Can private equity drive change in sustainable finance?

EQT signs the largest ever ESG-linked fund facility, targeting social and environmental targets across all portfolio companies. This is why it matters.

Stockholm-based investor EQT has completed the largest ever credit line linked to responsible investment metrics in the private equity (PE) space. Marking yet another milestone for environmental, social and governance (ESG) investing, its ESG-linked equity bridge loan, or subscription credit facility (SCF), is currently at €2.3 billion, with an upper limit of €5 billion. EQT manages around €40 billion in assets.

Beyond the size, the structure of the loan is especially noteworthy. This significantly increases the prospects of the global fund financing markets to scaling up and embedding ESG across entire portfolios of private companies, with customised ESG targets.

The ESG-linked fund financing mechanism (proposed by BNP Paribas’ Subscription Finance team) sought to align EQT’s sustainability strategy with its financing strategy. BNP Paribas acted as Agent, Sustainability Agent and Joint Sustainability Coordinator with Sweden’s SEB, with the support of a syndicate of 17 banks.

Alexandra Basirov, Global Head of Sustainable Finance in Financial Institutions Coverage, Alexis Collonge, Sustainable Finance Coordinator for Capital Markets EMEA, and Guillaume Hartog, Head of Subscription Finance, explain why this could be one of the most remarkable transactions of 2020.

ESG-linked credit facilities are popular instruments in sustainable finance, but are quite new for the private equity sector. Why?
Alexis Collonge: Indeed, sustainability-linked loans (SLLs) have largely developed for corporates, with the EMEA region at the forefront (total syndicated issuance of around €90 billion in volume and 100 deals in 2019). Typically, they work like other revolving credit facilities, while tying specific sustainability metrics to the interest rate paid by the borrower. This way, the borrower has a financial incentive to work towards attaining predefined environmental, social and/or governance objectives or key performance indicators (KPIs). This mechanism therefore aligns financing with the sustainability strategy at a company level, and therefore is particularly suitable for corporates of almost all sectors.

” Beyond the governance aspect at private equity management level, we managed to incorporate ESG targets for all its portfolio companies. ”

In January 2020, Eurazeo announced the first-ever SLL for a private equity firm, a widely syndicated €1.5 billion corporate facility for which BNP Paribas acted as sole Sustainability Coordinator. The mechanism of their facility mixed two levels of KPIs: first, at company level, Eurazeo committed to becoming carbon neutral; second, at portfolio management level, it applied strict sustainability governance throughout the investment cycle. This market premiere highlighted how PE pioneers such as Eurazeo had long integrated sustainability into their value creation process and were ready to take the next step by translating their advanced approach into the more constraining framework of sustainable financing.

Guillaume Hartog: Absolutely, and it underlines the advances BNP Paribas has made on ESG, which has given us the capacity to replicate this technology in the subscription finance market. The challenging starting point for the team was to identify a suitable asset manager for this new type of financing. EQT was well advanced on ESG front. Most importantly, it was ready to embark on this journey when we proposed the idea in October 2019.

What makes the EQT transaction so innovative compared to Eurazeo’s pioneering SLL?
Guillaume Hartog: Beyond the governance aspect at PE management level [see next question], we managed to incorporate ESG targets for all its portfolio companies – which will be determined when the fund starts to invest.

It was particularly complex: not only did we have to translate sustainability ambitions into manageable, measurable metrics, but also to define metrics that would apply to all EQT’s portfolio companies across numerous sectors, with diversified products and services, and different maturity cycles. We achieved it by developing a common set of ESG KPIs across all sectors and industries, as well as customised roadmaps, to be reported on quarterly and audited annually.

