ESG in private credit continues in the US, but not without significant difficulties

The behemoth pension fund announced last month that it has begun including ESG topics in its private debt due diligence questionnaire, Creditflux reported at the time. CalPERS, which oversees more than USD 500bn in assets, is asking private credit managers about how they assess risks associated with ESG factors for the fund or for co-investments. The investor is making sure these managers have the proper policies and procedures in place and are screening for material ESG risks.

They aren’t the only ones. But incorporating ESG has now become a touchy and sometimes politically charged issue, particularly in the US. And the private credit market lacks uniformity and, in ways, much heft.

While most investors in Europe generally agree that ESG considerations are positive, anti-ESG sentiment is brewing in the US. In late June, Committee Republicans advanced legislation to restrict retirement plans from considering ESG factors when making decisions. The Texas Attorney General has also warned financial institutions that ESG commitments could lead to enforcement actions.

Nonetheless, some US institutions, especially those that represent constituents working as teachers, firefighters and other public employees, seek to avoid deploying their capital into managers, strategies and assets that do not align with the values of those constituents.

LPs also want general partners they can trust because investing is a relationship business, said Constantine Braswell, a vice president in Callan’s Alternatives Consulting group.

Incorporating ESG into private credit is no easy task. There is a lack of consistency around how LPs and GPs approach ESG, and it can be tough for GPs to deal with a spectrum of investors that care about ESG to different extents, Braswell said.

There is also a lack of standardisation. Standardising due diligence questions would make it easier for managers to anticipate what investors will ask, said Nick Smith, a managing director for private credit at the industry organisation Alternative Credit Council. For investors, standardisation would allow for simpler comparisons between managers.

Direct lenders, which often fund private companies, have fewer tools than the equity owners. Private credit managers could in theory try to use ESG-linked covenants, but they tend to have little power in driving the decisions of portfolio companies, said Braswell.