New research provides recommendations for PRI signatories and other investors to take action on responsible investment in direct lending.

Nationwide - Today, the Principles for Responsible Investment (PRI) released “ESG incorporation in direct lending: a guide of private debt investors,” a new report on the growth of responsible investment practices in private debt investments.  

Building on PRI’s first report on private debt markets in 2019, this year’s report on how asset owners and managers are incorporating responsible investing into their private debt practices provides new analysis and actionable recommendations as both responsible investment practices and direct lending continue to grow. Private debt investors’ ownership rights differ from those in other asset classes, and this report finds that one tool unique to private debt has provided strong pathways for responsible investment: incentivization. 

“The private debt market has given rise to promising innovations, such as linking sustainability targets with interest rates, which provides a unique set of tools to encourage better sustainability outcomes,” said David Atkin, CEO of the PRI. “Innovation also brings risks, however, and investors must take care in how they structure these instruments. A failure to outline challenging targets or standardize practices may result in allegations of greenwashing - reporting must also be meaningful and subject to scrutiny and verification.” 

Through its evolution, PRI believes the private debt asset class is well-positioned for ESG integration. Asset owners and managers have long understood outcomes related to responsible investment to be material to their investments. As assets under management in funds with increasing uptake of ESG integration practices have grown rapidly worldwide, key markets have stepped up regulation and there have been two crucial Conferences of the Parties on climate and biodiversity. “The collection of ESG data has become widespread especially for due diligence purposes. Like other asset classes, however, integration with direct lending still has room to grow. The report is focused around three key themes: (1) improvements to ESG data, (2) engagement and sustainability-linked loans, and (3) climate risks and targets. 

“The key themes in the report emphasize that private lenders, sponsors and portfolio companies are critical collaborators in the effort of ESG integration in private debt,” said Adam Heltzer, Chair, PRI Private Debt Advisory Committee and Head of ESG at Ares Management Corporation. “In this effort, management teams of small- and medium-sized companies are increasingly looking to their private lenders to help accelerate the maturity of their company’s sustainability programs with a key focus on integration into business strategy. Together, these components have the potential to enhance value creation, better enable risk mitigation and achieve sustainability outcomes.”  

The report includes recommendations for what actions signatories can take in response to the findings from the report. These suggestions include creating standardized ESG clauses in loan documents, formulating methods for consistent KPIs and incentives, developing a portfolio-wide climate change response, and actively supporting the standardization of data collection and monitoring of borrowers. 

Private debt AUM has nearly quintupled since 2008, currently standing close to $1.4T with an anticipated compound annual growth rate of 11% through 2027. Private debt managers will continue to be a vital source of capital for key segments of the economy in the years ahead.