THE ESG CHALLENGE IN PRIVATE DEBT: TACKLING CLIMATE CHANGE
Today, climate change is clearly a major and pressing topic for worldwide societies, but also one of the highest priority ESG issues facing investors. As reported by the PRI in its recent “Investor action on climate change” report, in 2017 nearly 400 investors, representing US$22 trillion in assets under management, stood by the Paris Agreement for this purpose. They urged governments to implement the Paris Agreement, drive investments into the low carbon transition and support climate-reporting frameworks such as the recommendations of the Financial Stability Board Task Force on Climate-related Financial Disclosures. As an investment fund working with those same investors, Kartesia believes that it is our fiduciary duty to incorporate climate change concerns into our investment process. The challenge is to continue to engage with climate issues and maintain our position as a market-leading private debt specialist, where access to management and influence on companies might be more restricted than for private equity sponsors.
Kartesia is confident that companies with high environmental, social and governance (“ESG”) standards are typically better run, have fewer business risks and ultimately deliver better value. Responsible investment is therefore a vital part of our investment philosophy and process. We are signatories to the UN Principles for Responsible Investing (“PRI”) and have embedded responsible investing policies into our approach and our portfolio company review processes. We have dedicated staff with a real commitment to ESG, which translates into having a real influence and commitment to the issue. We use the negative screening strategy (i.e. excluding investments in sectors that by nature do not comply with our ESG mindset) for our funds, which is probably the most palatable method for secondary debt funds, due to the reduced risk profile. But regarding climate change, we have had to be more innovative.
Our mission is to provide liquidity and credit solutions to European small/mid-market companies and currently the level of reporting by those companies from an ESG perspective is relatively low. Additionally, Kartesia’s position as a lender may not always lead to discussions with management or increased reporting on ESG, which is unfortunately not often front of mind for target companies, especially in secondary deals. We decided to compensate for the lack of ESG data from our portfolio companies by using models. Since 2015, Kartesia has teamed up with service provider Sustainalytics (www.sustainalytics.com) to assess the carbon footprint of our portfolio companies on an annual basis. As our portfolio is made of private companies that do not report on carbon emissions, Sustainalytics uses statistical estimation models to estimate the carbon footprint of the total portfolio and compare it with the appropriate benchmark (MSCI Europe). This model considers several criteria for each portfolio company, including size, industry and FTE and estimates the overall weighted carbon intensity of each of our funds. The resulting report allows us to drill down to sector and peer group level.
Our partnership with Sustainalytics is still in its early working stages and we are constantly learning about the process of analysing and processing our portfolio. The estimation model used is evolving a great deal and not an exact science, but we believe it is an excellent starting point to get a clearer sense of our carbon footprint and to progress discussions with portfolio companies currently having the greatest negative impact. What is vital is that our investors have the relevant information required to monitor their own footprint or to reach carbon neutrality by balancing their investments with buying carbon credits.