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The ongoing energy crisis has caused a tussle between government policy and ESG mandates. The German government, for example, has swallowed the bitter pill of allowing coal-fired power back onto the grid. Alongside that, the FT estimates that European governments will spend at least €50bn this winter on new fossil fuel infrastructure and supplies. As a cold winter approaches, and gas shortages continue, it will be interesting to see how governments and investors re-evaluate their ESG priorities.
Wood Pellets
After issuing a sustainability-linked bond (SLB) in October 2021, Apollo backed Graanul Invest had already achieved its set target by year end - three years prior to the testing date. The group is not required to maintain its KPI once achieved, and therefore any future deterioration of the sustainability performance target (SPT) would not trigger the penalty.
As shown below, the target involved a 5% reduction in the carbon dioxide footprint of pellet production vs a 2020 baseline. Sustainalytics, which provided a second party opinion, claimed the SPT showed a moderate level of ambition based on historical performance. Yet we find the group decreased their footprint by 3.25% and 5% in FY 19 and FY 20, therefore a 5% reduction across the next three years seems achievable.
Both the fixed and floating rate notes held a hefty 75bps coupon step-up if the borrower failed to achieve the target - the largest seen in the HY universe. This point aside, Graanul would have known how achievable the target was, and could set the penalty accordingly.
Source: Graanul Invest SLB Adjustments, 9fin.com
A Panorama investigation released in early October uncovered that Drax, a renewable energy producer, was cutting down primary forests in Canada in order to produce wood pellets. Graanul came under the spotlight for similar allegations in July, after the NRDC issued a report on biomass sourcing in Estonia. Interestingly, both companies have close ties. Graanul supplied between 2-11% of Drax’s woody biomass imports between 2014 and 2018 and since then, Drax has continued to import wood pellets from Estonia.
To make matters worse, it was uncovered that Drax has received £6bn in green energy subsidies from the British taxpayer to date.
High yield investors seemed pretty unfazed from the reports, with prices on both Drax and Graanul bonds hardly reacting. To reassure lenders, Graanul released a statement claiming NRDC published wrongful accusations, whilst Drax denied cutting down primary forests and claimed the Panorama documentary was focused primarily on the ‘views of a vocal minority who oppose biomass’.
A more in-depth report on these events will be available for 9fin users in the coming days. Private E(SG)quity
The damaging accusations on Graanul doesn’t bode well for its ESG credentials. We also found that Graanul 2021 sustainability report filed in August, uncovered (or failed to cover) other concerning ESG policies. As noted in our QuickTake, “ESG reporting worsened in 2021, publicly reporting none of the standardised metrics 9fin assesses and providing no information on gender or ethnic diversity”. Apollo will be keen to improve reporting standards following their commitment to disclose more stringent ESG data for their portfolio companies. (If you are not a client but would like to request a copy of our ESG QuickTake on Graanul Invest, please complete your details here.)
Our in depth review of ESG data amongst issuers found that generally LevFin borrowers lag their investment grade counterparts. Of the 11 key datapoints we tracked, companies reported 4.97 on average. The report does note however that PE backed companies had slightly better reporting than non PE-backed private companies, but fall short of public companies. (If you are not a client and would like to request a copy of this report ESG within LevFin - Initial insights from issuer data, please complete your details here.)
Sponsor-backed borrowers aren’t just improving their ESG disclosure, we’ve also found they are disproportionally issuing green debt. Of the 62 sustainability-linked loan (SLL) deals recorded to date, 79% of them are sponsor-backed. In comparison, only 31% of SLBs were issued by private equity led borrowers.
Whilst SLLs have the added benefit of lowering interest rate costs (unlike SLBs), they also help private equity houses achieve KPIs set on their own sustainability-linked debt. Carlyle for example signed a €2.3bn ESG-linked credit facility last September with KPIs relating to board diversity, climate change and the improvement of ESG outcomes across their portfolio companies. Carlyle-backed Logoplaste & Nobian’s KPIs related to the reduction in CO2 emissions and Theramex’s targets were linked to board diversity. You can see how these targets align with the Sponsors own KPI goals.
Carlyle has been the most active in the LevFin market, with seven of its portfolio companies issuing sustainability-linked debt to date. The next runner-up is CVC with six deals and Apollo & EQT with five.
Leveraged Loans
After a lull through the summer months, ESG-linked financings are finally picking back up. Accell Group, a Dutch bicycle manufacturer, got the ball rolling with a €700m sustainability-linked loan. The loan hit the market to mixed reactions from institutional investors, showing the level of uncertainty around price discovery in the leveraged loan market.
