1. How do the incentives for ESG integration differ in private credit compared to the syndicated market or private equity? What makes private credit distinct?

The main difference between the two markets is the lack of ownership in private credit. We are lenders, not owners, and so to generate impact there needs to be a strong alignment of interests between the borrower and lender to implement a strategy of ESG integration.

At Kartesia, we have SFDR article 8 strategies as well as an impact strategy, which is SFDR article 9. Our impact strategy is built around two themes — a healthier planet and a better society. We perform full due diligence on companies to create an ESG action plan which includes 10 KPIs to improve sustainability. The two most relevant KPIs are linked to margins, which are supplemented by an annual carbon footprint assessment with guidance on how to reduce emissions.

Collectively, this ESG roadmap combined with insights on carbon emissions and an effective reduction plan provides the potential to de-risk business operations and accrue value over time. The financial incentives we offer through sustainability-linked loans (SLLs) are material and downward only — so the carrot without the stick — to drive stronger alignment between parties.

2. How can private credit funds grapple with the tension between ESG metrics and financial metrics, especially at a time when lenders have dry powder to burn and deals are few and far between?

What we see at Kartesia is that, even with there being dry powder, portfolio companies appreciate that ESG metrics are here to help them. Five years ago there could have been some tension, but today almost all European SMEs understand that they need to work on ESG targets to get insurance, to get loans, to recruit employees, and to find new distribution channels.

Regulation in Europe has been effective in making this message clear, and in subsequent years regulation will only become more encompassing. With Kartesia’s ESG focus, it really gives us a competitive advantage when working with European SMEs. Both the portfolio companies and the sponsors want to partner with us as they know we can help them develop their ESG strategies.

For example, new sustainable reporting regulations (CSRD) are due to come into effect for European corporations in the 2024 financial year. We are already recommending consultants to our borrowers that can help them with the processes involved in CSRD, as well as carbon footprint consultants that offer a discounted price through us. They see us more as a partner than a lender because of this.

3. Private credit is by nature a fairly opaque area of financial markets. How does limited market data affect the use and comparison of ESG data and targets?

I think over the past 12 months access to private credit data has improved significantly and there is a general convergence on the key focus areas of data collection, but it is still a work in progress. At Kartesia, we deal with this through several methods.

Firstly, we recognise that what is ‘impactful’ for one company may not be the same for another, even in the same sector, due to differences in scale and operations. So we prefer to build unique ESG action plans and KPIs for each company so that we can focus on driving the most impact for that individual business.

That said, we also recognise that there are convergences in some data points, like employee turnover rates, gender pay gaps, and board compositions, that need tracking. Kartesia does this annually through Reporting21, a platform for reporting sustainability metrics that has become the industry-standard across Europe. Not only does this allow for a more general comparison of data points across companies, but more importantly, the progress the company is making to its own baseline.

Third, we help companies find ways to better track metrics. For example, we work with a carbon footprint assessor that we offer to all of the portfolio companies of Kartesia, giving them a means to calculate complex ESG metrics without having to build an in-house team. This is often vital to businesses in the low-to-mid market, where they may not have in-house ESG functions or expertise.

4. 9fin has developed an ESG screener tool* that lets you compare ESG data points across sectors. Could this be a useful tool in solving the ESG data challenge in private credit?

Of course. The biggest challenge with ESG data is ensuring small-sized businesses are accounted for, it can be very difficult to get a full picture of ESG metrics at smaller companies. So any tool that provides a comparable, sector-based overview that can be applied to smaller companies lacking in data could be a real help.

(*9fin’s new ESG screener tool enables users to compare SFDR-aligned data points across industries. The screener solves the issue of data being inaccessible and incomparable outside of individual portfolios, allowing 9fin clients to compare data across the leveraged finance universe and understand the most material ESG considerations within a given sector.)

5. Touching on sustainability-linked loans (SLLs), are they a tool that Kartesia uses, and do you think it's a good fit for the sector that we'll see more of in future?

We use SLLs in our impact fund’s strategy and I expect we will start to see them more and more in private credit, but for now our main tool remains ESG engagement plans.

SLLs reduce financing costs for companies that meet KPI targets, which definitely provides an incentive, but it needs to be built around an ESG improvement plan that involves committed and ongoing engagement with the company to be truly effective.

6. How does Kartesia engage with sponsors throughout the lifecycle of a loan on ESG targets?

Sponsors can be a huge support for us when we are aligned on interests. During the due diligence phase for any of our deals, we check if the sponsor has signed the United Nations Principles for Responsible Investment (UNPRI), if they implement a responsible investing policy, if they have an ESG team, and if they are SFDR Article 8 or Article 9.

Once we reach the holding phase, we see them as a partner to engage on ESG with for their portfolio companies. For example, if they use an annual ESG questionnaire we will consolidate that tool within our own questionnaire. We also share our experience, network, and best practices.

But this isn’t just about Kartesia, I see private equity sponsors and direct lenders aligning on standardised ESG disclosure and sharing best practices a lot these days. Within ESG, people tend to collaborate and share resources quite willingly as we all want to improve together - not compete - in this area.

7. How do you make use of the flexibility inherent to private credit deals? Do you structure ESG-related covenants into deals? If so, how?

At Kartesia, deal structures retain all of the flexibility associated with private credit — bullet repayments, further committed facilities to support growth, sensible covenants and speed of execution.

For efficiency and to drive the most impact, downward margin ratchets are only linked to the two KPIs which drive the most impact for that business.

We also tend to take a board observer seat on the companies we lend to, allowing for greater visibility on progress and more fluidity with our support.

8. It seems clear that ESG integration into private credit will only accelerate in the coming years. What do you think are the most important things to consider in this growth so that ESG doesn’t become a simple box-ticking exercise?

At Kartesia we believe in leading by example. It’s true that in the ESG space there is a tendency to focus too much on questionnaires and not use data. We try to avoid this by leading by example, so anything we ask of our portfolio companies, we do ourselves.

In practice, this means always trying to be best in class in whatever metric that might be — climate impact, diversity and inclusion, and so on.

Another key development will be an acceleration in ESG regulation. The recent sustainable finance disclosure regulation (SFDR) in Europe really changed the practices of all private equity and private debt funds, I expect to see more far-reaching regulation in the coming years.

Last, I think artificial intelligence will improve existing applications for ESG and push open new doors for it to expand into. Some market players are already developing AI capabilities, and I think it will be easy to integrate these into how we collect, use, and compare ESG data.

9. Outside of ESG, what has been a recent personal achievement that keeps you motivated?

My greatest achievement to date is definitely my 20-month-old son! He’s an expert in imitating animal sounds, loves trainspotting, and calls me papa!