TwentyFour Asset Management
2019 has been a year of great development on the Environmental, Social and Governance (ESG) front. Demand for ESG products has grown exponentially, driven by more and more investors seeking to align their investments with their core beliefs.
In the asset-backed securities (ABS) space, rating agencies have recently started to develop an ESG framework and embed it in each transaction analysis, in response to investor demand for increased market transparency and more robust reporting on how ESG can affect credit risk.
We thought it was important to highlight another sign of progress in the primary market this week, with NIBC Bank issuing the first collateralised loan obligation (CLO) to consider ESG factors across all its investments. Since the beginning of the year, CLO managers coming to the market have been including ESG language in their investment criteria more commonly, excluding companies whose business is directly derived from the production or marketing of controversial weapons, the development of nuclear weapons, and thermal coal production, among others. This so-called negative screening is widely considered the first pillar of responsible investing; it’s the easiest to apply and therefore the most popular approach used by investment companies. But while we consider this approach better than nothing, we did not consider these CLOs to be ‘ESG CLOs’.
NIBC, though, has been involved in ESG/CSR focused lending in Europe for some time, and is the first manager to issue what we might call an ‘ESG CLO’ – the €410m North Westerly VI CLO, priced on November 18. Along with the first layer of negative screening, every loan in the pool has an ESG score which is a combination of two scores, a sector specific score and individual asset/borrower score. The overall assessment uses a mix of third party data and internal tools. Each score is dynamic and is monitored and updated on a regular basis, as a result of developments in the industry and engagement with the management. The last step in the process is the reporting, and we believe this innovation could enhance transparency in the loan market. Every quarter the trustee report will show the industry breakdown by ESG impact and portfolio breakdown by ESG scoring profile, which allows investors to track and question the underwriting of NIBC. In addition, the report will contain the weighted average ESG score of the portfolio and a comment regarding its evolution.
We looked in detail at NIBC’s process and we appreciate the effort and commitment it has shown in leading the industry on the right path. As a large CLO investor, we carefully assess deal governance and alignment of interest between parties is crucial for us; we typically engage with an issuer at an early stage to push for a structure and documentation language that is more protective for bondholders. In 2019, BBB- ratings have become the norm for the ‘BBB tranches’ of many European CLOs, which in our opinion has been the result of weaker deal economics forcing sponsors to look for more leverage. We haven’t been a fan of this, since secondary liquidity in BBB- rated bonds tends to be worse. This was initially also the case for the new NIBC deal, but after investor feedback NIBC reduced the leverage in the transaction, resulting in an “upgrade” of the initial rating to BBB. This was widely appreciated by investors, with pricing moving significantly tighter as a result, and was also in line with our current preference for liquidity and credit strength over stretching for yield.
This is not something that every manager has been willing to do. As debt investors we look at this behaviour very favourably, and we will always support managers listening to their investors. As far as ESG is concerned, NIBC as a CLO manager would receive a high score from us.