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CLOs have been engaging in ESG long before the term arose through negative screenings and exclusionary criteria. Since 2021, the process has become more formalised and market expectations and regulatory changes have solidified ESG as a fixture in the asset class. Although not without its challenges.

9fin sat down with the head of ESG at Polus Capital, Tina De Baere, to unpack the role of ESG in the CLO market. She discusses challenges that the CLO market has with integrating ESG into processes, including data gaps, long term engagement, and lack of clarity from rating agencies.

1. How has the integration of ESG considerations evolved in the CLO market over the past few years?

Polus’ leveraged credit team has been managing CLOs since 2006, and today the CLO platform has around $5.5bn in AUM across 13 CLOs. Having been in this space for almost two decades in Europe, we have seen ESG considerations increasingly incorporated into the documentation governing what a CLO manager can purchase.

Since 2021, these considerations have further evolved, with European CLOs now often being restricted from lending to companies in specific industries or involved in certain business activities. This list of exclusions has grown over time, with restrictions now typically linked to defined company revenue thresholds. Since last year, ESG considerations have expanded to exclusionary language towards companies which have violated specific international standards (eg. UN Global Compact Principles, International Labour Organisation’s Conventions) for human rights or responsible business conduct. Collectively, these changes reflect the growing influence of investors in the CLO market driving more comprehensive ESG standards.

2. How does ESG integration in CLOs differ to private credit?

The development of ESG integration in the private credit market is happening at a slightly slower pace compared to the CLO market or the broadly syndicated loan market. This is largely because private credit often involves smaller or privately held companies that may be earlier in their ESG journey, with limited resources and less established ESG reporting practices. Therefore, the availability and quality of ESG data in private credit can vary significantly, calling for a more bespoke approach to ESG integration within this space. This can include direct engagement with borrowers to encourage improved ESG practices.

3. What are the main challenges CLO managers face when implementing ESG strategies, particularly regarding data quality and standardisation?

One of the main difficulties for CLO managers is obtaining ESG data in a standardised format. At Polus, we provide investors with an annual ESG and carbon footprint report for all European CLOs on the platform. This requires standardised data to enable accurate ESG scoring for each borrower in the portfolio and consistent portfolio-level reporting for investors.

Across our CLOs, we source approximately 30% of greenhouse gas emissions data directly from portfolio companies, around 40% from external data vendors, and the remaining 30% are internal estimates. This highlights the industry's reliance on a mixture of sources, each with varying degrees of reliability, which can make it challenging to ensure data consistency and accuracy. However, ongoing advancements in data disclosure and standardisation are helping to address these challenges.

4. How do you balance ESG considerations with the need for portfolio diversification in CLOs?

ESG considerations are part of the decision-making process, allowing us to assess a broad range of investment opportunities that align with such considerations. At Polus, we do not believe in the outright exclusion of companies that hold low ESG scores. Instead, we believe in the ability to drive positive change within such companies, and often directly engage with them to better understand what is driving their ESG scores. We also actively engage with borrowers to encourage better ESG practices, and that helps to maintain diversification within the portfolio.

5. What does that engagement look like in practice?

The first step is to identify where a portfolio company is within its ESG journey. We review all ESG data received from the portfolio company, such as a completed European Leveraged Finance Association (ELFA) ESG fact sheet. Following this, we identify any gaps and begin engaging with the portfolio company on data disclosure. Once we are confident that we have the right data, we are able to evaluate how the company performs relative to its peers. If we identify any weaknesses relative to its peers, we typically follow up with questions about the company’s strategy and plans for improving those weaknesses.

6. What impact has the EU's Sustainable Finance Disclosure Regulation (SFDR) had on the CLO market, especially regarding Article 8 and 9 products?

Under the EU SFDR, CLOs are generally not considered to be financial products and are therefore unlikely to fall directly within this regulatory scope.

