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.
- Private credit – an investment universe with assets of over USD 800 billion in 2019 – is gaining further traction from innovative investment solutions
- The diversification benefits of investing private debt are increasingly being complemented with ESG considerations as they play a growing role in assessing private credit projects
- While ESG risk assessment is not yet standard in private credit, BNP Paribas Asset Management’s proprietary methodologies can offer investors optimal downside risk protection
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).
Credit where credit is due
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.
Sustainability comes of age
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.
Sustainable investing and private credit
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.
ESG, private debt and the current environment
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.
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