ESG(environmental, social, and governance) considerations have become increasingly important in private equity and other alternative investment industries. ESG-linked subscription facilities are a financing tool used by private markets funds that are committed to sustainable investment practices. These facilities are similar to traditional subscription credit facilities, with the added feature of ESG-linked pricing adjustments.
ESG-linked subscription facilities provide the fund with access to a line of credit, typically from a bank or other financial institution, to cover short-term financing needs such as fees, expenses, or new investments. The interest rate on the line of credit is tied to the fund's ESG performance, which is measured and verified by an independent third-party. The better the ESG performance, the lower the interest rate charged on the line of credit.
By linking financing to ESG performance, these facilities incentivise private markets funds to integrate sustainable investment practices into their investment strategies. The facilities also align the interests of the fund's management team with those of the limited partners (LPs), who are increasingly seeking out investments that align with their own ESG priorities.
The main ESG performance metrics that can be linked to subscription facilities depend on the objectives and priorities of the fund and its investors. Some commonly used metrics include carbon emissions, water usage, waste management, diversity and inclusion, human rights, community engagement, and supply chain sustainability.
For example, a fund focused on renewable energy may link the subscription facility to the amount of clean energy generated and the reduction in carbon emissions, while areal estate fund may link the facility to the energy efficiency of its properties and the use of sustainable materials.
The most common ESG metrics that are used in ESG-linked loans or subscription facilities include:
- Carbon emissions reduction targets or intensity reduction targets.
- Renewable energy usage targets, including the proportion of energy that is renewable.
- Social and labour standards, such as employee health and safety, labour rights, and diversity and inclusion.
- Water usage and conservation metrics, including water recycling and reuse targets.
- Waste reduction and recycling targets, such as a decrease in the amount of waste produced and an increase in the percentage of waste that is recycled.
In addition to those environmental metrics, social and governance factors are also important for many investors. Metrics related to employee relations, board diversity, executive compensation, and anti-corruption measures can be linked to subscription facilities to incentivise ESG improvements in these areas.
There are several potential benefits to ESG-linked subscription facilities. First, they can improve a fund's access to capital by attracting investors who prioritise sustainable investment practices. Second, they can incentivise funds to integrate ESG considerations into their investment processes and make a positive impact on the environment and society. Finally, they can help funds improve their ESG performance by providing a financial incentive to do so.
However, there are also potential drawbacks to ESG-linked subscription facilities. The ESG-linked pricing adjustments may be difficult to quantify and may vary between lenders, making it challenging for funds to compare and choose between different facilities. Additionally, measuring ESG performance can be subjective, and there may be disagreement between the fund and the third-party verifier about the fund's ESG score. Finally, the additional administrative burden of measuring and reporting ESG performance can be time-consuming and costly.
In conclusion, ESG-linked subscription facilities are a financing tool that can incentivise private markets funds to integrate sustainable investment practices into their investment strategies. They provide a financial incentive to improve ESG performance, align the interests of the fund's management team with those of the LPs, and can attract investors who prioritise ESG considerations. Anzere Advisory can help managers structure ESG-linked subscription facilities that take into account other factors such as pricing and terms, thereby saving time and money.
