A funded term loan backing Carlyle Group LP's acquisition of a minority stake in Jeanologia SL is thought to be the first European sponsored transaction with pricing on the funded debt directly linked to environmental, social and governance criteria.
While the equity markets have considered ESG for some time, the idea of integrating ESG criteria into a leveraged credit deal structure is relatively new.
Jeanologia creates clean technologies for manufacturing denim, focusing on eliminating the use of water and avoiding toxic waste. The company has agreed to a new euro-denominated holdco term loan B with a margin directly linked to a sustainability performance indicator produced by the company, related to its water-saving processes. If the firm meets its target for the annual water savings by the installed portfolio of Jeanologia technologies, the margin ratchets tighter, while if the target is missed by 15% or more, the pricing ratchets upwards.
The company's sustainability performance indicator is a pre-existing key performance indicator decided by the management team each year and communicated to lenders alongside the firm’s budget. The indicator is then tested at the end of the financial year.
Those close to the deal note there was no pricing premium on the transaction, which was arranged by Credit Agricole CIB and ING, but that the deal priced in line with the market, with the ESG margin ratchet laid overtop.
Jeanologia was founded on the basis of improving the environmental impact of the garment industry. The firm uses laser, G2 ozone, and e-flow systems to design and finish garments, to save water and energy and reduce reliance on chemicals. Its technology is used to create roughly 15% of the 6 billion jeans produced each year. In 2018, the firm's processes saved roughly 10.7 million cubic meters of water.
"For this company, ESG awareness is ingrained in its DNA," said Sam Lukaitis, an associate director in the global capital markets team of sponsor Carlyle Group. "It performs from both an environmental and an economic point of view. The water and electricity it saves and the waste it prevents all flows through to its bottom line. The ESG performance of this business is unambiguously tied to its economic performance."
While Jeanologia may be a good candidate for the first reported example of ESG-linked pricing for a sponsored deal, market participants say more private equity-backed names might structure similar green financings — although in the near term, this is more likely to be in the form of revolving credit facilities than funded term debt, with issuers leveraging their relationship banks.
"Many companies are now looking into reducing their environmental footprints, so it could certainly be translatable to set targets for that and link it to pricing," said Lukaitis. "If a company can demonstrate the importance of their environmental focus, it could be structured into a deal."
Certainly, ESG factors are increasingly important for European leveraged finance investors. According to the results of a survey by the European Leveraged Finance Association, or Elfa, on investors' views of ESG disclosure, risk and analysis, some 53% of respondents noted that these factors were very important when making investment decisions in high-yield, leveraged loan and private debt. A further 27% responded that ESG was "extremely important" to their credit decisions.
This year, the market has also seen the launch of the first ESG-linked collateralized loan obligations, which will not invest in issuers whose primary activity is tied to certain industries and practices, including oil and gas extraction, coal-fired electricity generation, hazardous chemicals, tobacco, or weapons and firearms. This approach is based on negative screening, however, whereas Jeanologia's deal looks to reward investment in companies striving toward bettering their ESG criteria.
Similar thinking is seemingly feeding through to all areas of the market, with arranging banks reportedly incorporating ESG factors into their underwriting decisions, and sponsors increasingly reflecting the concerns of their own LPs.
"We are now at an inflection point in the market," Lukaitis said. "ESG is so relevant to us as a global private equity house. The equity investors in our funds are very interested — they're perhaps more advanced than the credit markets in their thinking about and focus on ESG."
Carlyle announced its acquisition of a significant minority stake in the Spanish company from MCH Private Equity in March, and the financing was completed earlier in the year with the arranging banks. MCH retains a minority stake in the company. The sponsor's investment is expected to support the company's expansion plans, which will see the firm's spending on research and development double over the next three years.