Unwanted companies pose as green warriors to cut debt costs

Undesirable rated companies owned by private equity firms exploit ESG narratives to lower borrowing costs. Debt investors fear being played.

To cut a chunk of its interest rates, German packaging company Kloeckner Pentaplast GmbH, owned by SVPGlobal, has pledged to use more recycled materials and add more women to senior positions. French hospital operator Elsan SAS, also privately owned, is committed to improving customer satisfaction and reducing waste, while Euro Ethnic Foods SA, owned by PAI Partners, said it would increase the number of electric forklifts used in its stores.

The number of substandard European companies whose interest rates are tied to their performance against their sustainability targets has more than doubled since the start of the year. For their part, yield-hungry debt investors are willing to forgo some yield for borrowers who make environmental, social and governance improvements, even if they take a cautious eye on companies that can set goals. cosmetics or unambitious.

“We’re seeing a bit of greenwashing,” said Jonathan Butler, head of European leveraged finance at PGIM Ltd. “Companies are trying to price their debt at tighter levels by doing something they had to do anyway… Companies are exploiting the ESG angle to lower the cost of their debt.

The financial sector is under pressure from governments, regulators and investors to address general concerns related to ESG, including climate change and racial and gender imbalances in the workplace. This means that fund managers now need to consider more than just profit maximization in their investment thesis.

Significant change
Butler, like other managers, is concerned that pricing linked by a margin ratchet to ESG objectives is a “practical” way for companies to reduce financing costs without necessarily addressing sustainability values ​​in any meaningful way.

Take Kloeckner Pentaplast, for example. The German plastic packaging manufacturer’s ESG targets are not “particularly ambitious,” analyst George Curtis said in a blog for TwentyFour Asset Management.

Kloeckner Pentaplast promises to increase the proportion of women in management positions by two percentage points to 27%, the proportion of recycled materials in its packaging by four points to 26% and to reduce its emissions. The company can reduce its interest margin by 7.5 basis points, currently 475 basis points, if it meets all three targets.

The targets set for Kloeckner Pentaplast reflect a commitment to mainstream ESG factors as drivers of value creation, said a spokesperson for the company’s private equity owner SVPGlobal. If the targets are met, the company will be well positioned relative to its peers, he said, adding that most other players in the industry are single digits for the percentage of recycled material content.

Double discount
For loan funds, being overtly planet-friendly has become an important marketing tool, but giving out interest income could become problematic if the goals are deemed too easy.

“If you give companies easy milestones, they just get cheaper margin on the loan,” said Torben Skodeberg, co-founder of Capital Four Management. “We will then try to factor that into the initial margin, otherwise it will become unfair to our investors.”

And while the discounts available to businesses rated as garbage are much lower than in the investment grade market, lenders fear they will increase as the trend sets in and borrowers demand more. .

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