May 31, 2023 - Among the many topics covered at the LSTA/Deal Catalyst Annual CLO Conference was a look at ESG Considerations for CLO Managers and Investors. Given the amorphous nature of “ESG” the panelists started the session with a basic level set – what does ESG mean for credit markets? ESG offers a coherent label for certain environmental, social and governance inputs into the credit underwriting process. Looking at established standards through a credit lens, certain inputs are determined to be financially material and relevant to investment decisions. Although sometimes mislabeled “ESG integration”, impact investing where an investor is looking to achieve a positive outcome or mitigate a negative outcome through its investment decisions is an entirely different kettle of fish. Panelists all agreed that the primary ESG driver are investors – and those investors are growing in the sophistication of their requests.
Where financially material ESG factors inform investment decisions it is critical that managers develop frameworks that offer a consistent approach with clear definitions that is made transparent and explainable to investors as well as internal investment teams. Many managers have adopted proprietary frameworks for assessing credits on ESG factors and while these are most often tied to established standards those frameworks still differ. What need not differ however is the ESG information feeding in to them. After identifying the lack of useful, comparable ESG information as the greatest challenge in the market today, the panel offered that the recently launched ESG Integrated Disclosure Project seeks to address that problem by establishing a global baseline of ESG information on private companies. The ESG IDP has developed a template which offers a standardized approach to requesting and receiving ESG information from borrowers. Use of the Template preserves the private nature of borrower information – information is still shared only with prospective lenders – while offering an efficient method of communicating information with lenders. Highly aligned with information sponsors are gathering on their portfolio companies to bring further efficiency, the Template could be seen as the “common application” of ESG reporting. Panelists shared that market reaction has been very positive with borrower interest being seen in a range of transactions from BSL to private credit, and even middle market borrowers. These are just green shoots but the tool now exists for market stakeholders to advance ESG data availability.
And the time is certainly now – regulatory reporting requirements for asset managers are in place through the EU’s SFDR with similar rules expected in the UK. The SEC’s proposed ESG disclosure rule looks at funds and managers in a similar way. To maintain access to the widest pool of investors, the use of negative screens has become the rule rather than the exception. These screens are driven by investor request, but the use of negative screens -without any ESG-related objective – means that the vehicle/fund is an Article 8 fund with mandatory ESG reporting. On the flip side European investors are drawn to Article 8-compliant investments so it is clear that managers will both want and need to satisfy reporting requirements. By the same token, ESG is not for everyone. Managers noted the importance of having different flavors of offerings including non-ESG investment options to satisfy U.S. investors and in light of certain state statutes.