Environmental, social and governance (ESG) factors are now seen by investors as an essential component of credit analysis.
But in the absence of a consistent approach to ESG disclosure, investors rely on proprietary questionnaires to obtain the ESG information from borrowers they consider material to their investment decisions. As these questionnaires increase in volume, borrowers and their advisers want more direction from investors on what ESG information to include in company disclosures.
The European Leveraged Finance Association (ELFA) and Loan Market Association recently published a joint guide: Guide for Company Advisers to ESG Disclosure in Leveraged Finance Transactions (the Guide). The Guide stems from the ELFA's launch of its ESG Disclosure Initiative in June 2019 which has the goal of increasing ESG disclosures by borrowers and reducing the reliance by investors on individual ESG questionnaires. The Guide reflects ideas, experience and input from law firms, banks and private equity sponsors in the European leveraged finance market. It is intended to help company advisers with the issues relating to the integration of ESG risks into due diligence and company disclosures.
The Guide explores the main drivers behind investors’ need for more ESG disclosure and the evolution of the regulatory framework that requires borrowers to disclose how they are managing the financial risks relating to sustainability.
As a replacement to borrowers answering multiple investor questionnaires, the Guide recommends disclosing ESG information through company offering materials as well as an ongoing requirement for periodic reporting. The ELFA's view is that this approach will enhance investor confidence that the ESG information has undergone adequate due diligence and give the investors access to updated information when they need it. The Guide also seeks to develop a consensus on a core set of ESG disclosure topics and associated metrics (informed by ESG Fact Sheets) and facilitate a level of standardisation within the industry. The first set of ESG Fact Sheets were published by ELFA in January 2021 and are the culmination of the first stage of the ESG Disclosure Initiative. These resources are designed to guide the market to a consistent level of disclosure on a sector-level basis, and the first three sectors covered in the series are debt repurchasers, paper and packaging and telecoms.
The Guide also considers key points for advisers to consider when undertaking ESG-related due diligence, including the legal and regulatory framework for ESG diligence and assessing the “materiality” of the ESG factors and processes that are used to ensure the ESG information is properly captured. To assist with this work, the Guide sets out a roadmap on how to incorporate ESG-related disclosure into offering materials.
Finally, the Guide examines how ESG can be reflected in credit agreements by way of representations, information undertakings or covenants. Contractual disclosures and covenants that align to ESG metrics will strengthen the overall ESG message. However, contractual provisions must be achievable, readily accepted by the market and must not inadvertently result in default triggers. The Guide points to finding a balance between provisions that are meaningful for investors, but do not create unnecessarily onerous obligations on the borrower.