The TLB features a 15bps sustainability-linked ratchets, although none are science-based net-zero or carbon neutrality targets. The KPIs are linked to renewable energy usage, increased diversity of management, and increasing the amount of total audits on outside suppliers. Accell group has already made efforts to reduce carbon emissions in operations, with nearly 100% green electricity usage at its manufacturing units expected by the end of 2022, which contributes 71% (Bikes segment) of the net revenue. This makes the margin KPI “increase the proportion of renewable energy from 50% to 99% by December 2025”, seem like a deceptively easy target chosen by the company to reduce interest payments.
Buysiders we spoke to questioned if the company was doing enough to merit the ESG badge, stating “Yes, the product they are selling has ESG tailwind, but how are they performing relative to their sector?”. The company already has an “inherent” ESG angle due to them being a bicycle manufacturer. Clients can read our full ESG QuickTake for Accell group here or you can request a copy here.
Elsewhere in the market, Inetum incorporated four KPIs into its €600m TLB which helped fund Bain Capital’s buyout of the business. Another sponsor-led green financing. Interestingly, the borrower did not include sustainability-linked features into the bond portion of the financing, although this tranche was later removed. There hasn’t been much movement in terms of sustainable financing in the Software and Service industry, with no deals seen in bonds and only TeamViewer taking the plunge in loans in 2022. The LBO transaction comes with a 5bps margin ratchet, triggered if all four KPIs are achieved. Where two KPI targets are met and two KPI targets are not met, the margin will not be adjusted.
Despite the green financing commitment, a dark shadow looms over the company’s sustainability. The group is currently being investigated by the Basque Competition Authority for allegations of bid-rigging practices in connection with eight public tender offers to a total value of €2.4m. Although the investigation is still currently in its early stages with no material findings, alarm bells were raised by some lenders with one buysider saying it is, “certainly a red flag”.
As reported in our ESG QuickTake, the company has chosen to focus two of its four KPIs on diversity as Inetum lags behind competitors in terms of Diversity, Equity and Inclusion (DEI) performance. Whilst Inetum has also included a KPI on reduction of CO2 emissions, they have failed to disclose emissions produced across their value chain which seems like a significant gap in reporting as they partner with various cloud computing providers that emit large amounts of CO2. (You can request a copy of Inetum's ESG QuickTake here.)
Software businesses have long been forgotten in the ESG landscape. Although they are leaders in sustainability reporting, with 83% of companies reporting sustainability in 2020, ESG issues are rarely being translated into financing. Most tech companies have carbon reduction targets in place, which is in line with expectations as these companies tend to emit large amounts of CO2 due to activities such as running cloud data centres. However, this has not been reflected much in the KPI targets set for the few SLLs, with only Inetum so far having a KPI related to carbon emissions. The industry has also had to face accusations of greenwashing, with companies using Sustainable Development Goals (SDGs) to create positive publicity for themselves instead of as a framework to deliver real change. Many companies have been caught reporting only positive SDG impacts and ignoring the negative, giving investors a skewed view on their sustainability efforts.
Chart: KPMG Survey of Sustainability Reporting at Technology Companies (2021)
In its ESG imperative for technology companies, KPMG states “86% of global tech executives believe the technology industry requires more regulation and standards in the area of sustainability and energy efficiency”. And whilst tech companies are amongst the best for sustainability reporting, these companies should be able to improve their emissions and sustainability efforts without the need for laws and regulators constantly watching over them. KPMG Global CEO outlook 2019 found that 74% of CEO’s believe it is their personal responsibility to ensure their organisation’s ESG policies reflect the values of their customers, so we will have to wait and see if these CEO’s are able to follow through on this statements.
Selected 9fin ESG Highlights
9fin’s ESG filter has brought to light some important social and governance-related news items from the previous month which are worth highlighting:
BBC Panorama uncovered that Drax has been cutting down environmentally-friendly forests in Canada. The company, which has received billions of pounds in green energy subsidies from UK taxpayers, told Panorama many of the trees there had died and that logging would reduce the risk of wildfires
Lufthansa experienced a wave of pilot strikes organised by the unions over wage disputes which resulted in hundreds of flight cancellations in early September. The company was able to stave off a second round of strikes after reaching an agreeable fiscal package with the unions
Maersk Supply Services, a subsidiary of Maersk, announced their intention to begin using biofuel across their global fleet. They plan to use Hydrotreated Vegetable Oil (HVO), a sustainable biofuel that replaces fossil fuels without causing harm or depleting food sources
