ESG in private credit: A key differentiator?

4 min read 22 Sep 23

Although ESG integration is still relatively nascent in the private debt sphere, advances are being made as lenders take into account the long-term risks entailed with debt issuance.

The proportion of European assets under management with ESG considerations is advancing at pace – rising to nearly 60% of total funds in the last two years, as defined by Article 8 and 9 under the Sustainable Finance Disclosure Regulation1.

ESG integration in private debt overall, however, is still relatively nascent – but regulatory and investor demand has seen it become a key priority for the sector.

Considering ESG risks

E, S & G pillars are still fundamentally risk factors. When marketing ESG bonds or sustainable linked facilities, there may be ESG margin ratchets included within the documents, but they are not always significant and at times only swing in one direction. When integrating ESG in private credit, we believe bottom up credit picking and crucially company and owner engagement is what will be the differentiator.

As ESG risk factors tend to emerge over the longer term, for long term lenders, they can be key credit determinants. When lending to businesses, it is crucial to consider the risks that may have a detrimental impact over time – whether they be related to environment, governance or social issues – as these could affect a company’s ability to repay its debt.

"As ESG risk factors tend to emerge over the longer term, they can be key credit determinants."

Building a constructive relationship between business owner and debt provider can help to protect the value of the debt (and equity). This was observed through the COVID-19 pandemic, where support led to relatively low default rates by the end of 2020 despite the high levels of stress seen.

The data challenge

According to the European Leveraged Finance Association, implementing ESG considerations in private debt deals could bring ample opportunities, but the organisation also highlights how challenges remain. Not unique to private credit, obtaining reliable ESG data is one such challenge. Mid-market borrowers, in particular, may typically lack historical ESG data as these are smaller firms who often do not have dedicated ESG resources.

This is where proprietary research may prove pivotal when analysing potential borrower risks through an ESG lens. However, there is also emerging change for smaller firms as social enterprise organisations such as B-Corp in Europe, which verify high standards of social and environmental performance, transparency, and accountability, have the highest take up in smaller firms.

The good news for the large-cap European leveraged finance market, on the other hand, is that the raw materials with which to judge a company’s ESG risk management credentials – and sustainability intent –  are growing fast. For example, since 2021, we have seen company disclosure of carbon data improve from c.30% to c.70% and continue to develop2.

Engaging with borrowers on sustainability?

A large portion of private credit involves origination such as direct lending, private placements and infrastructure deals. When structuring these deals, lenders have no or limited voting rights compared to equity holders. However, as the sole or small club of lenders, there are soft powers at play and hence a strong access to engage with borrowers on ESG matters, as well as all other management or credit issues. This is a key benefit of private credit. The idea that engagement for debt providers is difficult has become a popular narrative and can be true in large listed deals. However, regular two-way interaction with borrowers is the norm for private credit. This close relationship can enable better monitoring, better transparency and lead to real-time understanding of borrowers’ performance, which in turn feeds better credit value assessment and ultimately better outcomes for investors.

1Morningstar, “SFDR article 8 and article 9 funds: Q1 2023 in review”, (, 4 May 2023.
2M&G, Findox, 2023.

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.

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