Environmental, social and governance (ESG) credit factors have become an increasingly prominent topic of discussion across the collateralized loan obligation (CLO) and leveraged loan markets. To date, most U.S. CLOs that have sought to incorporate ESG factors have done it through the addition of provisions in their transaction documents (usually within the "collateral obligation" definition in the CLO indenture). These provisions restrict CLO managers from investing in assets from companies in industries that are viewed as not ESG-friendly. This negative selection approach has been common in European CLOs for several years and is now becoming more prevalent in U.S. transactions. However, S&P Global Ratings believe the impact thus far has been negligible.
The ESG-prohibited industries vary by transaction. Although we have seen more CLO documents with language that prohibits investments in a single, fairly well-defined industry category (such as tobacco). We have also seen some transactions that include multiple and varied restrictions that exclude companies operating in:
- The extraction of oil, gas, or thermal coal, or the generation of electricity using coal;
- The production of or trade in controversial weapons;
- The trade in hazardous chemicals, pesticides and wastes, or ozone-depleting substances; adult entertainment; tobacco; gambling; predatory or payday lending activities; or weapons or firearms; and
- The production of opioids.
The scope of companies that could fall within an ESG-prohibited industry is broad and depends on how the indenture provisions are interpreted. Currently, it is up to the CLO manager's discretion to determine whether a company falls within an excluded category (and thus excluded from the CLO portfolio), based on the language in the indenture. Therefore, unlike our datasets in table 1 and chart 1, which reflect the broader categorization, a CLO manager could determine that a company that also develops parts for the national defense industry isn't part of the prohibited "weapons or firearms" industry. Alternatively, although S&P Global Ratings does not rate any obligors that trade in banned chemicals, the entire chemical industry, which represents 3.793% of total CLO exposure, could be deemed as "hazardous." If either of these scenarios occur, the percentage of ESG-prohibited assets in the rated pool could decrease or increase, depending on the CLO managers' decisions.
In addition, many ESG-prohibited industries are not common in CLOs (see table 1). For example, tobacco is one of the most frequently prohibited industries, but only two of the more than 1,000 CLOs rated by S&P Global Ratings globally (the rated pool) include a tobacco asset (both transactions include one each).
Table 1
| Prohibited Industries(i) | ||||
|---|---|---|---|---|
| Prohibited industry group | % of CLO assets | |||
| ESG-prohibited assets | ||||
| Chemicals | 3.793 | |||
| Gambling | 1.431 | |||
| Weapons or firearms | 0.956 | |||
| Opioids | 0.476 | |||
| Coal generated power | 0.146 | |||
| Oil and gas extraction | 0.080 | |||
| Coal mining | 0.057 | |||
| Tobacco | 0.002 | |||
| Non-ESG prohibited assets | 93.060 | |||
| (i)Based on the sorted Global Industry Classification System [GICS] codes in our CDO Evaluator. Data as of April 1, 2021. CLO--Collateralized loan obligation. ESG--Environmental, social, and governance. | ||||
Chart 1
Other Noteworthy Factors
The oil, gas, and consumable fuel industry comprise about 1.375% of rated CLOs, while coal-generated power obligors represent about 0.15%. However, coal mining and oil and gas extraction companies represent only about 10% of the companies in the industry.
A prohibited asset that we have not seen in many U.S. deals, though it is more prevalent in European CLO transactions, is gambling. However, casino-related obligors are commonly held in CLOs and appear in about 70% of CLOs. They comprise eight of the top 250 most widely held U.S obligors and 25 of the top 1,500. However, even with that sort of exposure, they still make up less than 1.5% of CLOs.
Corporations that have had litigation against opioid production comprise about 0.476% of CLOs.
We are not aware of any CLOs holding obligors in the adult entertainment and the remaining negative selection industries.
Limited Credit Impact
Prohibited industries comprise a small portion of the CLOs we rate and, therefore, do not pose a significant credit risk to CLO transactions (see table 2 and chart 2). Given how well diversified the average CLO portfolio is, we don't believe eliminating a few industries from the mix would have a material rating impact. Furthermore, our CDO Evaluator model captures and encompasses the risk of portfolios becoming less diverse, which is currently not the case.
Table 2
| CDO Monitor Metrics | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| SPWARF | DRD | ODM | IDM | RDM | WAL (years) | |||||||||
| Broadly syndicated loan CLOs | 2722 | 818 | 202.93 | 23.86 | 1.18 | 4.86 | ||||||||
| Middle market CLOs | 3934 | 645 | 70.23 | 14.45 | 1.02 | 3.60 | ||||||||
| SPWARF--S&P Global Ratings' weighted average rating factor . DRD--Default rate dispersion. ODM--Obligor diversity measure. IDM--Industry diversity measure. RDM--Regional diversity measure. WAL--Weighted average life. | ||||||||||||||
Chart 2
Related Research
- CLO Spotlight: CDO Monitor Benchmarks Report For U.S. CLOs: First-Quarter 2021, May 6, 2021
- U.S. BSL CLO Top Obligors And Industries Report: First-Quarter 2021, April 26, 2021
- ESG Industry Report Card: Collateralized Loan Obligations, March 31, 2021
This report does not constitute a rating action.
| Primary Credit Analyst: | Paul Kalinauskas, New York + 1 (212) 438 5408; paul.kalinauskas@spglobal.com |
| Secondary Contact: | Kate R Scanlin, New York + 1 (212) 438 2002; kate.scanlin@spglobal.com |
| CLO Sector Lead: | Stephen A Anderberg, New York + (212) 438-8991; stephen.anderberg@spglobal.com |
| Global Structured Finance Research: | Brenden J Kugle, Centennial + 1 (303) 721 4619; brenden.kugle@spglobal.com |
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