NEW YORK, March 16 (LPC) - US Collateralized Loan Obligation (CLO) managers are increasingly looking to issue funds with socially responsible principles that reflect their firm’s values as well as those of their investors, while still offering competitive returns.
Partners Group raised a US$409.5m US CLO last month with Morgan Stanley that includes several Environmental, Social and Governance (ESG) considerations, an area that is slowly gaining prominence in the US credit markets.
“We follow our own ESG guidelines in how we invest…and this language emphasizes the ESG standards we have put in place,” said Andrew Bellis, head of liquid loans at Partners Group, which includes the US and European CLO businesses. “We are just trying to formalize the documentation and take a consistent approach across deals.”
As pension funds and endowments become more focused on socially responsible investing, asset managers and banks have sought to limit their activities within specific sectors, including gun makers and fossil fuels. A robust ESG platform can be attractive to many funds that have specific sustainable investment requirements.
There was a record US$58.7bn of ESG loans arranged globally in the fourth quarter, up 307% from the same period in 2018, according to Refinitiv LPC data. In the first two months of 2020, there has been US$20.4bn of ESG loans issued.
“I expect to see an increase in investment restrictions or some other way ESG becomes a factor in CLOs because investors have their own set of principles or guidance when they make investments,” said Lana Deharveng, a vice president at Moody’s Investors Service.
Only a handful of US CLOs has included investment restrictions in recent years. Still, there are different managers that have started to include restrictions in the eligibility criteria, usually driven by investor requests, she said.
European CLOs have been quicker to include ESG language than US funds.
“It is not as prevalent in the US as it is in the EU,” said Yu Sun, a senior vice president at Moody’s. “But ESG is becoming a more popular trend – either as a firmwide initiative to emphasize ESG or a request coming from the investor side. Even though we haven’t seen many US CLOs with ESG language in the document, it’s an upward trend.”
Although restrictions on the pool of CLO-eligible collateral has the potential to be credit negative, the funds’ limited exposure to the industries subject to ESG restrictions largely mitigates the risk, the ratings firm said in an August 2019 report.
“In the short term supply and demand balance, ESG could put pressure on CLO asset selection and diversification, but in the long term, it could improve CLO credit profiles given the focus on ESG in the market,” Deharveng said. “CLOs will continue to be well-diversified as well as more ESG friendly.”
Partners’ Pikes Peak CLO 5 that priced in February may not purchase assets issued by a company where it or its affiliates receive more than 50% of its revenue from the extraction of oil and gas – including tar sands and arctic drilling – thermal coal mining or the generation of electricity using coal, according to a February 14 presale report from Moody’s.
The fund has similar restrictions on loans made to companies that produce or trade “controversial” weapons, components, or services designed for military purposes, pornography or prostitution, tobacco or tobacco products, ozone-depleting substances, or endangered or protected wildlife, according to the report. There are also limitations on companies that provide services related to gambling or payday lending.
“To date, US CLOs have not typically incorporated this ESG-related provision,” Moody’s analysts wrote in the presale report.
Partners Group included similar ESG language in its European CLO, Penta 7, according to Bellis, and some ESG guidelines in its Pikes Peak CLO 4, which priced in 2019. The language is broadly consistent between the firm’s European and US platforms.
“We have an ESG policy, and we follow it – this is not a one-off action to raise a CLO – this is how we invest across our liquid loan business,” Bellis said. (Reporting by Kristen Haunss; Editing by Michelle Sierra)