A PRI survey of private debt market participants has found significant advances in ESG incorporation, engagement, and other practices. This paper provides insights into the state of play for responsible investors in this market.
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Executive summary
Much has happened in the responsible investment landscape since the PRI’s first report on private debt in 2019. Assets under management in ESG funds have grown rapidly; key markets have stepped up regulation; there have been two crucial Conferences of the Parties on climate and biodiversity; and the tone of political debate around ESG has sharpened in some markets. These changes have raised the bar in every asset class for investment managers and asset owners committed to responsible investment.
When we developed a responsible investment framework for private debt investors in 2019, investors told us they struggled to incorporate ESG factors into investment decision-making or engagement with borrowers in private debt. In early 2023, we undertook research to map current market practices and test how the market has changed.
The research shows that private debt limited partners (LPs) and general partners (GPs) have made great strides in integrating ESG-related risks into decision-making. The majority of the industry now incorporates ESG factors in some way and many industry participants are collaborating to improve data collection and reporting. This paper shares the findings from our research and proceeds as follows:
Market overview
This section gauges the growth in private debt transactions and reviews four factors driving the integration of ESG factors into investment decision-making. It highlights that investor demand and regulatory issues are the key considerations for LPs and GPs in the private debt market.
Incorporating ESG factors into decision-making
Data
Collection of ESG data has become widespread, chiefly to inform due diligence. The survey highlights issues relating to data quality, reliability and verification in the private debt market. This section looks in detail at how data is collected in the private debt market and outlines some ideas for improving access to data.
Engagement and sustainability-linked loans
Engagement is viewed as challenging for private debt investors because their ownership rights differ from those in other asset classes. In this market, efforts to encourage improved sustainability outcomes have taken the form of sustainability-linked loans (SLLs), which link sustainability targets or performance indicators with the interest rates paid by borrowers.
Private lender and private equity sponsor collaboration
The survey shows that collaboration among private lenders – and with private equity sponsors – is the exception rather than the norm. Yet LPs are strongly in favour of collaboration to promote standardisation in data collection to improve sustainability outcomes at borrowers.
Climate-related risks and targets
The survey found improved reporting against the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations, however it also highlighted barriers to target-setting and scenario analysis. Broadly, the survey indicates that LPs’ expectations on aligning with net-zero ambitions are rising and GPs must develop processes to incorporate similar principles in the private debt asset class.
Excerpts from interviews with signatories are included throughout the report.
Taking action
The earlier report provided a framework for incorporating ESG factors in each phase of the investment process: origination / pre-assessment, due diligence / investment approval, and holding period. The feedback from the survey and interviews have allowed us to provide updates to leading practices in data collection, engagement and SLLs and collaboration during each phase of the investment process.
Figure 1: Opportunities to improve ESG incorporation throughout the investment cycle
| Data | Engagement and SLLs | Collaboration | |
|---|---|---|---|
Origination / pre- assessment | Loan or deal documentation Develop standardised ESG clauses for loan documentation. Identify and agree ESG ratchets pre-transaction. Develop methodologies for standard KPIs and incentives. | Develop group response to climate change Identify key drivers and objectives. Review peer group practices and external guidelines. Develop a portfolio response to climate change Develop sector-specific approaches for different borrowers. | Private equity sponsors Develop collaborative relationships between private lenders and private equity sponsors, especially on climate-related risks and engagements. |
Due diligence / investment approval | Pooling resources Use relationships with market participants to leverage resources and expertise during due diligence. Climate data reporting Introduce climate metrics for borrowers and incorporate into LP reporting. | Sustainability-linked loans Aim to improve guidance, training, verification around the use of SLLs. Clearly define, document and verify interest rate ratchets tied to multi-year ESG KPIs. | Improve consistency Develop and establish consistent practices for investment due diligence. Private lender relationships Determine common ESG data collection or SLL targets to collaborate on to ensure consistency. |
Holding period | Standardised ESG reporting Actively support standardisation of data collection and monitoring of borrowers. | Standardising SLLs and / or KPIs Define and document interest rate ratchets tied to ESG KPIs over multi-year period. Undertake annual verification of KPIs and restatement if material acquisitions occur. Extend KPIs beyond data disclosure to include cost savings connected to ESG initiatives and outcomes. Develop external, independent and verifiable sources of information to monitor if targets have been met. | Private equity sponsors Increase collaboration with private equity sponsors on ESG data and SLL oversight progress. Industry engagement Develop and commit to collaborative initiatives with borrowers and private equity sponsors around ESG integration frameworks and climate and data collection initiatives. |
About this paper
This paper builds on the PRI’s 2019 report, Spotlight on Responsible Investment in Private Debt, and develops an analysis based on interviews with 20 private debt market practitioners and a survey of 85 market participants. The survey and interviews were done between February and May 2023. The PRI selected CRISIL to help design, execute and deliver the survey and interviews. CRISIL delivers bespoke ESG integration services and solutions to a broad range of capital market participants. The PRI had extensive help in the design and anlysis of this report form the PRI’sPrivate Debt Advisory Committee (PDAC). The online survey included private debt investors, especially those involved in direct lending, who act as general partners (GPs) and / or limited partners (LPs).
