One of the challenges of sustainable debt is that debtholders traditionally have less influence on corporate behaviour than equity investors. The private debt space has a bigger lever, and while applying a sustainability lens to private businesses is not always an easy task specialist investors say it is a worthwhile one.

Ares Asset Management and Metrics Credit Partners are among the private debt lenders that believe their sustainability credentials can drive corporate environmental, social and governance (ESG) performance. This is drawing attention from asset allocators.

“A lot of our institutional investor clients want to work with us in relation to our capacity to originate transaction opportunities that can be structured to allow ESG criteria to be met more effectively,” says Andrew Lockhart, managing partner at Metrics in Sydney.

He continues: “Institutional investors can buy a green bond or the like. But our ability to have real impact comes from our capacity to originate transactions directly, including negotiating terms and conditions. It is quite a different market opportunity.”

Meanwhile, Ares arranged its first sustainability-linked loan (SLL) in March – to British private equity company Livingbridge. This A$280 million (US$209.4 million) deal supported the acquisition of Australian waste management company Waste Services Group.

Adam Heltzer, head of ESG at Ares in New York, says credit is no longer a de-emphasised asset class in the overall sustainability investment story. “There is more to sustainability than just the screening processes – there is an opportunity for direct lending to be formative,” he explains. “We are often the largest, most prominent lender in a transaction – our relationship with a borrower and sponsor can be much more additive and in-depth, which can create more space for engagement.”

Ares is one of the world’s largest direct lenders, with US$306 billion in assets under management and a direct lending book of A$200 billion. In August 2021, the company completed the largest ever private credit-backed SLL – a £1 billion (US$1.3 billion) debt facility to British sustainable engineering company RSK.

“We learned a lot through the RSK process and began investigating ways to scale the effort elsewhere, including Australia,” Heltzer adds.

Lenders like Ares and Metrics can build ESG objectives into the terms of a loan, starting conversations with borrowers and private equity sponsors about goals most closely tied to the risk profile of each company.

Due diligence on private credit deals for buyouts of unlisted companies is challenging, as these entities typically do not have the same culture of reporting financial data as listed organisations.

Charlotte Plaisant Millecamps, director, sustainable capital markets at Westpac Institutional Bank, says the bank is investigating ways to support smaller companies’ ESG goals. “One of the challenges is that they may not have the same internal resources or a large sustainability team – they may not be reporting on anything and there is no obligation to do it,” she explains. “The issue is always transparency – they are not releasing annual reports. We have to get to grips with what they are comfortable releasing externally in a sustainability report.”

Heltzer agrees that smaller and unlisted companies can be challenging to work with given portfolio company resource constraints – but formalising an ESG framework is an important first step. He adds that many companies have ESG practices in place but have not formalised them within a framework. Ares is keen to assist with this process.

“Mid-market companies often scale and professionalise core functions across key business areas, and ESG is no exception,” he explains. “Part of our vision is to be a catalyst for these companies as they think about progressing with sustainability. We can do so in a scaled way. We know the frameworks, service providers, metrics and disclosures.”

Lockhart has a similar view. He tells KangaNews Sustainable Finance: “We are prepared to have conversations with borrowers about ESG-related matters and how we can work together to improve performance.”