November 1, 2019 / 4:21 PM / 14 days ago

CLO managers under pressure to ramp up efforts on ESG investing

LONDON, Nov 1 (LPC) - A number of investors in CLOs are holding talks with CLO managers over how environmental, social and governance issues factor into their leveraged loan portfolio decisions.

CLO fund investors, such as ESG-focused Hermes Investment Management, are hoping that CLO mangers will increase their engagement with leveraged loan borrowers or their private equity sponsors on ESG matters.

Hermes is aiming to raise sustainability awareness by having in-depth talks with CLO managers in pitch meetings.

“We are engaging with CLO managers on ESG and how they factor it in to each loan investment decision, rather than simply asking them about their ESG policy. If a loan is scoring poorly on certain ESG metrics, we want to understand what the manager is doing to address this and what conversations they are having with the sponsor,” said Andrew Lennox, ABS portfolio manager at Hermes Investment Management.

“There is an increasing amount of data that supports the positive impact of engagement on investment performance, but we believe the CLO space is lagging.”

The ultimate goal is to see a wave of CLO managers that will ramp up efforts to hold issuers or sponsors to account on their ESG responsibilities, Lennox said.

The majority of private equity firms are not paying attention to ESG matters in their portfolio companies because immediate cost cuttings and earning enhancements are the priority following a buyout, rather than long-term ESG improvement planning.

LACK OF DATA

To address growing demands from CLO investors over ESG issues, some CLO managers have adopted a screening approach in their funds.

A total of six ESG-compliant CLO funds have been issued in Europe and at least two in the US so far, by avoid investing in sectors including tobacco, gambling, pornography, weapons and hazardous chemicals.

However, leveraged loans from these sectors are scarce, so the investment restrictions do not have significant credit impact on the CLOs and their performance is comparable to peers, according to Moody’s.

CLO managers argue it is difficult to measure ESG risk in leveraged loans due to the absence of ESG-related information on the issuers.

“We barely get enough transparency from the company and private equity sponsors. When you call the CFO and ask ‘Oh by the way, what is your recycling policy?’ The guy will hang up the phone,” said a CLO manager.

For well-resourced CLO managers, they might subscribe ESG data from several providers such as MSCI and Sustainalytics instead of doing by themselves, but still the data is limited in the leveraged loan market.

MSCI, which provides ESG ratings for 8,100 equity issuers and 5,000 fixed income issuers, admitted the challenges of leveraged loan coverage.

“Some leveraged loan issuers are very small, private companies. Nobody has that data,” said Elisabeth Seep, head of fixed income ESG Products at MSCI.

Without full ESG coverage on the leveraged loans, the CLO managers will struggle to show investors how well they integrate ESG in their investments.

“If we don’t rate all of the underlying collateral, then we won’t have access to sufficient information to form an overall view on the transaction,” said Andrew Steel, global head of sustainable finance at Fitch Ratings. (Editing by Christopher Mangham)

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