ESG provisions in CLO documentation evolve as demand grows

Roughly 12% of European CLOs that priced in 2021 included a commitment in the documentation to carry out ongoing reporting for environmental, social and corporate governance, according to Review Port, an independent documentation research firm.

This figure includes those managers that have committed to disclose ESG scoring as well as those that have committed to general publishing on their ESG credentials.

The rapid growth of ESG provisions in European CLOs has been one of the key themes of this market in 2021. Still in its infancy, ongoing ESG reporting is one of the next steps, with negative screening in the form of ESG eligibility criteria now firmly market standard.

Review Port's figures are based on a sample of 182 European CLO deals, comprising predominantly new issues and resets, which also showed that 35% of CLOs pricing in 2021 adhered to UN Global Compact Principles, according to the research firm.

As for negative screening, CLO managers that have spoken to LCD concur that in 2021, investors were increasingly requesting what they wanted to see in ESG eligibility criteria language. As more specific requests come in from different investors, the job of harmonising those requests has become a taller task for managers.

Among the business activities that often feature in exclusion language — a laundry list that typically features areas relating to tobacco, weapons and coal — gambling is likely the most relevant sector for the leveraged loan market, given the number of gambling companies that are loan borrowers, with some managers describing this area as the next frontier for ESG in CLOs.

As yet, there has been no meaningful push from CLO investors to exclude gambling from CLO portfolios, aside from a handful of investors from specific regions, LCD understands. Indeed, only roughly 14% of CLOs analyzed by Review Port that priced this year have included blanket exclusions for gambling companies in their documentation.

There are certainly differing views in regards to gambling and gaming, with those seeking to market themselves as more ESG-heavy most likely to include wider restrictions, and some going as far as to predict that gambling companies will eventually be pushed into the direct lending space, however this is not a common view shared by managers.

For those managers that invest in gambling and gaming, some have argued against the route of blanket exclusions, preferring instead to take a more detailed approach to assess if a company is providing entertainment or, at the other end of the scale, taking advantage of customers.

"Exclusion language is getting along the right lines and is well considered, increasingly focusing on the quantity of revenues; however, gaming is hard to write around," one manager said earlier in the year. "Nevertheless, we've had more conversations about gaming over the last year."