Alternatives Watch 2022 Outlook: Close Group Consulting

No stranger to tackling the hard questions when it comes to helping investors grasp ESG risk, Tamara Close has made it her mission and her business to provide investors with the best tools to truly know what risks are lurking in a variety of asset portfolios.

Close founded her firm in Montreal after spending over 10 years in senior management roles within the risk and public markets investment groups of Canadian Pension PSP Investments. She has over two decades of combined experience in capital markets and ESG strategy. Her aim is to work with investment management firms and asset owners to advance their ESG integration practices across both risk and value frameworks. She was previously managing director and head of ESG Integration for KKS Advisors, a leading, independent, global advisory firm.

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She has also held various investment management positions for the Bank of Montreal and Credit Lyonnais in the global derivatives and foreign exchange markets and was previously the head of research and risk for a start-up fixed income asset management firm in Montreal. She is also the founder and creator of the Sustainable Risk Assessment Framework.  

Based in Boston, Anuj Shah is a partner with Close Group Consulting and works with asset owners, asset managers, investment banks and corporations on ESG integration. He was a partner with KKS and oversaw that firm’s strategy, operations and business development activities in the U.S. and UK, prior to joining Close Group Consulting.

He is also currently an advisor to Nossa Data, a firm that provides digital solutions to companies looking to streamline their ESG reporting, and at BonBillo, a global incubator program for start-ups using technology to advance the UN Sustainable Development Goals. He is also a project partner and collaborator with the VeriStell Institute, a globally focused think tank that enables corporate entities to embrace ESG and Corporate Purpose.  

With so much noise about ESG and in private debt strategies in asset management today, we thought it made sense to see how Close Group is helping the industry integrate ESG within investment strategies.

What are likely to be the key issues regarding ESG this year for investors and for managers, given the current macroeconomic environment?

Certainly, top of mind for investors will be climate change risks. We are seeing a sharp focus on transition risks, in particular carbon emissions. However, physical risks from climate change are starting to take a higher priority, especially for investments in capital-intensive sectors operating in more vulnerable parts of the world, as these will face the biggest impacts.

Two issues that are rapidly becoming systemic ESG issues include biodiversity and human rights in supply chains. Similar to physical climate change risks, every investment that has an exposure to land use will inevitably have an exposure to biodiversity risks. 

The increase in data availability and transparency of supply chains will make human rights in a company’s value chain even more important. The challenge of assessing these risks increase dramatically when trying to assess them through a non-developed country lens.

Given the conflict in Europe, we are expecting more attention going forward to be on macro ESG analysis such as democracy factors. The conflict will also put greater focus on the global disequilibrium for both energy and food supplies.

One interesting impact is the speed at which large multinational corporations have pulled out of Russia in the past weeks. As Boards and decision makers become more ESG and sustainability focused they are able to pivot more quickly and make these decisions because they know their stakeholders will support them. This is probably not something we would have seen five years ago.

Private debt strategies are increasingly in demand by allocators. Are there ESG-friendly initiatives that you have come across and what do they do?

The core focus of ESG analysis for a private debt investor will invariably be in the underwriting process. After that, managers will re-assess and monitor the ESG exposures of a borrower. Private debt investors however also have a real influence on the sustainability and resiliency strategy of a company through engagement with management and through sustainability linked products.

In the EU and the UK, we have seen an emergence of sustainability linked loans from private debt managers. This remains a very effective way to ensure capital is being allocated to companies that are implementing ESG or sustainability strategies.

The downside of sustainability-linked loans is that companies are not penalized for not implementing the sustainability initiative, they just forego the ratchet or discount, which today sits somewhere between 5 and 10 basis points.

Double-sided sustainability-linked loans are less common but create an incentive for borrowers to implement sustainability initiatives, otherwise they will end up paying a higher interest rate on a loan and see their cost of capital rise.

How can large established private debt firms implement ESG effectively? Does this upend their entire strategy and process?

Private debt firms cannot slow down their underwriting process. They need to maintain a certain level of agility and speed. Because they are already focused on identifying the key financial risks for a borrower, ESG analysis, if done right, aligns perfectly to this.

If you think of ESG issues as the intangibles of a company, which today can account for a significant part of the valuation of a company, identifying any E & S risks (private debt firms are already looking at G issues) will inevitably help identify material risks to the borrower.

More importantly, how can there be effective measurement to ensure that objectives are being met? What has Close Group done so far in the credit space?

We are seeing asset owners advancing their expectations on the granularity of ESG assessments as a path to more precise or effective measurement of ESG risks.

They want to know that their asset managers have the ability to move from an industry-level assessment of risk to a portfolio company-specific level of ESG risk. To that end, we have developed a proprietary methodology to first identify company-specific material ESG issues and then secondly assess and score granular level E, S and G risks. The benefits to this approach on the credit side are numerous and include more precise ongoing monitoring and zeroing in on the highest risks which could form the basis of a ratchet in a sustainability-linked vehicle.

Similarly, we’ve also created a proprietary methodology to assess portfolio company-specific climate risk across three primary categories: physical, transition and liability risk. We make both of these assessments available to our clients in private credit, but they are applicable in other asset classes as well.