THL Credit Advisors is joining the growing group of credit managers that have formulated an environmental, social and governance investment framework. THL is applying the ESG framework across its bank loans, high-yield, collateralized loan obligation, and direct lending portfolios.
"We believe that ... integrating ESG considerations has improved our investment process and provided a more comprehensive framework for the firm's portfolio managers and credit analysts to consider potential risks that could affect the performance of companies and issuers," Brian Good, co-head of THL Credit's Tradable Credit team, said in a release.
Much of THL's ESG investment framework is consistent with the United Nations–backed Principles for Responsible Investment, or PRI. About 20 CLO managers across the U.S. and Europe have committed to the PRI, according to Moody's analysts led by Frank Cerveny.
ESG made inroads in the European market in 2018, with CLO managers Permira Debt Managers Ltd., Bardin Hill Loan Advisors (UK) LLP, and Fair Oaks Capital Ltd. issuing ESG-compliant CLOs. That push has also come as a number of European pension funds have increasingly shown interest in ESG criteria.
More CLO managers in the U.S. have followed suit, including Partners Group, with its most recent Pikes Peak 4 CLO, as well as MJX Asset Management LLC, with its Venture 38 CLO in July.
Current CLO exposure to non-compliant issuers
Moody's analysts in August examined several of the ESG-compliant CLOs and found that negative ESG criteria would have a limited credit-related impact on CLOs, mostly because the percentage of loans in industries that would be affected remains relatively small. Among the few ESG CLOs Moody's has rated so far, sectors that would be prohibited include oil & gas extraction, weapons, pornography, tobacco, and gambling.
Within existing CLOs, loans in the hotel, gaming, and leisure industry would stand to face scrutiny, but still only make up about 2.87% in European CLOs and 1.96% in U.S. CLOs, according to Moody's. However, while the average exposure to potentially restricted sectors remains low, Moody's also found that 5%-7% of some European CLOs hold debt that would not be ESG-compliant, while a handful of U.S. CLOs hold between 7%-11% of such names.
A key to the growth of more ESG-compliant CLOs, though, will be the growth of ESG-related leveraged loan issuance, given the challenges CLO managers already face in sourcing attractive collateral into their portfolios. This would only dwindle further with the application of negative ESG criteria.
In anticipation of more future ESG-related issuance, attorneys at White & Case last week published a report detailing the different forms of ESG-compliant CLOs that could be expected in the coming years, whether they be corporate credit CLOs with both negative and positive ESG criteria, or Sustainable Development Goals CLOs, with loans made specifically to clean energy, infrastructure, and/or microfinance borrowers.
Some $83 billion of CLOs have been issued in the U.S. so far in 2019, according to LCD. More broadly, CLOs account for roughly 60% of the nearly $1.2 trillion in outstanding U.S. leveraged loans. In Europe, there has been more than €20 billion in new CLOs issued so far this year, ahead of the pace established in 2018, which set a full-year record for European CLOs issued.
