The Carlyle Group has launched one of the US private credit market’s first sustainability-linked loan programmes, offering middle-market credits a pricing benefit for committing to reduce their emissions or embed other climate-related performance indicators.
The private equity and debt giant's “decarbonisation financing programme” aims to incentivise a borrower group with often little grasp of its carbon footprint to invest “sweat equity” in calculating and then reducing emissions profiles, according to Megan Starr, global head of impact at Carlyle.
Carlyle has not disclosed the size of its programme, which it says “represents the latest step in [its] ongoing efforts to drive progress in energy transition”.
To qualify, borrowers must usually submit an externally verified carbon footprint within six months of signing a loan with Carlyle, which manages US$143bn in credit, including direct lending. Its credit business is separate from its PE operation.
Carlyle will then pick and monitor appropriate KPIs with borrowers. Its ESG team will work with companies to achieve the sustainability performance targets embedded in their loans.
Targets will be set at “the intersection of ambition and feasibility”, Starr said. “We have to meet companies where they are.”
Companies will not be penalised for missing the targets embedded in their loans. But in what Starr terms a “carrot approach” they will rewarded with lower pricing for achieving them.
Targets will be grounded in climate science. They will not be based on a single methodology such as the Science-Based Targets initiative, however. None is comprehensive enough to encompass all potential sectors, the firm said.
Carlyle’s motivation behind the programme is two-fold.
First, the programme should improve the credit profile and lower the risk of its portfolio. “We see in the data that companies that are setting and achieving emissions-reduction targets, and that are seen as being on the forefront of the energy transition, are increasingly outperforming,” Starr said.
Second, the programme should provide a competitive advantage. “Borrowers are really struggling with the cacophony of carbon demands coming at them from different stakeholders,” such as customers, sponsors and employees, Starr said.
Taking a private SLL that provides a financial benefit for resolving this “carbon conundrum” represents “a really interesting constellation of stakeholder alignment”, she added.
The firm will also gain access to rare data. As a non-controlling asset class, credit has lagged PE’s ability to collect ESG data and incentivise improvements in ESG performance.
Starr notes the “extreme paucity of any sort of [ESG] data on the private credit side” and describes the loan programme as a “Trojan horse” for obtaining actual carbon emissions data.
Carlyle has already inaugurated the facility with loans to two PE-owned companies. They are to a buyout of Fairway Lawns and a refinancing of The Carlstar Group, a speciality tyre and wheel firm. Morgan Stanley Capital Partners closed the Fairway deal in May, where management invested alongside the middle-market PE firm. American Industrial Partners has owned Carlstar since the end of 2013.
Carlyle did not reveal the size, maturity or structure of either loan, citing client confidentiality. It was the lead investor and administrative agent on both borrowings.
The new programme follows Carlyle’s launch in May of an integrated platform for investing in “emerging opportunities” from energy transition. The platform has 38 portfolio investments across renewable energy, thermal power, upstream, midstream and downstream oil and gas, digital infrastructure, and transport.
It appointed Macky Tall, chair of its infrastructure group, to lead the initiative.
In February Carlyle, which has been measuring Scope 1 and 2 emissions from its buyout portfolio for three years, announced a target of reaching net zero by 2050 or sooner.
It also committed to 75% of portfolio companies’ Scope 1 and 2 emissions being covered by Paris Agreement-aligned climate goals by 2025. After 2025 all new majority-owned portfolio companies must set Paris-aligned goals within two years of ownership.
In 2021 the firm co-led the creation of the ESG Data Convergence Project. It says that its bottom-up carbon footprinting of portfolio companies is helping “create and execute increasingly more effective decarbonisation strategies across investments”.