Park Square Capital, a US$10 billion investor in private credit, is a signatory to the UNPRI.

ESG in private credit deals is making steady progress as investors wise up to the risks from ignoring Environment, Social, and Governance (ESG) criteria.

“For us there’s limited upside and potentially a lot of downside if there are ESG issues when we’re investing,” said Robin Doumar. He is a co-founder of independent debt provider Park Square Capital.

The company is one of the biggest non-bank lenders to private equity in the US and Europe. Mr. Doumar was speaking in an interview with Bloomberg.

ESG in private credit: Example of PG&E

A potent example is the credit performance of utility company Pacific Gas & Electric. The rating of the company crashed from investment grade to a bankruptcy filing after the California wildfires in 2018.

Further, climate supporters allege the company sacrificed safety at the altar of safety and is responsible for the fires.

This example shows how managing environmental risks (the ‘E’ in ESG) is crucial to the borrower’s credit risk.

How does Park Square handle ESG?

“We think about an ESG risk if it really has the ability of impacting the performance or the value of the business,” said Mr Doumar. “Given our credit focus, the key decision point for us is really at initial investment.”

However, the company passed on companies engaged in weapons manufacturing, price gouging, or having links to corruption or bribery.

On the other hand, Park Square welcomed the ESG angle in private credit deals in business services, healthcare, and those related to infrastructure.

US credit rapidly becoming ESG-friendly

Mr. Doumar’s views tie in with those of Teresa Cutter, head of sustainable investing at San Francisco-based direct lender White Oak Global Advisors. White Oak has $6 billion in AUM. It was an early adopter of ESG principles in 2015.

“There is a growing ‘greenlash’ in the US against current policies with respect to the environment, and we are seeing a meaningful uptick in interest in ESG from public and private investors,” she said in August.

ESG in debt: Green bonds taking off

According to the Climate Bonds Initiative (CBI), the market for green bonds, which are issued by companies to finance various environmentally friendly projects, has quadrupled in the past five years.

For instance, in 2018, the issue of green bonds touched a record $167 billion.

However, 2019 will likely dwarf 2018. In the first six months of the year, green bonds have already scaled $100 billion.

Park Square on the current private credit environment

“The deal quality is very high, but the purchase prices of the transactions are also historically high, and that’s particularly true for high-quality businesses,” Mr. Doumar said.

Mr. Doumar said it was hard to generate large returns if PE deals structure, for example,  at 15.5x EBITDA with half the capital structure in equity.

“So what you’re likely to see is compression of equity returns,” he said. “And so on a risk-adjusted basis, both senior debt, but particularly junior debt on a relative basis are very attractive.”

[Related story: Goldman CEO David Solomon: Time for ESG Investing to Go Mainstream ]