ING, the Dutch banking group, has become the latest private equity market participant to embrace sustainable investing. The lender this week closed what it claims is the world’s first capital call facility with an interest rate linked to sustainability performance.
The loans will operate as a carrot and a stick, slashing interest rates if sustainability targets are met and carrying penalties if not. The concept is potentially applicable to other asset classes and, with impact investing on a tear, these facilities could become a familiar sight.
So how do these loans work? Sister publication Private Equity International caught up with Fi Dinh, a Singapore-based director who led ING’s first transaction in this area, to discuss fund terms, interest rate calculations and ESG targets.
How does this type of loan fit into the LPA?
The limited partnership agreement tends to have the framework around the actual loan itself, for example so whether investor capital can be pledged as a security, how the loan can be used and whether there’s clean down, and so on. This type of facility is just an overlay on what is a subscription credit facility in order to encourage ESG-improvement and responsible investment.
Typically, the company will already have an ESG framework and those frameworks might not be contained in the LPA, but rather the private placement memorandum or other investor communication, which is why the [ESG] facility does not need any significant amendment of the LPA.
How is the interest rate adjusted?
There are two main elements to the interest rate: the base rate, such as LIBOR or Euribor, and then the interest margin on top of that. One reflects the cost of funding, and the other is what the bank charges on that type of facility.
The concept of varying the margin is not new; for example, multi-currency facilities have to take into account different costs of borrowing and will set margins to promote the use of certain currencies. A bank might set a cheaper borrowing price for Australian dollars to encourage funds to draw more Australian dollar loans under that revolving credit facility.
The interest rate discount is not ratcheted because it’s applied at portfolio level with complex underpinning metrics, so it doesn’t make sense to then break it down at the output level. It’s a meaningful change so that we’ve put a structure in place that works for the firm and that also helps the investors to see the value in it.
Within this sort of facility there will be a penalty if certain targets are not met, but there are different types of penalty and we’ll be constantly assessing whether it’s a blip or a systemic certain issue.
What factors go into deciding the ESG targets?
We spend a lot of time talking to the company about the target set to ensure that it’s ambitious but also achievable. We have a very intensive dialogue with the company, the investment teams and the asset portfolio management teams, so they have to buy in all the way through.
A combination of internal framework and an external sector-based impact analysis goes together into the proposal before we have a dialogue with the company. We’re looking at a portfolio-level scorecard, not individual portfolio company targets, so in a fund that’s constantly investing, it’s going to be a dynamic structure.
Fi Dinh is director, APAC fund finance and insurance sector finance at ING, based in Singapore.