Junk firms are posing as green warriors to reduce debt


LONDON: Junk-rated companies owned by private equity firms are tapping environmental, social and governance (ESG) narratives to cut borrowing costs. Debt investors worry about being played.

To lop a sliver off its interest rates, German packaging company Kloeckner Pentaplast GmbH, owned by SVPGlobal, promised to use more recycled material and add more women in senior roles.

French hospital operator Elsan SAS, also private-equity owned, pledged to improve customer satisfaction and cut waste, while PAI Partners-owned Euro Ethnic Foods SA said it would increase the number of electric forklift trucks used in its stores.

The number of sub-investment-grade European firms whose interest rates are tied to how well they do on their sustainability goals has more than doubled since the start of the year.

For their part, yield-hungry debt investors are willing to give up some return for borrowers making ESG improvements, even as they cast a wary eye on companies that may be setting cosmetic or low-balled goals.

“We see 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 needed to do anyway...Companies are exploiting the ESG angle to reduce the cost of their debt.”

The finance industry is under pressure from governments, regulators and investors to factor in broad ESG-related concerns including climate change and workplace gender and racial imbalances. That has meant fund managers now have to factor in more than just profit maximisation in their investment thesis.

Butler, like other managers, worries that pricing linked by a so-called margin-ratchet to ESG targets is a “convenient” way for companies to cut funding costs without necessarily addressing sustainability values in a meaningful way.

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

Kloeckner Pentaplast is promising to increase the share of women in senior roles by two percentage points to 27%, the proportion of recycled material in its packaging by four points to 26% and to cut its emissions. The company can trim 7.5 basis points (bps) off its interest margin – currently 475bps – if it meets the three goals.

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

For loan funds, being demonstrably planet-friendly has become an important marketing tool, but giving away interest income could become problematic if targets are deemed to be too easy.

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

And while discounts available to junk-rated companies are much smaller than in the investment-grade market, lenders fear they may get steeper as the trend takes hold and borrowers push for more.

Already this month, French private hospital operator Elsan doubled its potential discount to 15bps. As is common in such deals, there’s an equivalent premium if Elsan misses targets. ─ Bloomberg

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