Julie Castiaux (Head of Sustainable Finance at KPMG Luxembourg): Since 1 January 2023, asset managers have had to comply with the Sustainable Finance Disclosure Regulation’s (SFDR) Level 2 reporting obligations, while facing more regulatory scrutiny on their sustainability risk and reporting processes.
Alongside completing SFDR annexes for each Article 8 and 9 product, financial market participants have also received additional information requests from the CSSF through a dedicated eDesk process. Beginning of 2023, the CSSF launched a data collection exercise on the SFDR’s precontractual and periodic reports, starting with questions related to entity compliance. And this is only the beginning.
While sustainable finance is already business as usual for some finance professionals, the market still struggles to collect accurate and exhaustive data, define clear strategies, and adapt its operations to ESG, including creating portfolios and producing reports. Private debt asset managers facing these challenges can harness their direct connection with companies to influence them on sustainability, collect more information, and increase their transparency through SFDR reporting.
Incorporating ESG factors into corporate debt transactions can provide borrowers with access to larger pools of capital and tangible debt pricing benefits, if they can demonstrate that a positive ESG impact is delivered.
Deal structures are evolving beyond “green” initiatives to focus on social or governance factors, such as employment practices, board diversity and access to education.
In October 2022, the Loan Market Association (LMA) highlighted that “over the course of the last 18 months, ESG aspects of private debt have grown exponentially and now feature in the majority of deals in the middle market, the main market for private debt deployment”. Limited partners’ (LPs) growing demand for Article 8 private debt funds is driving the increasing integration of ESG factors in investment strategies.
Private debt investors can harness ESG opportunities by investing in green-, social- and sustainability-linked loans defined by corporates to finance their projects. These types of loans have grown significantly since the beginning of 2020 — in 2022, 50% of European leveraged loans included sustainability-linked features. 1
Green-, social- and sustainability-linked loans are increasingly standardized through frameworks that integrate ESG from due diligence processes and investment decisions to dedicated reports. These frameworks, such as LMA’s loan principles and guidance, help boost transparency and investors’ access to information on the financing’s use, and are usually covered by external verifications or assurance.
In this sense, ESG’s integration in private debt marks a revolutionary change, with market participants increasingly focused on expanding their ESG agenda.
In this year’s survey, we included a specific question regarding the ESG classification of funds under the SFDR (Figure 8). While this classification is still ongoing, for the funds for which we received the information, most of the funds are classified under Article 6 (77%), followed by Article 8 (17%) and Article 9 (6%).
Article 6 covers funds that do not integrate any kind of sustainability into the investment process, while Article 8 funds promote environmental or social characteristics, or a combination of both, and Article 9 funds must have a sustainable investment objective.
Source: KPMG/ALFI debt fund survey