The UN's 17 Sustainable Development Goals (SDGs) are rapidly becoming the equivalent of a household name in the investment world. As a result, more and more asset managers are offering products that link to the goals; strategies that offer environmental and societal impact while delivering financial returns. Although most of this activity is taking place in the public equity and bond markets, at NN Investment Partners (NN IP), we believe that private debt can also play a significant role when it comes to contributing to a more sustainable economy and prosperous society.
The term private debt simply reflects any debt investments that are made in private and not traded publicly. Examples of segments in this broad and rapidly growing asset class are corporate loans, infrastructure and project finance debt, commercial real estate loans and residential mortgages. Investing in private debt requires close monitoring and careful asset management, which ensures that investors can effectively use your voting and step-in rights to engage with the borrower when needed. This long-term commitment and buy-and-hold philosophy of private debt goes hand in hand with the long-term goals of contributing to a more sustainable economy and prosperous society.
In fact, environmental, social and governance (ESG) considerations increasingly form a key part of the due diligence process and finance documentation of private debt projects, with the inclusion of specific information covenants and KPIs focusing on a more sustainable economy and prosperous society. Already back in 2003, the Equator Principles (EPs), were established primarily to help determine, assess and manage environmental and social risk for an important part of private debt, namely in global infrastructure and project finance transactions. They have since become an internationally recognised benchmark, aiming to reduce and where possible avoid any negative impact on the environment and society through the projects they finance.
SDGs - guidance for investors
Private debt generally invests more directly in the real economy than public debt. This is because it funds concrete acquisitions, projects and assets, aligning it well with the 17 SDGs. According to the Business and Sustainable Development Commission, achieving the SDGs (due in 2030) opens up around USD 12 trillion of market opportunities in four economic systems: food and agriculture, cities, energy and materials, health and well-being. These, in turn, represent about 60 percent of the real economy. The most obvious example obviously is the high-profile carbon emissions reduction in renewable power generation, which has always been a core part of infrastructure and project finance debt.
However, there is more than renewable energy. The table below shows NN IP's SDG infrastructure breakdown and illustrates the breadth of potential investment themes which include projects in transportation, healthcare and education, for example. The advantage of such investments is that they have specific objectives and generally provide greater transparency on the use of the investment proceeds.
Source: UN Sustainable Development Goals, NN Investment Partners, October 2018
The SDGs represent an important set of goals and can also act as a useful tool or guide in different parts of an institutional client's investment process. In the very early stages, they can help define what matters most to a pension fund, insurer or any other type of investor and are often adopted in investment policies. In this way, they can also help guide the asset allocation, for example, by considering Green Loans that contribute to SDG 7 - Clean and Affordable Energy, or infrastructure and project finance debt assets that contribute to SDG 9 - Industry, Innovation and Infrastructure. At the other end of the spectrum, the SDGs can play an important role in reporting, where investments are linked to the SDGs. This creates a feedback loop enabling investors to see whether their holdings "match" the SDGs within their initial investment policy.
ESG data availability and reporting
The nature of private debt means there is generally less public information available since most information is provided under strict confidentiality arrangements. This also holds true for ESG data as the companies or entities that issue private debt are not usually covered by Sustainalytics, MSCI or other data vendors. This means investors have to do their own homework to determine what aspects are important in the underlying asset class and, more specifically, the sector in which the borrowing entity operates.
There are few commonly accepted standards on ESG/SDG data and reporting in private debt at the moment. Nevertheless, a lot of work is being undertaken to compare both in-house and external sustainable and impact strategies and to learn from best practice. Furthermore, initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, the recently published EU taxonomy for sustainable activities and industry-led developments such as the global real estate sustainability benchmark (GRESB) infrastructure assessment, are useful and we closely monitor and support all such developments. Overall, the strong governance and tailor-made documentation that are features of typical private debt transactions give investors increased transparency on a financial and impact level, while the longer-term investment focus and ring-fenced nature of real assets makes it easier to assess them and report on the degree of impact.
Alistair Perkins is head of Infrastructure & Project Finance at NN Investment Partners