As noted here, environmental, social and governance (ESG) factors are becoming increasingly relevant in financial markets and have impacted a range of financial instruments. The European leveraged finance market has always been sheltered from outside influences, but as investors, banks, sponsors and companies themselves are increasingly aware of and impacted by ESG, leveraged markets must react and adapt.
In the context of the European Green Deal and related sustainable finance initiatives, leveraged financial market participants have identified opportunities to integrate ESG into the documentation of high yield loans and bonds. For exemple :
- Due diligence: Initially, an assessment of ESG policies and procedures through early disclosure and due diligence exercises, discussions with management and road shows.
- Disclosure reporting: Issuer/borrower specific reporting on compliance with ESG policies and procedures, as well as potentially broader reporting requirements related to applicable legislation or bespoke Key Performance Indicators (KPIs).
- Pricing rewards: decrease in margin ratchet for favorable achievements and/or compliance with ESG measures or predetermined KPIs, coupled, in some cases, with corresponding margin increases for non-compliance.
The features described above are not necessarily innovative as such compared to traditional “green” or “sustainability-related” products – described in more detail here – but they do add an interesting and new twist to the finance market. leveraged, a world often historically caricatured as being solely driven by uncompromising economic performance at the expense of everything else.
There are clearly challenges with integrating ESG characteristics, particularly in finding the right balance between meaningful and measurable accountability. From an issuer/borrower’s perspective, avoiding trigger hairs is important, but from an investor’s/lender’s perspective, any ESG metrics need to be robust enough, especially if those market participants report themselves to their own investors or comply with regulatory obligations. Finally, it is important to ensure that any economic benefit resulting from ESG compliance does not lead to so-called “greenwashing”, giving the wrong impression about the sustainability or the environment of the performance of a company. an issuer/borrower. Investor demand for independent reporting and consistent application of ESG standards and frameworks, whether through rating agencies or otherwise, is expected to only increase.
Despite the many open questions and avenues to explore, given its wide sphere of influence and large number of market players, it is refreshing that the leveraged finance market is embracing ESG.
The Akin Gump team will work with industry players to track ESG in leveraged markets and is available to discuss.