Despite this, we have seen a growing number of CLO investors requesting reporting that aligns with Article 8 requirements, particularly with respect to the disclosure of Principal Adverse Impact (PAI) indicators. Since 2022, CLO documentation has increasingly included language that encourages CLO managers to provide a Principal Adverse Sustainability Impact (PASI) statement, which is predominantly a standardised set of ESG metrics established by the EU regulator. Completing this PASI statement requires significant resources, assessing on average around 200 borrowers in a typical CLO portfolio, along with navigating the limited availability of data for all the specified metrics.

We have seen the emergence of a few “Article 8-aligned CLOs” that promote certain environmental and social characteristics and follow reporting practices similar to those required for Article 8 fund products. This development shows the growing demand from investors for greater transparency and ESG alignment, even for investment products that are not formally covered under the SFDR.

7. Are there any industry level initiatives that are working to improve ESG considerations in the CLO market?

There are several industry-level initiatives aimed at enhancing ESG integration in the CLO market. I am co-chair of ELFA’s ESG committee, which has over 100 individual members across more than 40 different investment firms. Additionally, we have achieved important progress with the development and the launch of the ELFA ESG fact sheet series.

These ESG fact sheets assist borrowers in preparing ESG disclosures by highlighting the most material ESG topics for a given corporate sector. As a result, new deals are now typically launched with a baseline level of ESG data, provided by borrowers through the completion of these fact sheets. This initiative has established a standard for ESG disclosure across the loan market, enabling analysts to conduct a more thorough ESG analysis at the underlying loan level for CLOs.

Another important initiative is ELFA's CLO manager ESG questionnaire, which was developed by ELFA's CLO investor committee. This questionnaire highlights that CLO manager-level ESG activities are also a key area of interest for CLO investors, covering topics such as the carbon footprint at the manager level (covering scope 1, 2 and 3), and has questions on TCFD reporting and DE&I activities, including diversity statistics at both the firm and investment team levels. The questionnaire also helps to standardise expectations and encourages greater transparency around ESG practices at the CLO manager level.

8. Looking ahead, how do you envision ESG integration in CLOs evolving over the next few years?

With the implementation of the Corporate Sustainability Reporting Directive (CSRD), which mandates sustainability reporting for portfolio companies, we anticipate progress in ESG integration for CLOs over the next few years. While there are some initial challenges associated with the CSRD, we expect that once these are resolved, it will not only increase the volume of available ESG data but also improve its standardisation and quality. This, in turn, will enable more consistent and comparable ESG assessments across companies. It may take a few years, though, before we fully reap the benefits of this corporate regulation.

9. Outside of your role at Polus, are there any other interesting projects you are working on?

I'm actively involved with the PRI Structured Products Advisory Committee, where we’re working on several exciting securitisation initiatives. That's how I started my career within securitisation, hence the ongoing passion for the asset class. We're also working on projects specifically focused on CLOs and the plan is to deliver some impactful developments in the near future.

I also really enjoy working with a UK-based social mobility charity called Fairfield Enterprise. They're dedicated to helping ambitious 19 to 24 year-olds from low-income backgrounds who are keen to build a successful career in finance. Polus collaborated with Fairfield to launch its summer internship programme in 2023, offering interns the opportunity to rotate across various teams in our London office over an eight-week period. This year, we have expanded the programme to provide even more support for intern candidates.

In addition to the interview process, we now invite candidates to spend half a day at our office where they can meet Polus employees from different teams. They can also receive tailored CV advice and industry insights, engage in networking sessions, and build valuable professional contacts in the industry.

Therefore, even if a candidate does not secure an internship with Polus, they still gain meaningful experience, practical guidance, and connections to help them pursue future career opportunities. Several colleagues and I volunteered to devote our own free time to this initiative, and it has been incredibly rewarding to see the positive effect on these young adults and to contribute to efforts that actively promote diversity and inclusion in our industry.

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9Questions — Tina De Baere, Polus Capital — ESG a fixture in CLOs

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