Private credit funds adopt ESG
Even as the concept of financing linked to environmental, social and governance factors has suffered a backlash in recent months, some Asian private credit funds are employing it as a core of their lending strategies while still delivering double-digit returns.
Hong Kong-headquartered ADM Capital, Philippines-based ARQ SME BDC and Beacon Fund from Vietnam have one key thing in common – a laser-like focus on ESG.
In fact, the Beacon Fund, Vietnam’s first private credit fund, stands out for the generous incentive it is willing to offer its borrowers making a social impact. Shuyin Tang, co-founder and CEO of the fund set up in 2020, described the approach as “impact-linked loans”, which carry step-downs in interest margins based on impact targets.
“We do choose metrics that have a direct link to operational and financial value creation,” she said.
An example of the impact target is a borrower from the retail sector that increases its frontline staff retention rate to a certain level in exchange for a reduction in the interest rate that can be as much as 100bp or more – multiple times higher than the low to mid-single digit incentives typically seen on ESG financings provided by banks in Asia Pacific.
Tang explained that frontline positions, such as shop assistants, are typically not the highest paying jobs and are quite vulnerable, often being contracted positions, but they are crucial for the success of a retail business.
Meanwhile, ARQ is also offering a product called SheSecure in partnership with Investing in Women, an initiative of the Australian government, that lends to women-owned or led small businesses.
Similar to Beacon Fund’s impact-linked loans, borrowers of SheSecure will receive financial incentives upon achieving certain milestones in relation to gender equality improvement, such as the proportion of female employees and training on sexual harassment.
Abigail Tan, co-founder and managing partner of ARQ, explained that her fund’s target borrowers include those that are women-owned or led and those enabling positive impact on the climate or community.
Around 70% of ARQ’s portfolio companies are women-owned or led.
“We like companies that have the demographic dividend story in the Philippines as an underlying tailwind. But we prioritise SMEs that are aligned with our mission of sustainable and inclusive growth,” Tan said.
Meanwhile, Hong Kong’s ADM Capital pursues a lending strategy with an ESG focus across Asia Pacific.
“It is not because we only want to do good to the world, but on a more basic and more urgent level, ESG is a risk that has to be identified like any other risks that are involved in lending,” said Sabita Prakash, managing director at ADM.
ADM conducts a full-fledged analysis of the ESG risks for the borrowers that it lends to and holds discussions with the companies on the formation of an environmental and social action plan. Failure to implement the ESAP will constitute an event of default following which ADM can choose to accelerate repayment of the loan or foreclose on the security.
Prakash said that the fund will ensure the ESAPs are practical and useful for the borrowers and that they completely understand what they are getting into.
Climate events such as floods and fires, and social issues such as child labour and slavery, are risks that can easily turn profits to losses, according to Prakash.
One example is a US$20m three-year loan ADM provided to India’s online credit provider KreditBee back in 2019. ADM encouraged KreditBee to provide more attractive terms to women borrowers in order to improve the gender ratio in its loans portfolio, promoting diversity and thereby improved asset quality.
So far a majority of ADM’s borrowers have completed over 90% of their ESAPs on time, according to Prakash.
Double-digit returns
All three private credit funds are achieving returns of 10% or above from their strategies, including tailoring loans to match the business cycles and needs of their borrowers, and using various equity kickers or fee structures to enhance returns.
The Beacon Fund targets borrowers with annual revenues of around US$3m–$20m and provides loans typically of around US$500,000 to US$2m with tenors of three to four years and interest rates of about 8%–12% on average. In some instances, if the borrowers achieve certain milestones or grow in scale, the private credit fund earns additional fees or is issued shares in the borrower.
This mechanism involving additional fees and equity options also forms part of the structures of some of the private credit loans from ADM as well as ARQ SME BDC.
“As we are often the first professional investors to back these companies, we also want to give ourselves the opportunity to get a bit of upside if the company performs well, so we often insert warrants or an ‘investor bonus’ if certain milestones are achieved,” said Tang at the Beacon Fund.
In the second half of 2024, Beacon Fund provided a four-year loan to Bo Cau Services, a telecommunications infrastructure provider which enables last-mile internet connectivity services to homes and offices in Vietnam. It was the second loan from Beacon Fund to the company.
“The beauty of this from a lender perspective is they have very long-term contracts with the internet providers and they get paid no matter which service provider you choose,” said Tang, adding that Beacon Fund is the first private credit lender to Bo Cau.
Meanwhile, ARQ targets returns in the 15%–25% range combining both the interest rate and the equity component, which can be in the form of a royalty, warrants or other income-sharing mechanisms, according to Tan.
“We first try to understand the entrepreneur’s aspiration, what is driving their needs, and their cash conversion cycles before designing the loan structure,” said Tan. “Also, we recognise that not all entrepreneurs want to raise equity.”
ARQ focuses on lending to small and medium-sized enterprises, with loan sizes of around US$500,000 to US$4m. The tenors are typically up to five years and repayment schedules can be as flexible as milestone-based, especially for event-driven loans, according to Tan.
ADM is the largest among the trio interviewed for this story with US$1.5bn of assets under management as at the end of December. ARQ has deployed more than US$50m to over 50 SMEs since its inception in 2017. Beacon has raised more than US$25m since its inception in 2020.
ADM’s Prakash said that the fund’s returns could arise from a combination of cash, back-ended or PIK coupons and equity upside. “If the company’s cashflow cannot support a cash coupon of 10%, we will back-end the coupon and so on,” she said.