The corporate significance of ESG (Environmental, Social and Corporate Governance) principles is escalating at lightning speed, and with a growing precedence in the funding arena.

Driven in part by the ESG reporting obligations that are developing in the UK and Europe, compliance with ESG principles has been on the horizon for a number of years. However, the pandemic has brought into sharp focus for the finance sector the importance of delivering sustainable shareholder value and the need to prioritise our own ESG positions.

We are seeing an ever increasing number of facilities focus on measurable ESG targets. Whether they relate to carbon footprint reductions, diversity targets in the boardroom or sustainability & recycling targets, it is becoming clear that borrowers and lenders are shaping their future behaviour by linking ESG performance to financial metrics. The margin ratchet is certainly the tool of choice for now, however future development will follow.

The private fund markets are being ever more innovative with their investments options. ESG isn't a completely new concept to PE investors. The Walker Guidelines were introduced back in 2007, requiring certain PE firms and their larger portfolio companies to meet enhanced guidelines around transparency and reporting. Since then, we've seen a continuing commitment from the PE sector to demonstrate responsible investment, increasingly through specific social investment funds or “impact investing”.

In the year that will see sustainability disclosures start becoming widespread in the European Union and the FCA begin its consultation on the UK’s approach to climate-related financial disclosures, the importance of ESG to fund managers and investors has never been greater. The real trend is a move towards obligations with teeth. An increasing number of private equity and private debt funds are linking management fees and team remuneration to achievement of the ESG goals the fund is setting – and that is proving to be a real incentive for investors to invest. There is also a growing movement from in-house assessment of ESG performance to third party auditing with achievements assessed by a growing number of ESG auditors.

In turn, the fund managers – and the world of corporate finance more generally – are putting their own business dealings under increased scrutiny with a wholesale review of their governance strategies, requirements and structures. The boardroom of the future may still be under development, but it is clear that the value of solid governance structures and systems is a key element for companies wanting to make the most of the growing ESG focus.

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