What are the ESG metrics linked to EQT’s credit facility?
Guillaume Hartog: The first KPI is related to governance. If the following requirements are not attained by all EQT portfolio companies, the premium margin is payable regardless of social and environment KPIs:

  • Appoint a board member responsible for ESG
  • Assess the status of the portfolio company on greenhouse gas (GHG) emissions covering scope 1 and 2 [1], and fulfil a sustainability materiality analysis [2]
  • Implement an ESG strategy with a trajectory aiming at achieving at least one of the two following targets: either reducing GHG emissions, aligning with Paris Accord targets within 5 to 15 years; or if not relevant, another ambitious target that is neither linked to gender equality nor to renewable energy

Alexis Collonge: The second set of ESG KPIs is focused on social objectives, specifically gender equality on the board of directors of portfolio companies. It has set a target of 40% women within 24 months of acquisition, which is ambitious compared to the EU average (close to 12% for mid-size privately owned company) and even more so compared to the PE world.

Guillaume Hartog: The third set of ESG KPIs is focused on environmental objectives, targeting an increase in the share of renewable energy in the total purchased electricity of each portfolio company. The roadmap of energy transition goes up to 85% of clean energy within 30 months.

” Since investors have the power to influence the ESG strategy of companies in their portfolios, they are instrumental actors to diffuse and scale up sustainability in the economy. ”

All these thresholds are really ambitious. They are at once transformative and impactful at company level, but as the first facility in the fund financing space, we wanted to set a meaningful reference for the market. The strong track record of EQT’s ESG teams meant it was the right candidate to implement such an ambitious strategy.

It is worth noting that the facility was very well received by the market (oversubscribed despite its size), setting a solid benchmark for subsequent green financing in the fund financing space.

Is this structure replicable, and what is its potential? Could it become a trend among institutional investors?
Alexandra Basirov: The structure of this credit facility relies on tangible and measurable KPIs. Such KPIs are replicable for those private equity firms that have the ability and willingness to implement them to their portfolio companies. We have already seen this in Asia with a transaction we executed for ADM Capital.

The EQT facility is, of course, significant because of its size, and highlights the potential for what we hope will become a growing market. A vital foundation was EQT’s strong pre-existing sustainability governance and ambitious targets: it brought its excellence in management into the development of sustainability in the private equity space. This raises hopes that the structure could become more prevalent among PE firms. It also contributes to increasing the availability of high-quality ESG data and disclosures on privately-held companies.

The very large size of this transaction and the strong support it received from a wide group of international lenders, despite the difficult market conditions of the past few months, is more evidence of the capital markets’ shift towards sustainability. Ultimately all finance should be sustainable.

Since investors have the power to influence the ESG strategy of companies in their portfolios, they are instrumental actors to diffuse and scale up sustainability in the economy. The EQT transaction follows a broader trend in the institutional market, which has become increasingly aware of the importance of broader societal objectives. It increasingly recognises that sustainability creates better risk-adjusted returns with positive real-world outcomes.

Alexandra Basirov is the Global Head of Sustainable Finance, FIC. Alexandra is responsible for driving the commercial strategy for sustainable finance for BNP Paribas’ financial institutions client base, working closely with the group’s business lines. She has helped position the bank as a leader in sustainable finance across various products and actively engages with multiple stakeholders internally and externally.

Alexis Collonge is Sustainable Finance Coordinator for Capital Markets EMEA, thereby fostering the diffusion of sustainability-related awareness, initiatives and product cross-fertilisation within this perimeter and beyond. He has notably actively contributed to the establishment and development of the Bank’s leading sustainable loan franchise.

Guillaume Hartog is Managing Director and Head of Subscription Finance. The Fund Financing team provides fund level various type of financing, for asset managers that are close and strategic clients to the bank, both in US and EMEA. The BNP Paribas book is currently amounting to €10bn and includes mainly private equity funds, infrastructure funds, real estate funds, funds of funds and credit funds

[1] The GHG Protocol Corporate Standard classifies a company’s GHG emissions into three ‘scopes’. Scope 1 emissions are direct emissions from owned or controlled sources. Scope 2 emissions are indirect emissions from the generation of purchased energy. Scope 3 emissions are all indirect emissions (not included in scope 2) that occur in the value chain of the reporting company, including both upstream and downstream emissions.
[2] A sustainability materiality analysis is a method to identify and prioritize the possible Environmental, Social and Governance (ESG) issues that are most important to an organization and might impact the business.