, according to affiliate title Private Funds CFO. In a statement, Patrick Cordes, BPEA’s chief operating officer, noted that the facility would enable the company to be more transparent with investors about how it is using its ESG approach to “make a difference in the world”.

Still, if it sometimes seems as though the future of the industry lies with these products, they aren’t suitable for all. Head of treasury at EQT, Magnus Lindberg, told PEI that turning traditional sub-lines into ESG-linked ones can accrue significant costs – for example, by bringing in third-party auditors to assess portfolio companies’ KPI progress.

Vicky Du, global head of fund finance at Standard Chartered, which was co-lead arranger and sole sustainability co-ordinator and sustainability structuring agent on KKR’s ESG-linked line, said: “We have been in situations where we look at [the] viability of a green loan or sub-line for a fund, but the fund is at a very early stage. In those cases, it can be that the fund’s governance is not sufficient to meet requirements, or not robust enough to deliver the results.

“[In those situations] we are able to work with the sponsor, give our advisory services to bring them up to standard. We are doing this across the board with many sponsors hoping to achieve a certain set of standards.”

With one of the most commonly cited issues with ESG-linked facilities being a lack of standardisation across the board, ironing out the kinks could result in even more players participating in the ESG-linked facilities arena in the coming year.