6. Impact investing

Impact investing in private markets – where investments pursue positive externalities alongside financial returns – has entered the institutional mainstream.

But while impact investment headlines tend to focus on equity, private debt is actually the largest contributing asset class. It accounts for more than one-third of total AUM, at 34 percent, according to the Global Impact Investing Network, followed by real assets, at 22 percent and private equity, at 19 percent.

Interest in the space among LPs and GPs has been growing in recent years, with a number of new players entering the market. In 2021, for example, BlackRock launched a private equity impact investing strategy.

The asset manager joins firms such as TPG, Bain Capital, KKR, Blackstone, Apollo Global Management, Morgan Stanley and Hamilton Lane in launching a dedicated impact strategy.
Scott Barrington, CEO at North Sky Capital, which launched an impact fund of funds in 2005, describes the entrance of mainstream asset managers as additive. He told Private Funds CFO’s affiliate title New Private Markets that these arrivals could attract larger pension funds to the impact space.

“We are at a bridging moment where these pension plans will start with the big shops and then begin discovering more intentional, yet smaller, funds to invest in, either through their now bigger fund sizes or separately managed accounts that create customised investment themes like the ones we are beginning to do.”

7. ESG integration

A recent study by Intertrust Group on the attitudes of private capital CFOs found that ESG had cemented itself as a key consideration for private fund leaders.

When asked if they had an ESG, CSR or sustainability policy in place at their firm, almost 85 percent of the Intertrust survey’s respondents said they did. However, that figure looked less solid when they were asked about the implementation of ESG into their investment process. More respondents said they were in the process of implementing ESG policies into their investment process than had already done so.

According to Intertrust product director Antonello Argenziano: “Knowledge and expertise on ESG integration and timely ESG data are crucial to comply with investor demand and sustainability legislation. A framework to collect, monitor and report ESG data is key in this and, in turn, technology, scalable processes and expertise will be necessary in addressing those requirements.”

“The more we can contribute our data, the more valuable this benchmark will become as we all strive to drive ESG improvements at our companies and generate long-term value together,” Carlyle’s chief executive Kewsong Lee said at the time.Last year, private markets heavyweights Carlyle Group and California Public Employees’ Retirement System announced they would track and report a standardized set of six ESG metrics, with their ESG Data Convergence Project open to any GPs and LPs that wished to join and agreed to support the principles of the work.

8. Sustainability-linked loans 

It is hard to believe that as little as two years ago the concept of a sustainability-linked loan was little understood in the world of private debt.

In short order, the asset class has embraced the use of such loans – which offer discounted rates to borrowers if certain sustainability targets are met – and issuance has skyrocketed. According to research from Bank of America, H1 2021 saw the take-up of such loans hit $350 billion, far in excess of the $200 billion achieved for the whole of 2020, which was previously the busiest year for sustainability-linked lending.

A compelling advantage for private debt funds is the ability to get a seat at the table on ESG when LPs are demanding action. “We are increasingly linking loans to positive ESG outcomes for our portfolio companies,” says Anthony Fobel, CEO at Arcmont. “In particular, identifying company-specific ESG improvements that, if met and independently verified, result in a margin ratchet, thereby reducing the interest cost to the company.”

The long holding periods of private debt investors, typically five years, put managers in a good position to drive some positive social and economic impact alongside a financial return. But debt funds were long skeptical of their ability to exert influence. This new model for creating impact as lenders thus has huge potential.

“Private debt funds can put in place meaningful incentives to encourage portfolio companies to improve their ESG ratings”

Anthony Fobel

Fabian Chrobog, founder and chief investment officer at North Wall Capital, says: “I think you’re going to see a whole lot more sustainability-linked loans in the future because as far as we are concerned it is one of the easiest ways to see ESG policies implemented. It is one of the few tangible and measurable ESG-related changes we can make in investments, and that’s what makes it so exciting.

“This is something we could do on every single one of our loan facilities without actually having to change anything we do in our day-to-day business, achieving what our investors want us to achieve with our underlying borrowers.”

But only a material discount with challenging targets and ongoing support will make a real impact, says Coralie De Maesschalck, head of ESG and CSR at Kartesia. “At a time when the charge of ‘greenwashing’ for marketing purposes is topical, some sustainability-linked loans in public markets have been criticized for offering minimal discounts in reward for soft improvements.”

Data presents another challenge. Cécile Lévi, head of private debt at Tikehau Capital, says: “The main hurdle is measurement because you need to make sure that’s harmonized and there is some agreement on the way we report. That will take years, but maybe some accounting rules will come so that, like revenues and EBITDA, there will be harmonization on standards.”

However, she adds: “We consider these ESG ratchets will become market standard to the point where it should not be something you have to highlight and treat separately. They will become plain vanilla, and when that’s the case we will be where we should be.”

9. Climate disclosures

In an increasingly regulated environment, private funds grappling with ESG are subject to ever-greater calls for disclosure around their climate initiatives.

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) has gained traction in the private equity industry to improve and increase reporting of climate-related financial information and promote further insight into the risks and opportunities presented by rising temperatures, climate-related policy and emerging technologies.

The UK government, for one, has already publicly vocalized its goal to become the first country in the world to make TCFD-aligned disclosures mandatory across the economy by 2025, going beyond ‘comply or explain.’ It announced in late 2021 that UK-registered companies and financial institutions would need to start disclosing climate-related financial information from April 2022.

In a recent survey on responsible investment practices in private equity, PwC found that only 13 percent of respondent firms have structured an approach in line with the TCFD framework, although 36 percent said they are considering climate risk during their due diligence stage.

Bobby Turner, founder of Turner Impact Capital, says the creation of standards for reporting by third-party organizations has been a “good start.” However, he adds: “Part of the challenge is that a lot of the architects of these frameworks are academic in nature. They haven’t actually been on the frontline of delivering and implementing social or environmental change. They haven’t necessarily done the field work to create flexible and more accurate reporting.”

Turner would like to see industry frameworks consolidate where overlapping reporting requirements risk creating inefficiencies for investors and GPs.

10. Knowledge sharing

Knowledge sharing plays a significant role in improving investment performance. It is also essential when incorporating ESG measures.

With firms and lenders getting creative, there is a desire to share information on emerging practices. ESG is a “collaborative corner” of finance, as Megan Starr, head of impact at Carlyle Group, put it. Carlyle has secured about $12 billion of ESG-linked financing at both the asset and fund level; Starr recently had a call with fellow ESG head at a US private equity firm to walk through Carlyle’s approach to setting and negotiating KPIs.

There is competition as well as collaboration, Starr said, but “that is going to lead to better outcomes and environmental and social progress.”

EQT is another firm that has taken an early lead in this space. In June 2020, the firm secured an ESG-linked fund-level bridge facility with an upper limit of around €5 billion. BNP Paribas and SEB were the sustainability coordinators.

“We are very happy to be transparent about it and share our learnings,” said James Yu, a partner at the firm, responsible for the financing activities in the private equity and mid-market teams. “Our banks are asking us for permission to pitch other sponsors with what they have done with us… and we welcome that.”