As companies gradually become aware of the importance of a shift towards implementing ESG standards, the impact private debt funds can have on pushing industries towards a more sustainable future becomes clear. “Private debt has a greater ability to force companies to put in place sufficient reporting to give quality data to be able to analyse the potential impact on article 9 and produce quality information,” explains Philippe Lenges, partner private equity audit leader and private debt firm leader at Deloitte, who will speak at an LPEA event on on Thursday 23 February.

To access the loans needed, there will be “companies that are going to be involved in concrete projects that will have a goal or a positive impact in relation to ESG,” he says. This then would make “private debt particularly suitable for an article 9 fund,” or a “dark green” fund that has a sustainable investment objective, explains Marie-Laure Mounguia, a private equity and private debt partner at EY. Lenders will be able to apply pressure on businesses to invest in, for instance, renewable energies or social policies aligned with gender equality.

“You can really play on the interest rates that are applied by embedding ESG criteria. You could put a financial incentive on ESG objectives on which the borrower will really have an impact in their accounts,” says Mounguia. “The incentive is very strong in private debt and the impact is really direct. It works well on article 9, but it's more difficult on equity because there you have to go through mechanisms to remunerate the company's management.”

SFDR a tool for private debt

Timing plays in the favour of the private debt sector--which has continued to in Luxembourg--here too, as the Sustainable Finance Reporting Directive (SFDR), by pushing for more transparency, has been more heavily applied since the start of 2023.

“The SFDR is an opportunity for private debt to shine because of the transparency. That’s why we see this boom on articles 8 and 9 in private debt because they manage to set up the mechanisms very well,” says Mounguia. Lenges adds that “the advantage of private debt asset managers is that they have direct access to the companies and their information, and they can directly influence these companies to get it.” If companies are unwilling or unable to provide the necessary information on their projects, those managers can choose not to invest in it.

Data collection in private sector takes more effort

The issue--often mentioned in relation to the SFDR--will be the collection of sufficient and consistent data, the two experts underline. “We are not dealing with listed companies--they are private companies for which it is an additional effort to set up this reporting,” says Lenges. It is in companies’ interest, however, to invest in this--not only for financial reasons but also because alignments between lenders and borrowers now incorporate ESG objectives. 

The other is the definition of ESG criteria. Despite existing frameworks presented by different institutions, “everyone is free to define their own criteria,” acknowledges Mounguia. This flexibility can become a breeding ground for greenwashing, but “it is difficult to set up something that is truly tailored to each investment strategy. [ESG frameworks are] a bit of a double-edged sword: if you put in too strict a framework, you can risk excluding things that could have an impact.”

The EIF will present its best practices for ESG in private debt at a seminar organised by the Luxembourg Private Equity and Venture Capital Association on Thursday 23 February. Mounguia and Lenges, alongside panelists, will also explore market trends, data collection, the impact of lenders compared to shareholders on ESG, and further developing topics in the private debt sector.