LONDON, June 16 (LPC) - Carlyle-backed plastic packaging firm Logoplaste has amended a €570m leveraged loan financing, becoming the first environmental, social and governance-linked loan to test Europe’s institutional investor base.
The amendment to a €370m-equivalent term loan B, a €50m revolving credit facility and a €150m capex facility was announced on June 8. It will see margins going up or down, depending on the firm’s reduction of its carbon dioxide (Co2) emissions.
“It’s truly novel for institutional investors and the Single B market. Many of them have never had a sustainability-linked pricing discussion in their lending committee before,” a banker said.
It comes after another Carlyle-owned business, Jeanologia, Spanish maker of denim manufacturing equipment, last year linked the margin of its buyout loan to water savings. It was a club deal held by a handful of commercial banks.
“It was a commercial bank proposition in Jeanologia, but the sustainability-linked loan was tested with institutional market for the first time in Logoplaste,” the banker said.
In May 2019, Spanish telecom operator Masmovil became the first European issuer of leveraged debt to incorporate an ESG rating. However, unlike Logoplaste and Jeanologia, the ESG rating was only linked to a €250m revolving credit facility and capex line, rather than incorporating the term loan too.
ESG-linked loans enable companies to cut their borrowing costs by achieving pre-arranged ESG targets. Costs rise if they don’t.
While the practice has been widely used by investment-grade companies over the last few years, it is rare in the leveraged loan market, which generally has margin ratchets based on companies’ leverage ratios.
However, private equity firms have come under increasing pressure to adopt ESG measures from their investors, such as pension funds, and have recently started to consider putting ESG goals in the pricing structure of portfolio companies.
Since it is a new concept to the market and needs the support of investors, the ESG-linked margin ratchet on Logoplaste is relatively narrow at just 5bp-10bp.
“Logoplaste needed to be mindful on pricing as it was a proposal that will lead lenders and investors to suffer from a yield standpoint if the company hits the sustainability key performance indicator,” the banker said.
Some investors argue it’s not necessary for a company to bundle ESG goals into their pricing structure, as they should commit to them no matter what.
“It’s a bit of a mixed signal to link margin ratchets to actions the company should be doing anyway,” a CLO investor said.
However, a number of sponsors disagreed, saying borrowers are used to being incentivised by pricing.
“It’s how the traditional financing markets work around financial performance, where we incentivise companies to perform well financially. It’s the same for ESG goals, where we incentivise companies to do the ESG they should be doing,” said a global head of ESG at a private equity firm.
“ESG factors are material to a company. It’s increasingly an indicator of business strength and business resilience from a financial perspective.”
The leveraged loan market is trending towards ESG further and the market is ready for sponsors to use ESG goals to cut borrowing costs, credit analysts said.
Sponsors and investors are looking for more consistent metrics for measuring ESG, in a bid to see some sort of uniformity in the market, paving the way for more widespread use.
“As the market agrees on consistent metrics for measurement, we expect these to be part of the debt agreements and many firms will have such targets, with benefits for hitting or penalties if not,” said David Gillmor, sector lead, European leverage finance, S&P Global Ratings.
Bankers echoed the view, but warned timing was key on pushing sustainability-linked loans in the term loan B market.
With investors battling to manage their portfolios in the wake of the coronavirus pandemic, ESG is not at the forefront of lending for many at the moment.
“I believe investors are open to the new structure once things are back to normal. But for now, being able to deleverage is the focus for investors and it’s not the moment to try any new structure,” a second banker said.
ESG GOAL OR ESG SCORE?
In addition, there are mixed views on whether pricing should be linked to an ESG score provided by a third party, or a specific ESG goal, which could be a wide range of subjects including carbon emissions, fuel and water usage, employment, renewable energy, access to affordable energy, child labour, and the empowerment of women.
“It might be easy to focus on one goal, but we think all E, S and G factors are essential. A company could have a great improvement in the environment category, but do badly on corporate governance,” said a portfolio manager at one of the biggest European asset management firms.
“It’s more appropriate to use an overall ESG score that is measured by a third party.”
Masmovil’s ESG score is rated by S&P.
In July 2019, S&P gave the firm’s ESG score 67 out of 100, and it will give a 15bp margin reduction if the score improves, or margin increase if the score goes down.
However, some other investors think it’s not a one size fits all approach.
“It’s very company specific. Masmovil makes lot of sense for it to use an ESG score but it is not one model to fit all,” a second credit portfolio manager said. (Editing by Claire Ruckin and Christopher Mangham)