Embedding environmental, social and governance (ESG) criteria within private credit investment processes can reduce downside risk and open up a range of thematic opportunities, BNP Paribas Asset Management’s Sustainability in private debt investing briefing paper explains.
Institutional investors such as insurance companies and large defined benefit (DB) and defined contribution (DC) pension funds, where scale and long-term time horizons allow, are focusing more and more on private credit as long-term bank lending has shrunk under growing regulatory pressure.
The private credit investment universe is diverse. It encompasses investment-grade senior private debt such as infrastructure and commercial real estate loans through to sub-investment grade corporate lending, for example, to small and medium-sized enterprises (SMEs).
This breadth creates diversification benefits, as does optionality across the capital spectrum (e.g. fixed versus floating rate, senior or mezzanine transactions) and the geographical and currency exposures that result from investing in global portfolios.
BNP Paribas Asset Management (BNPP AM) has broad-based, worldwide expertise in originating and managing private debt transactions for institutional investors. A benefit of partnering with BNPP AM is access to a unique dual origination engine that couples the expertise of investment teams with the resources of the wider, A+ rated, BNP Paribas Group.
One feature of the institutional market has been the rise and evolution of sustainable investing and the growing momentum for embedding ESG considerations into investment decisions, thus fostering more active asset ownership.
BNPP AM was a founding signatory to the UN PRI in 2006, implemented the UN Global Compact Principles and sector policies of the BNP Paribas Group in 2012. We signed the Montreal Carbon pledge to align portfolios with the Paris agreement in 2018 and launched an extensive Global Sustainability Strategy in 2019.
This strategy, like that of the wider BNP Paribas Group, identified three themes
These are priority areas in our ESG-compliant investment processes and product innovation.
Sustainability activities are coordinated by our Sustainability Centre, which is responsible for ensuring ESG risks are embedded into all the investment teams’ investment processes.
While ESG risks have increasingly been embraced in listed markets, their take-up in private markets, particularly private debt, is not as widespread.
Part of the challenge is that the underlying asset classes are highly diversified, which makes it difficult to apply a standardised process. With SMEs for example, loan sizes tend to be smaller, CSR policies tend to be absent, board diversity is often irrelevant and data is often unavailable. This means customised processes are needed to ensure a meaningful management of ESG risks.
When BNPP AM’s Global Sustainability Strategy was launched, there were no ESG standards to speak of relevant to private credit. So our Sustainability Centre has developed methodologies using proprietary tools to identify the key risks associated with each asset class, promote ESG practices and transparency, and support the key themes that underpin our overall strategy. These methods are described in more detail in our latest briefing paper.
Even after each private debt transaction has been vetted and sanctioned, BNPP AM’s investment team and Sustainability Centre continue to monitor the financial metrics and ESG characteristics of the transaction to manage the credit risk and ensure continued compliance with ESG policy.
After an inevitable pause this year due to COVID 19-led market turmoil, we believe opportunities will arise for institutional investors prepared to take a long-term view.
Within private credit, BNPP AM favours diversified portfolios flexible enough to be able to capture these opportunities, while managing ESG risks.
As with listed markets, we believe the incorporation of an ESG assessment can lower downside risk and allow investors to invest in the structural themes linked to climate change, energy transition, the environment and inclusive growth.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
 Source: Standard & Poor’s – 5 April 2019
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