By Paul J. Davies
BlackRock Inc., Budowner Anheuser-Busch InBev NV and a plastic
packaging maker in Portugal are among a flood of borrowers using
financial carrots and sticks to improve their performance on things
such as the environment and boardroom diversity. The sticks,
complain some investors, don't leave much of a mark.
Since last summer, companies have issued nearly $240 billion of
debt with special rules that reward them with lower borrowing costs
-- or penalize them with higher ones -- depending on if they meet
self-made targets for things such as cutting carbon emissions, or
for getting more women on boards, according to Dealogic. That
nearly doubles the total issuance of such debt over the previous
three years.
Lenders have long put ratchets on loans or step-ups on bonds
that cause interest rates to change depending on a company's
financial performance. But the idea of tying interest costs to
nonfinancial risks, such as reducing carbon emissions, or improving
governance, is relatively novel.
The surge in bonds and loans tied to environmental, social and
governance performance, known in industry parlance as ESG, is
meeting a huge demand from investors for such investment
products.
Fund managers like them because they qualify for ESG-labeled
funds that they can sell on to investors. One irony of ratchet
loans, is that the investors get paid more if the companies fail to
meet their objectives. This is meant to compensate investors
because a borrower that misses governance targets is a riskier
prospect.
For the borrower, it is also a way to get cheaper loans.
BlackRock, one of the world's largest asset managers, recently
arranged a $4.4 billion loan facility linked to racial diversity,
women in leadership and sustainable assets under management in its
own business that could raise or lower its financing costs by at
least 0.05 percentage points -- equivalent to $22 million annually
if the facility were fully drawn. The normal interest rate is
0.625%, according to BlackRock's SEC filing.
Tariq Fancy, who spent nearly two years as chief investment
officer for sustainable investing at BlackRock and runs an
education-focused nonprofit organization in Canada, says such
penalties are too small to matter.
"A BlackRock might get a bit of egg on its face if it doesn't
hit its targets, but that's not going to make any difference to the
individual decisions made down in the business," he said. "How is
the hiring person going to know, or care, that the finance
department makes marginally more or less due to their hiring
decision?"
A BlackRock spokesman said the financing enhances the company's
"commitment and accountability to achieving certain sustainability
goals."
Budweiser beer owner AB InBev is among the top-10 ESG-linked
borrowers, with a loan of $10 billion issued in February, according
to Dealogic.
The first junk bond with an ESG-linked step-up was this year's
EUR650 million deal, equivalent to $784.2 million, from coal-heavy
Greek electricity group Public Power Corp. It faces 0.5 percentage
point in extra interest if it fails to cut carbon dioxide emissions
by 40% by 2022 versus 2019 levels -- or EUR3.25 million
annually.
Since last summer, around $15 billion of loans that have ESG
linked financing costs have gone toward private-equity deals,
according to 9fin, a research firm. These are the first such
leveraged loans sold to investors through specialist investment
vehicles known as collateralized loan obligations.
The penalties and benefits attached can be as little as 0.025
percentage point of annual interest for each target. That compares
with typical savings of 0.25 percentage point for reducing
debt-to-earnings multiples by the equivalent of one-quarter of
annual earnings, according to 9fin.
"It's the reputational risk that comes from missing your target
that is much worse" than the interest penalty, said Fraser Lundie,
head of credit at fund manager Federated Hermes.
He wants to buy ESG-linked debt and encourage companies to
pursue challenging targets, but not when it offers a worse return
than plain debt from the same firm.
"A company might have one bond that is sustainability-linked,
but the whole company is explicitly tied to that sustainability
target," Mr. Lundie added.
He also wants to see more standardization in the size of
ratchets, how regularly companies are assessed against targets and
measurement by independent parties.
Carlyle is one of the private-equity firms that has been most
eager to add ESG targets to the financing of its portfolio
companies. In February, it also arranged a $4.1 billion credit line
that its own buyout funds can use in which interest costs are
linked to board diversity among their portfolio companies. It
wouldn't disclose the size of the ratchets.
"The fact that you have an economic consequence to a target
you've set raises the profile of that target, everyone knows it's
there," said Sam Lukaitis, a director in Carlyle's European
financing group. "I think the economic impact of these will grow
over time."
Carlyle-backed Portuguese plastics packaging group Logoplaste
last summer became the first company to add ESG-linked interest
costs to a junk-rated loan sold to investors. It has targets linked
to emissions and use of recycled plastic, each worth 0.05
percentage points.
The company already had reasonable green credentials for a
plastics business through an accident of history. Its founder
Marcel de Botton, had run Portugal's largest plastics company
before a socialist revolution in the mid-1970s ultimately led to
him losing control of the business.
When starting again, he aimed to avoid rules on employee
ownership by keeping his businesses small: That sparked the idea of
smaller scale packaging production on the same site of its clients'
factories, which meant less emissions from transporting goods.
Later, he saw that as an environmental virtue and separately set
up a plastics recycling business.
Gerardo Chiaia, Logoplaste's chief executive, said having
publicly-declared ESG targets attached to financing were mostly
about increased scrutiny and accountability. But the financial
incentive is also important. "It is putting your money where your
mouth is," he said. "I believe it's going to become part of the
license to operate."
Still, some investors don't like being asked to pay for changes
they believe companies should be making anyway.
"If you want to reduce your own carbon footprint, you're not
going to ask your mortgage provider to give you a discount for
doing it," said Jonathan Butler, London-based co-head of global
high-yield at PGIM, the fund management arm of U.S. insurer
Prudential Financial. "This is effectively just a backdoor way of
private equity reducing their margins [on borrowing costs]."
Write to Paul J. Davies at paul.davies@wsj.com
(END) Dow Jones Newswires
May 04, 2021 07:25 ET (11:25 GMT)
Copyright (c) 2021 Dow Jones & Company, Inc.
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