Jessica Pyman, Control Risks’ Regional Head of Business Intelligence in the Asia-Pacific, sits down with Alexander Shaik, Partner of the credit fund ADM Capital, to talk about the fund’s ESG strategy.
Which guiding principles and standards do you apply to determine which companies to lend to and how to improve their ESG compliance?
Shaik: We start by reviewing restricted industries we just do not touch: sin-based industries, gambling, hard liquor, weapons and munitions, drift-net fishing, industrial deforestation in primary forests, other activities that cause environmental degradation, coal mining. This list broadly follows the IFC’s Exclusion List, with elements from FMO, the Dutch Development Bank.
Companies that filter through that are then examined by our Investment Committee. Our head of ESG sits on the committee as an observer, and she provides inputs from inception — looking at risks, at a company’s reputation, at how we can improve its performance.
Then, at the same time that we start our other due diligence streams, we will do ESG due diligence. An independent ESG expert will go out to the portfolio company, interview management, look at the premises and deliver an action plan to address any deficiencies against IFC PS and our suite of ESG policies. That plan is then encapsulated in our finance documents – the loan agreements, the facility agreements – and it has the same binding effect as the financial covenants.
Our ultimate objective is to use our debt to improve a company’s ESG performance and protocols — from the day we go into the day we go out, two or three years later.
We also hope to use the E&S data we collect from our companies to assess how they are doing but also to look at ADM Capitals E&S value add as an asset manager. We currently measure our operational emissions Scope 1, 2 and 3 emissions, such as electricity consumption, workers’ commutes and business travel. We are also measuring our portfolio emissions through collecting GHG emission data from our borrowers and using PCAF. We also monitor our Climate Value-at-Risk (VaR) using Intensel.
You seem to have standardised your environmental social-action plan and to work according to both a credo and a templated approach that draw on the Sustainability Accounting Standards Board (SASB) and the Principles for Responsible Investment (PRI). But the abiding challenge still seems to be the lack of consolidation there is across ESG criteria.
Shaik: We have a proprietary toolkit that our investment team use at an initial, concept note stage, based on the SASB Materiality Map and MSCI’s ESG ratings methodology. From there we manage each project to IFC PS, and the Action Plan is to address the gaps identified against IFC PS, so our own process is quite clear. We were the first Asian fund ex-Japan to sign up to the UN PRI and also are signatory to the UNGC, so we are aligned with international standards.
Is what you are asking portfolio companies to do onerous for them? How much resistance do you encounter?
Shaik: Our remit is the whole of the Asia-Pacific region; that covers a very diverse thematic and cultural mix. In the developed markets — Australia, South Korea, Japan, Hong Kong, Singapore — there is broader acceptance of ESG standards in the underwriting and the pricing of loans. In the emerging markets — Southeast Asia, India, China — there is less. We have to invest time in educating our borrowers. Even in developed markets, some are very entrenched in their ways. Having capital to deploy towards E&S considerations helps, obviously, but we have also noticed that almost universally the borrowers eventually appreciate the benefits that come from respecting standards.
It’s a little bit like going to the dentist. The experience can be quite painful; maybe you don't even want your teeth to be fixed. But almost always after the fact, you are glad you got it done. Not only do companies understand we are helping them — we are lending them money and fixing their teeth — quite a few are embracing our ESG and environmental and social management standards as good for business. They say, “I've done this, so why don't I put it on my website and advertise to my customers, for example, that I'm tracking my carbon emissions per unit output, which makes me better than my two competitors in Singapore?”
If you are borrowing at an interest rate in the mid-to-high teens, you will be looking to eventually refinance. If we can manage well our ESG stewardship of a company, the company will come out better positioned for that. The credit committees of mainstream banks and development finance institutions now reward companies that are well-run in terms of ESG: They fast-track them or give them an extra score on governance
How has ADM developed mechanisms that go beyond the differences among existing standards?
Shaik: One set of guidelines are the IFC performance standards — really, eight standards covering different industries. Those are quite a detailed toolkit and relevant across sectors and to an emerging market context, in particular. But within any given industry, there are different levels of risk.
How do you assess this at a portfolio level if your portfolio is always changing? The timeframe of private credit lending is quite different from other asset classes.
Shaik: That is challenging. In one period, we might be providing credit to services; in another, construction, which is heavier in carbon footprint. We need to identify benchmarks, and benchmarks that are geographically relevant. We do not compare an Indian agribusiness with a Japanese agribusiness because the two contexts are completely different.
Do you track what happens after you exit — after the companies have improved their practices and you have been paid back?
Shaik: We don't have the systems to do that. We are often invited to stay on company boards because of our helpfulness in governance. But we don't have the luxury of private equity, of being present for ten years with an ownership stake. We offer a short-term solution to companies until they can get back into regular banking channels. So our goal is always to leave a company a couple of levels better off on its ESG journey than where we found it.
Are there sectors you prefer to finance?
Shaik: Right now, we are sector-agnostic in our private credit portfolio. We launched last year a full sustainability-focused fund in Indonesia — the first sector-specific, thematic impact fund we have managed.
But the market is increasingly asking that E&S and specifically climate impact be measured across portfolio companies. If asset managers commit to net-zero targets, they will need to focus more on investing in low-emissions businesses or on appropriately pricing high-emissions ones. That is not happening yet, but we see this developing as a trend.
Would you say that a broader energy transition is going to be very difficult in Asia, because the markets here are starting from a different base than, say, those in Europe?
Shaik: Yes, Asia has a much larger greenhouse gas footprint. And there are enormous social consequences, which have been hidden — the hairy underbelly of Asia’s 20-year growth. But we feel that precisely for that reason, we can have a much greater impact here than, for example, in Norway.
You've been doing this since 2006. Is it like night and day between then and now?
Shaik: In 2006, Asian growth was unchecked and rampant. The social and environmental costs were huge, and yet financial markets barely recognised the need for ESG implementation in financing. Back then, when we set up the ADM Capital Foundation and started our ESG journey with the money lending, we separated the businesses entirely, geographically and legally. We weren't talking about the foundation to anyone who didn't specifically ask because we wanted to signal to our investors and stakeholders that we were focused on financial returns and sound risk-adjusted policies. Now people are asking us about our ESG impacts, and those are front and centre.
What is the role of the foundation today?
Shaik: The foundation takes donations from the top-line revenues of our fund management business. It has invested more than $50 million in 30 projects across Asia since 2006. It has helped with some major initiatives in Hong Kong: a public ban on shark fin consumption, helping to initiate Eat Without Waste, with a focus on single use plastic. We have significant efforts against wildlife trafficking. Redress, focused on sustainable fashion, was incubated in our offices. Regionally, we have initiatives such as China Water Risk, which provides data and research on water scarcity and pollution on the mainland and beyond. We have backed projects in Cambodia, India, Thailand relative to children at risk, and on the environmental side, landscape preservation, marine wildlife, deforestation, for example.
There is a virtuous cycle between our business and our philanthropy. We use our fund-management skills to help the foundation. The foundation is an incubator for growth projects, research and data.
What is the outlook for private credit and ESG integration over the next five years?
Shaik: I think most people agree that we cannot continue business as usual. Large patches of the world have become uninsurable because of weather events, droughts and floods, for example. And these are, of course, linked to global emissions and global warming. How quickly change is reflected in global financial markets remains to be seen. But we know that is the future.