ESG focus rises on debt market agendas
Environmental, Social and Governance (ESG) is very much a topic of the moment in the finance market and is becoming increasingly prevalent in the debt markets. As social awareness and government regulation continues at pace, lenders are adapting themselves for a world in which economic success is not limited to financial returns and where high ESG standards will become the market norm.
lenders are challenging themselves on how they can make positive ESG changes
Lenders are no strangers to ESG considerations, which have featured heavily within credit and risk management for years. Driven by investors, as well as wider social awareness, lenders are challenging themselves on how they can make positive ESG changes through the businesses they support. A clear, well thought out strategy to implement these changes and provide benefits to borrowers is also being used as a differentiator by some lenders to actively encourage good ESG practice.
- Ratchets are provided as an incentive to improve rather than as an assessment of the borrower. This provides the opportunity for businesses that aren’t necessarily seen as ESG compliant today to benefit from these incentives by demonstrating the right behaviours
- Margin discounts typically range from 5-15bps and are based on pre-defined and bespoke, measurable KPIs
- These incentives are also not specifically focused on ‘green’ sectors but a broad range of sectors
- The ratchet mechanics and KPIs are individually agreed between the borrower and the lender. These can range from areas such as carbon footprint and sustainable processes, to staff training, employment diversity and social impact
- Extra reporting from the borrower is required to compile annual ESG reports to demonstrate improvement on the agreed metrics
debt markets recognise the need to adapt in order to capitalise on future opportunities
To date, ESG ratchets have been limited as lenders continue to balance this with their capital return requirements. Non-ESG eligible borrowers in the long run may need to pay higher margins to allow for more significant discounts to those who are ESG compliant. However, there is a clear direction of travel within ESG trends, and the debt market recognises the need to adapt in order to capitalise on future opportunities.
Clearwater International is regularly engaged with lenders and transactions with ESG features and can further discuss any of the above items.
