Private equity is committed to helping the world. Lenders want proof

Words can be cheap in the loan market, now some lenders want to change that.

In recent years, borrowers have been able to obtain a reduction in their interest charges in return for achieving objectives linked to environmental, social and governance (ESG) objectives. This trend was boosted this year by private equity firms seeking a share of the stock.

ESG loan issuance reached $ 87 billion in the first quarter, triple the amount for the same period last year, according to data provider Refinitiv.

As billions pour into the market, some lenders are reluctant to trust borrowers’ word that they are meeting their goals in everything from reducing food waste to promoting more women.

“The burden of proof is going to increase. Be prepared for it,” said Mark Wade, head of sustainability research and management at Allianz Global Investors.

Three industry associations that represent underwriters, law firms and asset managers in Europe, the United States and Asia revised their sustainability lending principles last month.

They now say borrowers need to get an independent external audit of their performance against goals, a change driven primarily by investors buying the loans and lenders arranging them, according to the London-based Loan Market Association.

The change in direction was prompted by developments in the broader lending market, but it coincided with the shift from private equity to sustainability lending.

Under pressure from their investors to show that their leveraged buyouts aren’t just about generating returns, private equity firms, which often use leveraged loans rated below the investment grade to fund acquisitions, were responsible for 95% of ESG-related emissions in Europe. unwanted loan market so far this year, according to financial intelligence provider Reorg Research.

Disclosure has always been a challenge for loan investors and, in particular, creditors of private equity holding companies. Many are private companies, and unlike bonds or stocks, loans are not government securities, so they are not bound by the same disclosure requirements.

“The biggest criticism we hear is the problem of having data to assess the situation,” said Armin Peter, head of sustainable banking and global head of the debt capital markets union at UBS.

Boom in leveraged loans

It is not known at what scale and how quickly the voluntary guidelines will be adopted.

Some market observers expect this to be an evolution, with independent verification of ESG objectives eventually becoming the norm, as is the case in public bond markets.

But in the short term, the strong demand for over-supply leveraged loans, in addition to a booming demand for ESG products, means borrowers often have the edge, allowing them to avoid debt. monitoring by third parties.

ESG-linked leveraged loan issuance this year has increased 14-fold to € 19 billion in May from 2020, according to Reorg.

“The amount of liquidity offered relative to the number of high-quality deployment opportunities influences the conditions to be met,” said Murad Khaled, head of leveraged financial capital markets EMEA at Bank of America, who organized sustainability – loans linked to businesses supported by Carlyle and CVC.

ESG-linked leveraged loans save on the cost of borrowing between 0.05 and 0.15 percentage points if targets are met, while costs similarly increase if the goal is missed, according to Reorg.

Almost two-thirds of transactions do not require a third party to verify that ESG objectives have been met, according to data from Reorg.

Granted, not all targets may need external verification if the data is readily available in a company’s regular disclosures, say investors and bankers.

But even within the private equity industry, the demand for surveillance is increasing.

Four months after the buyout company Carlyle Group negotiated a financial package of CHF 413.5 million ($ 452 million) for its acquisition of the Swiss watch industry supplier Acrotec, it is still negotiating how to show the principal Blackstone lender that it is meeting its sustainable development goals, according to two sources familiar with the matter.

Carlyle has been offered a loan by the lending arm of Blackstone Group Inc (BX.N) in which the interest rate drops if Acrotec meets sustainability goals such as limiting its energy use and recycling .

He also negotiated a revolving facility whose borrowing costs are reduced if the funds are used for a project that has a “measurable environmental benefit”.

Blackstone wants an independent party to verify that Carlyle is achieving his goals, according to a source close to his position. Carlyle, on the other hand, wants the third party to be involved only in setting goals and expects Acrotec management to certify compliance, another close source said.

Carlyle Global Head of Impact Megan Starr said her companies self-reporting on sustainability goals was no different than how they reported other data related to their debt commitments to creditors.

“They have a fiduciary responsibility to make sure the data is accurate,” she said.

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