For many years now Anthesis has been supporting our general partner (GP) clients by undertaking ESG due diligence and then on acquisition, assisting with their onboarding programs. Over time, we have seen the ambition around those onboarding programs grow. Originally, this exercise comprised a simple introduction to the client’s standard ESG KPIs, and a high-level health check to ensure that the Portfolio Company’s (PC) key ESG aspects were being managed. But today, more and more of our clients are seeking to ensure that their PCs have meaningful ESG strategies in place from the outset of their investment period.
Trends in ESG loans
Over recent months, we have seen a new and compelling driver emerge in this process. Uptake of ESG or sustainability-linked loans and related products, at or relatively soon after acquisition, is becoming more commonplace, especially in Europe. As the name suggests, such products link to demonstrable ESG improvements at the borrower, in exchange for which the business can seek to benefit from a reduced cost of borrowing. ESG improvements can be at the company level or at a project level or focus on specific KPIs identified by the company. The metrics chosen must be meaningful (in that they are core to the borrower’s business) and the improvements also then need to be ambitious and transparently calculated.
Sustainability performance indicators
The starting point for such a process is a baselining of the borrower’s current ESG performance to allow agreement to be made on the topics that will become the KPIs. In the language of the Sustainable Linked Loan Principles, the Sustainable Performance Targets will be the ESG improvement basis of the loan agreement. Typically, this is a small number of agreed targets (around two-thirds of all SLL contracts have only 1 or 2 metrics), with a greenhouse gas emissions reduction target being the most common KPI, followed in second place by a broader performance metric associated with achieving an improvement in an ESG score or rating. To be ambitious, unless going for a standard high bar target such as setting a Science Based Target or similar (often far too big a leap for many PCs), KPIs really do need to be bespoke, designed with an understanding of the situation at the borrower.
Driving financial sustainability through performance targets
GPs who commission ESG due diligence and then post acquisition ESG onboarding processes do so to manage risk and look to enhance value by improving ESG performance during the ownership period. In addition, now they are at an advantage in preparing their PCs to be able to move quickly ahead to exploit such financing options. Increasingly, clients are asking Anthesis which might be the right Sustainable Performance Targets pre-acquisition as part of our due diligence advice, as having that foresight when entering discussions with a lender puts the borrower in a driving position. The formal onboarding process can then be used to fine tune the detail.
This process is also making lenders a more important stakeholder in the discussion as to what should be the standard KPIs that GP’s ask their PCs to report on. In Europe, we have had many requests over the last year to ensure that KPIs align with the EU Sustainable Finance Disclosure Regulations (SFDR), such that GPs can be prepared to make their own disclosures under that regulation and that data meets their LP’s and other stakeholders’ requirements. Into this mix has arrived the Data Convergence Project and its suite of metrics. Generally overlapping with those of the SFDR’s Principle Adverse Impact Areas, we have seen a stronger specific ask from lenders, especially in North America, for these data points to be included in the ask of borrower PCs.
This blog was authored by Tim Clare, Director & Global Lead for Transactions and Sustainable Finance, and Mike Jennings, Director of Sustainable Finance.
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