The Integration of ESG in Private Debt Funds: ESG in the Private Debt Sector of North-western Europe: Examining the Integration of ESG and the Subsequent Effect on Investment Decisions

Emilie Juel

Student thesis: Master thesis

Abstract

With the planet facing unprecedented environmental challenges, social inequality, and governmental issues, financial institutions and regulators are rethinking traditional investment schemes and recognizing the potential of investments driven by sustainability. However, the unique characteristics of the private debt asset class, relative to more tangible asset classes, has caused a slow and turbulent progress of integrating ESG standards in their investment processes. Academic research on the intercept of ESG integration and private debt funds is very scarce. As a result, researchers have not been able to portray how ESG is being integrated into the investment practices of private debt funds.
By using descriptive statistics and in-depth qualitative data as a research strategy, this thesis examines how ESG is integrated into the investment process of private debt funds in North-western Europe and what effect ESG findings has on the investment decision. The empirical data behind this research consists of 11 interviews with North-western European private debt managers and a questionnaire with responses from 48 private debt managers in North-western European. Furthermore, private debt specialist at UN PRI, Jonathan Jones, was interviewed to add additional nuances to the discussion.
The thesis demonstrates a current absence of a unified perception of ESG amongst the private debt firms in North-western Europe, and ESG is therefore handled in a plethora of ways. The findings show that roughly 15% of private debt managers lack an established ESG policy, with most managers having established one in the last two years, indicating a trend of making ESG a more integral part of the investment process. The research also showed that private debt funds utilize known ESG frameworks such as the UN PRI, GRI, and SFDR to guide investment decisions. However, the degree of ESG commitment varies significantly and managers use varying approaches to manage ESG. While negative screening remains the most prominent approach, an increasing number of managers are implementing internal rating frameworks, impact investing, and sustainability linked loans to improve their ESG implementation. ESG scores of internal rating tools can help investors assess ESG, but financial factors still tend to outweigh ESG factors. By shifting the narrative of ESG in this sector from being a means of differentiating to being a shared responsibility amongst actors in the financial sector, it will enable the development of a common efficient set of best practices to manage ESG risks. Yet barriers hindering this includes the lack of comparable high-quality data, cost, insufficient means to measure ESG, and the time-consuming nature of its due diligence, particularly in the short timeline of debt investments. Other barriers indicate an inadequate expertise with experience in private debt. Upcoming initiatives are working towards providing guidance to promote sustainable investing and ensure efficient practices.
Still, questions arise about the responsibility of private debt managers on sustainability impacts of underlying assets. By fostering collaboration, enhancing transparency, and deepening ESG integration, the private debt sector can improve the practices to integrate ESG. The transition towards a truly sustainable private debt market continues, with strong demand and opportunities for further research.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2023
Number of pages110
SupervisorsKristjan Jespersen