Two of the of leading topics among private equity dealmaking in 2022 have been the emergence of ESG strategy and direct lending, and it appears that these two trends will continue to drive M&A. Here’s how:

In a study conducted by Ocorian, a capital markets services provider, ESG is said to move up on the agenda of direct lenders. The firm found the growth of a loan market for socially sustainable projects as the biggest priority for lenders.

“ESG is firmly established as a core part of business operations in the direct lending sector and that can only increase as our research shows,” says Martin Reed, head of capital markets – Americas at Ocorian. “It is interesting to see that socially sustainable lending is seen as the key priority by market participants but worrying to see that data quality and availability is a major issue.”

In Ocorian’s study, the firm identified that 82 percent of direct lending executives specializing in first-lien loans to firms with under $1 billion annual revenue in the U.S. and U.K. expect the focus on integrating ESG into loan terms will increase over the next 18 months. Additionally, the research identified that the biggest priority among U.S. lenders is the facilitation of the loan market for socially sustainable economic growth such as affordable housing.

It won’t be an instant switch to ESG strategies as there still remain barriers to entry. The lack of quality and consistent ESG data, lack of understanding of ESG principles, cost, and lack of service providers demonstrating ESG principles represent the greatest challenges for implementing ESG in the direct lending sector.

It felt inevitable that ESG strategies would hit the growing direct lending landscape similarly to its impact on private equity in recent years. It will be interesting to examine as market uncertainty will likely continue into the first half of 2023, how dealmakers will fair in integrating ESG.

Will direct lenders find that there are new, untapped dealmaking opportunities when integrating ESG strategies, or will the strategy become a burden on finding firms with value lending opportunities? Let me know your thoughts at [email protected]

Cole Lipsky