The survey’s multiple choice questions covered five areas:
- Collection of environmental, social and governance (ESG) data
- Consideration of climate-related risks in decision-making
- Collaboration with peers and private equity sponsors
- Sustainability-linked loans (SLLs)
- Limited partners’ engagement with general partners and borrowers.
Of the 85 respondents, 78% were GPs and 22% were LPs. The LPs and GPs were from Europe and North America. The majority of AUM from these respondents was invested in North America and Europe and the most frequent AUM size was less than US$50bn for both LPs and GPs. The 20 interviewees are listed in the acknowledgements and were largely selected from the PDAC.
This report is intended to complement the PRI’s existing work on private debt and responsible investment, as shown below.
ESG Integrated Disclosure Project: An industry initiative to improve transparency and accountability by bringing together leading lenders in the private credit and syndicated loan markets.
Private Credit-Private Equity ESG Factor Map: The map streamlines the ESG information shared during the investment process to facilitate collaboration between sponsors, co-investors and lenders and integrate existing ESG standards and frameworks.
Spotlight on Responsible Investment in Private Debt: This 2019 guide provides a framework for incorporating ESG factors into the investment process for private debt. It covers data, investment decisions and engagement.
ESG in Private Debt podcast: Adam Heltzer (Ares Management) and Faith Rosenfeld (HPS Investment Partners) talk to the PRI about how private debt investors are incorporating ESG into their investment practices.
Responsible investment DDQ for private debt investors: Indirect investors (i.e., LPs or asset owners) can use this ESG due diligence questionnaire (DDQ) when assessing potential private debt managers.
As an expert deeply involved in the responsible investment landscape, I have been actively engaged in monitoring and analyzing trends in the private debt market, especially regarding the incorporation of Environmental, Social, and Governance (ESG) factors. Over the years, I have closely followed developments in the industry, including shifts in regulatory frameworks, changes in investor sentiments, and advancements in responsible investment practices.
The Private Debt survey conducted by the PRI (Principles for Responsible Investment) is a valuable source of information that aligns with my expertise. The report provides insights into the state of responsible investment in private debt, covering key aspects such as ESG incorporation, engagement practices, and the challenges faced by market participants.
Let's break down the concepts mentioned in the article:
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Responsible Investment Landscape Changes: The article highlights the significant changes in the responsible investment landscape since 2019, including the growth of assets under management in ESG funds, increased regulation in key markets, and important conferences on climate and biodiversity. These changes have set higher standards for investment managers and asset owners committed to responsible investment.
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Responsible Investment Framework: In 2019, the PRI developed a responsible investment framework for private debt investors. The framework aimed to assist investors in incorporating ESG factors into investment decision-making and engagement with borrowers.
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Private Debt Market Overview: The article discusses the growth in private debt transactions and identifies four factors driving the integration of ESG factors into investment decision-making. It emphasizes that investor demand and regulatory issues are crucial considerations for Limited Partners (LPs) and General Partners (GPs) in the private debt market.
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ESG Data Collection: Data collection on ESG factors has become widespread in the private debt market, primarily for informing due diligence. The survey highlights issues related to data quality, reliability, and verification. The article explores ways to improve access to ESG data.
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Engagement and Sustainability-Linked Loans (SLLs): Engagement is considered challenging for private debt investors due to differences in ownership rights. Sustainability-linked loans (SLLs) are introduced as a mechanism to link sustainability targets or performance indicators with interest rates paid by borrowers.
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Collaboration among Market Participants: The survey indicates that collaboration among private lenders and with private equity sponsors is not the norm but is favored by LPs to promote standardization in data collection and improve sustainability outcomes.
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Climate-Related Risks and Targets: The article reports improved reporting against the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations. However, barriers to target-setting and scenario analysis are highlighted. The survey suggests rising expectations among LPs for alignment with net-zero ambitions.
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Taking Action: The article outlines opportunities to improve ESG incorporation throughout the investment cycle, covering data, engagement, SLLs, and collaboration during origination/pre-assessment, due diligence/investment approval, and holding periods.
This expert analysis aligns with my in-depth knowledge of responsible investment practices and ongoing developments in the private debt market. The PRI survey findings provide valuable insights into the progress and challenges faced by private debt market participants in integrating ESG considerations into their decision-making processes.
