Private debt gets to grips with carbon reporting
Although the private debt market lags public markets when it comes to reporting the carbon emissions it is responsible for, some funds are already calculating the carbon footprint of their portfolios and looking to identify carbon-adjusted returns.
UK-based alternative credit specialist AlbaCore Capital believes it is one of the first managers to do line-by-line estimated carbon footprinting in private markets, across its US$9.5bn of assets under management comprising private credit, CLOs, liquid credit and structured credit in Europe.
"We have an ESG overlay and are very loud proponents of our carbon-conscious investing strategy, which is very simply measuring the estimated carbon footprint of your portfolio. In the traditional financial markets, 90% of people still don’t speak carbon or engage on it,” said AlbaCore chief operating officer Matthew Courey. "In terms of carbon reporting, we’re trying to get the whole industry to do the bare minimum.”
The rapidly growing private debt market is expected to play a major role in the energy transition. Private equity giant BlackRock said in October it expects the global private debt market to roughly double to US$3.5trn by 2028, while data provider Preqin expects that the market will reach US$2.8trn within the same period.
However, the industry has been far slower than public markets to report carbon emissions, largely due to the difficulty of sourcing information on small and mid-cap companies, which have fewer ESG resources.
"Private debt is not yet as organised as public debt. We see it in our reported coverage, in some cases our public debt carbon coverage is sometimes double that of our private debt carbon coverage," said Yiannis Bartzilas, director of ESG at investment firm Muzinich, which specialises in public and private corporate credit.
Muzinich has been doing carbon reporting since 2021 for private companies using estimates provided by independent carbon data providers and by contacting the companies in which it invests.
AlbaCore's carbon-conscious investing strategy, which was launched in February 2022, is a proprietary peer-mapping model and methodology that gives a read-across from 15,000 public companies' disclosures and allows AlbaCore to estimate a portfolio's carbon footprint even when issuer data are not available.
Carbon-adjusted returns are calculated using a range of carbon prices that AlbaCore converts into basis points of annual return to help standardise and compare against different funds. The strategy can also be applied to companies' cost of capital by calculating contingent liabilities on their balance sheets.
"In what I call carbon-adjusted returns, debt markets price carbon in. Say that two companies should have a cost of capital or debt at 8% and one would cost another 50bp to mitigate its carbon, so you charge that company 8.5% – that's how the debt markets engage," Courey said. "That's like an ESG ratchet on steroids and properly calibrated to the cost."
He said the process is neither time-consuming nor costly and that getting ahead of increasing regulation will provide a competitive advantage. "There's a train coming in regulation, standardisation and accounting standards and it's going nowhere else than right at us," Courey said.
Increasing disclosure
The European Leveraged Finance Association's ESG Fact Sheets that were launched in September 2021 and updated in January 2022 have driven a significant increase in carbon disclosure by issuers and more investors are requesting the information. The trade body is planning another update in February.
By the end of 2023, around 60% of issuers were reporting direct Scope 1 emissions from their own operations and indirect Scope 2 emissions from purchased energy, up from about 40% a year earlier, ELFA said.
“Last year was a breakthrough year where we saw more companies reporting on carbon and then CLO managers in turn started reporting this information to investors,” said Oliver Newman, a senior credit analyst at Fidelity International and co-chair of ELFA’s ESG Committee.
ELFA worked with Initiative Climat International and in September produced a guide to carbon footprint measurement for companies and their lenders and published a report in October on CLO carbon and climate disclosures for CLO managers.
“We're far from finished on the subject of carbon reporting. We're very much still in the early data-gathering phase," Newman said.