Spotlight on responsible investment in private debt

The core concepts of responsible investment are the consideration of environmental, social and governance (ESG) factors in investment decisions and investor stewardship, alongside a commitment to both corporate and investor transparency.

Such concepts apply to all asset classes, but there are differences in the way practitioners implement responsible investment depending on whether they invest in public or private debt or equity, and in liquid or illiquid markets.

The theory and practice of ‘mainstream’ responsible investment and institutional investment in private debt have both matured during the decade since the financial crisis of 2007/8. However, little has been written about how investors can invest responsibly in private debt. This paper aims to promote better understanding of the rationale for responsible investment in the context of private debt investments. Through this work, the PRI aims to fill an industry knowledge gap by providing guidance and examples discussed with practitioners across various private debt strategies. This report will be complemented by the PRI’s upcoming industry guide for responsible investment in hedge funds.

The paper is based on desk research, interviews with 18 investors and industry stakeholders, and group discussions among PRI signatories (see contributors). Although the funds that participated in developing this report are all domiciled in Europe, the guidance is not specific to any particular region. Private debt professionals, including deal teams, portfolio managers, risk and compliance officers, and ESG functions working for asset owners, investment consultants and investment manager organisations, will find this report useful when considering the application of responsible investment in their investment processes. Relevant investor case studies can be found in the Appendix.

Key takeaways

The key concepts of responsible investment are complementary to private debt with its core focus on analysing and managing risk through relationships with investee entities.
There appears to be significant responsible investment activity among private debt managers and a desire to further develop best practice in the industry.
It seems that small business managers are willing to learn about the importance of ESG if investors are prepared to educate them, but this will not overcome the issue that small businesses will inevitably lack the resources to address all material ESG issues, meaning that investors will need to proactively address those issues.
Among the challenges identified by interviewees, perhaps the greatest is the lack of objective, consistent and timely publicly available data on private companies. However, this also presents an opportunity for those with a good understanding of how ESG issues relate to borrower creditworthiness. It remains to be seen whether an industry-wide solution will emerge.
Collaboration and information sharing between co-lenders and private equity sponsors will increase ESG transparency for borrowers.
We anticipate increasing investor demand for clauses relating to ESG in legal documentation, but the willingness of small businesses to accept such clauses will depend on broader market dynamics, including interest rates and competition from other investors and banks.

Tell us what you think

The PRI welcomes readers’ feedback on the content of this paper as we work towards building consensus among private debt investors on best practice responsible investment. Please contact [email protected] to share your thoughts.