There have been a number of high-profile ESG-linked subscription finance facilities put in place over the past few years, and these include a €2.3 billion line adopted by EQT in 2020 and a $4.1 billion line adopted by Carlyle last year, which was specifically linked to progress in levels of board diversity at underlying portfolio companies.

But how much impact do these loans really have on the fund finance market and how much are they affecting the environmental and social challenges they’re ostensibly designed to address?

“There are real consequences to not meeting the ESG criteria,” says Tom Smith, partner at Debevoise & Plimpton, which acted on the EQT deal. “If the tests are satisfied, there is a margin benefit, and if they are not met, there may potentially be a margin penalty. It is a mechanism that can change attitudes and actions within the private equity community.”
Carolina Espinal, managing director at HarbourVest Partners, meanwhile, believes ESG-linked facilities could be viewed as particularly attractive in a higher interest rate environment.

“ESG-linked facilities provide the opportunity for a discount on rates if agreed upon metrics are reached. In a higher interest rate environment that could prove very appealing,” she says. “It is an exciting innovation in the credit markets and there is plenty of room for this space to develop.”

Others, however, are more circumspect. “I think there is an element of greenwashing that goes into these facilities,” says Steve Darrington, CFO at Phoenix Equity Partners. “I don’t think they are going to have any significant ESG impact, although they are, of course, a step in the right direction.”

“Our conversations with clients seem to indicate that the jury is still out, in terms of the benefit of these facilities,” adds Khizer Ahmed, founder of Hedgewood Capital Partners. “There have been some notable, high-profile transactions in this space recently and we are watching developments closely to ascertain definitively whether these are genuinely differentiated offerings, or if they are merely designed to benefit from the ESG label.”

Jonathan Harvey, Investec Fund Solutions’ head of relationship management, believes the margin reductions on offer are insufficient to drive widespread adoption. “Hitting ESG targets is a good marketing tool when fundraising, but these ESG-linked loans offer very little economic benefit. There is an average margin reduction of 5 to 10 bps, and typically at the lower end of that spectrum. Furthermore, any reduction the GP does receive will usually have to be recycled into carbon credits rather than going into their pocket,” he says.

If we see regulatory change, whereby ESG-compliant loans enable banks to hold less capital, however, that could be a gamechanger. “That would lead to bigger margin reductions,” says Harvey. “But without that, the risk to the lender is the same and the amount of capital that the bank has to hold is the same, so there is very little economic compulsion for GPs to sign up.”