Luke Lu
Miles Li
Andrew McClymont
With ESG principles being increasingly recognised as integral to sustainable investing and corporate decision-making, what will the future look like for ESG in corporate loans?
Key takeaways:
- Positive outlook for CLOs with hopes of interest rate cuts
- Loan deals incorporating ESG language often have better collateral composition
- Greater transparency needed around ESG considerations
The Environmental, Social and Governance (ESG) principles have been growing rapidly in the financial world, reflected by the expansion of the UN Principles for Responsible Investment signatory list, regulatory proposals and industry-level efforts and standards.
The ESG concept firstly appeared in Collateralized Loan Obligations (CLO) offering documents in 2018, and began to emerge in CLO contracts rapidly as investors increasingly focused on sustainable and responsible investing through the years. ESG disclosure in CLOs is typically voluntary, with negative screening through eligibility criteria or exclusions being the predominant method of ESG consideration.
We analysed CLO deals with and without ESG language, by identifying and categorising the ESG-related language in their documentation. We found that deals with ESG language are more likely to have better collateral composition (lower WARF, higher WAS, and lower Caa%) and stronger structural protection, compared to those without such provisions.
ESG deals vs non-ESG deals
Looking at performance, ESG deals have outperformed non-ESG deals across vintages, with more recent vintages typically including ESG language. Our analysis shows that ESG investments favour conservative, low-risk strategies that yield high returns. These deals appear to have a more balanced risk-reward profile. In contrast, non-ESG deals are performing weaker, maintaining a more conservative approach but not achieving the same robust returns.
Unlike the exclusionary language in the CLO deal documentation, the ESG language in loan documents usually comes in the form of KPI and spread ratchets. The loan borrower could be rewarded with a margin reduction if they meet the ESG-tied KPIs or be penalised with higher financing costs for failing the KPIs.
Amid geopolitical tensions, high inflation, and market volatilities, the ESG trajectory has faced some headwinds in the last two years. However, the market has stabilised in 2024 on rate cut hopes, and the recent sustainable loan issuance activity has recovered from the third quarter of 2023 low, signaling a positive outlook for sustainability loan financing.
Read more about
Legal Disclaimer
Republication or redistribution of LSE Group content is prohibited without our prior written consent.
The content of this publication is for informational purposes only and has no legal effect, does not form part of any contract, does not, and does not seek to constitute advice of any nature and no reliance should be placed upon statements contained herein. Whilst reasonable efforts have been taken to ensure that the contents of this publication are accurate and reliable, LSE Group does not guarantee that this document is free from errors or omissions; therefore, you may not rely upon the content of this document under any circumstances and you should seek your own independent legal, investment, tax and other advice. Neither We nor our affiliates shall be liable for any errors, inaccuracies or delays in the publication or any other content, or for any actions taken by you in reliance thereon.
Copyright © 2024 London Stock Exchange Group. All rights reserved.
The content of this publication is provided by London Stock Exchange Group plc, its applicable group undertakings and/or its affiliates or licensors (the “LSE Group” or “We”) exclusively.
Neither We nor our affiliates guarantee the accuracy of or endorse the views or opinions given by any third party content provider, advertiser, sponsor or other user. We may link to, reference, or promote websites, applications and/or services from third parties. You agree that We are not responsible for, and do not control such non-LSE Group websites, applications or services.
The content of this publication is for informational purposes only. All information and data contained in this publication is obtained by LSE Group from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data are provided "as is" without warranty of any kind. You understand and agree that this publication does not, and does not seek to, constitute advice of any nature. You may not rely upon the content of this document under any circumstances and should seek your own independent legal, tax or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Neither We nor our affiliates shall be liable for any errors, inaccuracies or delays in the publication or any other content, or for any actions taken by you in reliance thereon. You expressly agree that your use of the publication and its content is at your sole risk.
To the fullest extent permitted by applicable law, LSE Group, expressly disclaims any representation or warranties, express or implied, including, without limitation, any representations or warranties of performance, merchantability, fitness for a particular purpose, accuracy, completeness, reliability and non-infringement. LSE Group, its subsidiaries, its affiliates and their respective shareholders, directors, officers employees, agents, advertisers, content providers and licensors (collectively referred to as the “LSE Group Parties”) disclaim all responsibility for any loss, liability or damage of any kind resulting from or related to access, use or the unavailability of the publication (or any part of it); and none of the LSE Group Parties will be liable (jointly or severally) to you for any direct, indirect, consequential, special, incidental, punitive or exemplary damages, howsoever arising, even if any member of the LSE Group Parties are advised in advance of the possibility of such damages or could have foreseen any such damages arising or resulting from the use of, or inability to use, the information contained in the publication. For the avoidance of doubt, the LSE Group Parties shall have no liability for any losses, claims, demands, actions, proceedings, damages, costs or expenses arising out of, or in any way connected with, the information contained in this document.
LSE Group is the owner of various intellectual property rights ("IPR”), including but not limited to, numerous trademarks that are used to identify, advertise, and promote LSE Group products, services and activities. Nothing contained herein should be construed as granting any licence or right to use any of the trademarks or any other LSE Group IPR for any purpose whatsoever without the written permission or applicable licence terms.
