It is no surprise, then, that 90 per cent of responses to the CBA-KangaNews survey report that their firm integrates ESG into the overall credit process as opposed to having a separate ESG function. This ranks well ahead even of negative screening (see chart 5).

“ESG is part of our risk assessment, and credit analysis is a risk-assessment exercise,” Scully explains. “Any ESG topic that is relevant to a particular individual credit will – if we think it is a risk to the success of our investment – be something we look to mitigate. This might be through documentation or advocacy for changed business practices, but it is an integral part of making sure that everything we do makes sense in a risk-adjusted manner.”

Two-thirds of surveyed private-debt investors report using negative screens, and while this is the second-most used ESG approach, it significantly lags the equivalent result from the CBA-KangaNews survey of mainstream Australian fixed-income investors. Negative screening was ubiquitous in the earlier survey, being deployed by 97 per cent of responding investors.

At the private-debt roundtable, investors suggested the heterogenous nature of their asset class makes uniform ESG overlays less useful. This also explains why most ESG approaches do not produce a red-line outcome for investment decisions.

Sahota explains: “As a very bespoke asset class, private debt takes in a range of industries and businesses. This means we can’t have a single checklist that applies to all deals. Our ESG view can have an impact on a deal’s economics but we are also advocates of greater reporting and information provision.”

Scully adds: “We have negative screening that rules out industries we think have inherent ESG risk that cannot possibly be mitigated, as well as placing limits on those that have higher levels of ESG risk as the norm. Then we have our own policy and procedure on credit modelling across corporate and structured credit. This is really a qualitative process, though we would love to generate a quantitative outcome over time.”

Further illustrating the degree to which ESG considerations are part of the business-as-usual environment in the private-debt space, nearly 90 per cent of respondents to the CBA-KangaNews survey say ESG has a “significant” or “somewhat” of an influence on investment decisions – including 40 per cent at significant level (see chart 6).

While the impact may be significant it is rarely as straightforward as a simple red or green light to buy. The fact that private-debt investors can negotiate with borrowers on sustainability strategy and the trajectory of their environmental performance means there can be more impact than a pure negative-screen-led ESG approach. Investors suggest this is often more art than science, however.

Robinson comments: “Even when we are looking at something like cutting thermal coal, the question becomes really difficult when it is not 60 per cent of a business’s revenue but 10 or 15 per cent of revenue and declining. In this case, we would look at the trajectory of this component of revenue. We would rate this type of business as at least a medium environmental risk, but we would be willing to engage with its management team about what it believes to be the direction of the business.”

Angus St John, Sydney-based global head of investor client management at CBA, adds: “It is clear that ESG, as a whole, is baked into investors’ decision-making process. We are still getting to grips with whether there are consistent criteria across E, S and G, or whether it is more ad hoc – including on a credit-by-credit basis.”

There is also some doubt about the idea of using debt financing explicitly to fund borrowers’ environmental transition, based on the fundamental role of debt as a stable part of the capital structure. There is significant interest in the concept but it has yet to garner universal support – and some private-debt investors do not believe transition is an appropriate use of debt financing for risk reasons (see box).

On the other hand, the process of certifying a security can, and often does, add to ESG transparency and improves investor response to the borrower, according to Charles Davis, managing director and head of sustainable finance and ESG at CBA in Sydney. The survey suggests this is increasingly becoming a component of the conversation between companies and their debt investors on sustainability rather than its end point, though.

“As the UOP market started to develop, there was a lot of focus on specific debt instruments, such as green bonds, and maybe not as much focus at the overall borrower level,” Davis adds. “Entity-level assessment certainly seems to be absolutely front of mind nowadays, before an assessment of the debt instrument takes place. We hear it across the public and private side, which shows how the market is maturing in its thinking.”

Cunningham adds: “Some of the ongoing reports that come out of the deal certification process will be really important and indeed I wouldn’t be surprised if we start seeing more of a lens turned on these over the next couple of years. The market in general will start holding companies to account over whether they have or have not achieved the goals they set themselves.”

More than a third of private-debt investors already require detailed impact reporting from borrowers, while only 20 per cent require nothing beyond standard reporting (see chart 9). Meanwhile, although issuer reporting – standard and ESG-specific – is the most-used source of sustainability data, more than three-quarters of private-debt investors say their in-house analysis is key (see chart 10).

This should not come as a surprise, as Nicole Kidd, Sydney-based head of private debt, Australia at Schroders, explains. “I have heard it said that relying on third parties for data is like wearing someone else’s glasses – it is really difficult to get a clear picture. Creating tools internally allows for a very holistic and consistent view, right across our business and throughout the world, as well as access to information from an amazing amount of data sources.”

The scale and depth of in-house analysis used by private-debt investors is extensive. Kidd continues: “The criteria we use to assess businesses from an ESG lens is vastly more thorough than I was used to from my background in investment banking – and it is evolving all the time. How we look at a company today is probably not going to be how we look at it in 12 months.”

The theme of rapid evolution comes up again and again in the private-debt space, and its investors clearly anticipate poor ESG performers having to pay a material capital premium. More than half the respondents to the CBA-KangaNews private-debt survey say this is already the case and all respondents predict this outcome within 3-5 years (see chart 11).

As Scully points out: “It may be a liquidity-rich world, but I believe companies deemed poor ESG performers are already finding their available liquidity reducing. Institutional and individual investors constantly expect more influence over where their capital is allocated, to ensure its use aligns with their beliefs and values.”