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June 2022 | Issue 246
Opinion Direct lending

ESG should not be viewed as a set of principles being imposed on investors — it’s a natural evolution

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Randy Schwimmer
Co-head of senior lending Churchill Asset Management
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It’s not easy for fund managers to assess the most green option
Exiting a building the other day, I noticed a mother and her two young sons in front of me. The boys ran to the automatic revolving door. “No,” she said, opening the swinging door, “come this way.” For a moment my energy-saving conscience scolded her. Until she added: “That door uses electricity.”
Welcome to the challenges of an ESG world. Which exit is the greenest: the one using electricity or the one losing heated or cooled air?
Covering ESG in a thoughtful way, which Creditflux does regularly, means acknowledging its complexities and contradictions. What is clear is the breadth and depth of this movement. ESG’s impact on investor and manager behaviour has changed the way we look at the world. How did that happen and what does it mean for private capital?
ESG has a long and rich history
Beginning with the US civil rights movement and apartheid in South Africa, fund managers used their growing clout to encourage change. Environmental awareness grew in the 1960s and 1970s with Chernobyl, Bhopal and the Exxon Valdez disasters highlighting the lasting damage created by corporate mismanagement. The global financial crisis was also a reminder that financial markets run for profit alone, without regard to sound governance, can cause havoc in the economy and society.
These historic milestones contributed to a sense that companies don’t exist in a vacuum. As one study put it: “There are links between the companies in which we invest and how they interact with the environment and society in which they operate.” It’s hard to know whether this development is a natural outgrowth of a half-century’s experience or reaction to investor pressure and regulatory scrutiny.
Yet there is a precedent for hope around data legitimacy. Nutrition labels are a given today, but in the 1960s the idea of listing calories and serving sizes was far-fetched. With better technology, food can be more precisely analysed. In the same way, claims that food is ‘organic’ also attracted regulatory attention. The SEC is now focusing on funds calling themselves ‘green’.
ESG integration describes the process whereby investors incorporate all aspects of environmental, social and governance elements in their risk analysis of a business or manager. Every investor develops their own framework to measure quality against a spectrum of elements. Underlying this is the assumption that companies managing their ESG frameworks effectively are likely managing other aspects of their businesses competently.
For credit investors, it’s less about the upside. The public fixed income market has now adopted and refined ESG datasets and frameworks to mitigate downside risk. Assisted by rating agencies, these questionnaires mirror checklists in financial categories, albeit with a blizzard of details across items such as carbon emissions, supply chains and shareholder rights.
Applying an ESG lens in private markets is the next frontier. One would be hard pressed to find more potential for beneficial impact than with private equity capital and attention. The clear challenge with smaller companies is to extract data to apply the right metrics, or, in some cases, to find data at all.
Financing partners know too that ESG focus can add value for private equity investors while protecting lenders from default risks. As one asset sales head put it: “Lenders working together and influencing the decisions of companies are key for improving on ESG.”
The close relationship lenders have with owners and borrowers is also key to successful ESG integration. The tighter the circle of credit providers, the more likely key issues will be communicated.
ESG should not be viewed as a set of principles from outside the asset universe being imposed on investors. Rather it’s a natural evolution combined with the reality of an interconnected planet.
What matters, after all, is not the definition or categorisation of these principles, but the effort to create some alignment, modified over time, with your firm’s moral and ethical standards.
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Global credit funds & CLO's
June 2022 | Issue 246
Published in London & New York.
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