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How ESG is finding its way to commercial lending and financing

Environmental, social and corporate governance (ESG) investing principles are more and more often being applied to commercial lending and fund financing. This means investors will have to find ways to integrate ESG into their investment processes, because whether loan recipients or the investment funds adhere to these principles is going to affect the terms for the lending or investment.

HSBC recently announced it would no longer fund oil and gas projects. Churchill Asset Management, part of Nuveen and TIAA, sees the rise of ESG compliance affecting private credit. Churchill itself began following ESG principles in 2017, and uses these principles to evaluate private equity investments it funds. More broadly, ratings agency Moody’s sees greater ESG risks affecting the quality of corporate and sovereign credit.

How this affects industries

Industries that are particularly risky for ESG compliance, like oil and gas, mining and agriculture will find that capital costs more, because investors are trying to follow ESG initiatives. As Churchill lending and ESG executives Randy Schwimmer and Mickey Weatherston wrote in their analysis of ESG’s effect on private credit:

“ESG should not be viewed as principles outside the asset universe being imposed on investors. Rather, it is a natural evolution of historic developments combined with the reality of a shrinking interconnected planet. What matters, after all, is not the definition or characterization of these principles, but the effort itself to create alignment, modified as necessary over time, with your firm’s moral and ethical standards and the investment choices you make.”

On that basis, Churchill advises that making sure ESG principles are integrated into investment should begin by applying ESG factors when researching possible investments. That in turn seeds ESG principles to grow into a firm’s portfolio management and its investment strategies. However, the relevance of ESG factors could vary depending on what asset class or investment strategy is in play.

ESG Lending – a trend

HSBC’s action was not an isolated move. The bank has shifted its corporate lending in the energy sector to support companies making efforts to move to less carbon-intensive power sources. Still, firms including sustainability in fund financing have to set hard metrics and stretch their KPIs to account for the challenge of being sustainable, according to a Funds Europe report including observations on the topic by RBS, abrdn, Reed Smith, Avardi Partners and Deloitte.

For companies and firms that have low ratings when it comes to following ESG principles, credit risk will rise, as Moody’s reported. That means liquidity and refinancing is also riskier, as these companies capital structures rely more on leverage. Their risk management policies are weak. Among companies, consumer products, restaurants and retail have risks that make them speculative investments, according to Moody’s.

These assessments and actions by big, respected financial industry names show ESG principles getting a foothold, and extending out to the targets of investments – the companies that use the lending services to operate their business. Soon, ESG compliance will be a factor that investors cannot ignore.

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