Investor demand for socially responsible projects is slowly making its way into private credit markets in Europe, initiating change in a burgeoning area of corporate finance.
Linking loan terms to environmental, social, and governance goals is relatively established in premium corporate debt, but remains relatively rare in the $ 850 billion universe of alternative credit. Barings LLC and Tikehau Capital SCA, the so-called direct lenders who provide finance to mid-sized companies, are among those now adopting such packages.
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This may be just the start, as more and more lenders realize that they can refine their credentials with increasingly discerning investors. If others follow suit, it would further deepen the integration of climate change into the world of finance, where it is already. felt in everything from mortgages to credit risk to the central bank.
“They might have the best returns in the world, but if they don’t think about ESG they won’t be recommended or see investments from us,” said David Scopelliti, Global Head of Credit. private at Mercer LLC, which manages over $ 320 billion. “There are certainly managers who have come out of the funnel because they do not have strong systematic ESG integration – if any – in their investment process.”
Direct lenders charge more than banks for financing promises of speed, confidentiality and flexibility in return, and it is this premium that has attracted scores of new investors over the past decade. Lenders will need to see the tangible benefits of ESG-related transactions for these initial transactions to become a trend.
Mechanics of transactions
Private credit backing TowerBrook Capital Partner LP’s acquisition of Talan SAS arranged by Tikehau and supported by CVC Credit Partners LLC offers the consultancy firm the opportunity to reduce the interest rate by until 30 basis points per year – a pretty big potential discount.
The fall in prices is linked to demanding targets for the company, including a minimum proportion of women in the management team, a target which is increasing every year.
French private equity company Eurazeo SE has already financed two buybacks and a third is under negotiation. One of the packages aimed to finance the acquisition at the end of last year of the French intellectual property software company Questel SAS. Under the terms, Questel may reduce the margin on the € 500 million ($ 606 million) financing for the buyout by meeting reporting requirements such as measuring its fossil fuel consumption.
“It’s a real way to integrate ESG indicators at the company level,” said Alice Foucault, CEO of Barings, who led the club of direct lenders for the deal. “It’s not a significant margin reduction, but it’s something that can make a difference.”
In Europe, private credit reached $ 259 billion in March 2020, including $ 142.7 billion in direct loans. That’s almost six times more in a decade.
Read more: ESG loans to capture a larger share of the European GI market in 2021
But the typically smaller companies targeted by direct lenders are generally not subject to the reporting requirements of large companies that have done ESG financing. until now. This means that a key test for lenders will be to prove that the criteria written in the loans are effective and not just there to appear socially conscious, according to Scopelitti.
“From a risk perspective, we make sure we pick the category winner,” said Cécile Mayer-Levi, head of direct lending at Tikehau, which has so far granted six ESG loans. “In three or four years, we’ll see if these companies have outperformed. “
Despite the challenges, Stéphane Bostyn, director and head of capital markets, financing and treasury at Eurazeo, says that the direction of the industry is clear.
“Previously, the market was not really ready for this, lenders could not accept a negative impact on their margin,” he said. But “this will be the path taken by everyone in two or three years.”