Explore how the private debt market is embracing ESG as a strategic lever for risk control and value creation.
Private markets have seen ESG considerations evolve from a peripheral interest into a defining force. No longer optional, ESG integration is increasingly recognized as essential for value creation, risk mitigation, and maintaining the license to operate. Driven by regulatory pressure, shifting societal expectations and growing investor demand, momentum continues to build. In 2024, ESG assets under management in private markets surpassed USD 1 trillion - with Europe accounting for 70% of the global market [1]. Historically viewed as a laggard in ESG integration, private debt is rapidly catching up. According to Preqin’s June 2024 Investor Survey, half of investors have an ESG investment policy in place for private debt, or plan to have one within the next twelve months.
A Critical Lever for Sustainable Transformation
Private debt occupies a unique position in accelerating sustainable transformation.
Private lenders exert unparalleled influence over portfolio companies – from operational decisions to long-term strategy. Their extended investment horizons and increasing alignment with ESG objectives make them well-positioned to embed sustainability deeply and systematically into business models.
Given that downside protection is central to credit investing, ESG factors —governance, environmental risks, and social license to operate — are becoming critical indicators of long-term creditworthiness. As a result, private debt managers are increasingly incorporating ESG factors into credit risk assessment, loan structuring, covenant negotiations, and ongoing borrower engagement.
ESG Integration Demands a “Hands-On” Approach
Unlike public companies, private firms face limited ESG disclosure requirements. This makes ESG data collection a more “hands-on” process, requiring direct engagement to gather meaningful insights. In addition, the diversity of underlying companies makes it difficult to apply a standardised due diligence process. With SMEs, loan sizes tend to be smaller, CSR policies may be absent, and board diversity difficult to implement. Consequently, managers must conduct tailored due diligence to investigate the company’s activities, policies and processes.
ESG Integration: A Lifecycle Approach from Entry to Exit
In private debt, the integration of ESG begins at the very outset of the investment lifecycle. During screening and due diligence, ESG frameworks and tools are useful to assess both material risks and potential value creation levers. In this respect, Kartesia can rely on Candriam’s long-standing ESG expertise and sizeable resources.
ESG due diligence can cover a wide range of factors, including the company’s business model against sector-specific ESG risks, its alignment with Sustainable Development Goals (SDGs), its environmental liabilities, governance practices, human rights risks, supply chain resilience, and climate transition readiness. Sector-specific ESG risk matrices and quantitative scoring systems can be embedded into evaluation processes to mitigate downside risks, such as exposure to regulatory fines, litigation or reputational damage.
On top of flagging potential ESG weaknesses that could negatively impact the company’s ESG profile, the goal is also to identify ESG strengths that will potentially drive growth and differentiation. This step is the opportunity to define specific environmental and social targets for the short, medium or long term – for example a carbon reduction plan.
Following the investment, active engagement is critical to translating ESG potential into tangible outcomes. Investors can set clear ESG expectations, establish KPIs, and link management incentives to sustainability performance. Post-investment ESG monitoring often involves annual reporting on material issues, implementation of decarbonization or diversity strategies, and proactive risk management. The evolution from passive monitoring to active engagement reflects the growing understanding that continuous ESG improvement is a key driver of operational excellence and long-term value.
Finally, demonstrating strong ESG credentials at exit — whether through formal reporting, third-party ratings, or impact assessments — can unlock premium valuations and attract a broader buyer universe, particularly among corporates and asset managers with sustainability mandates. Leading investors recognize that ESG legacy matters: they aim to leave companies not only financially stronger but also more resilient.
Structuring the right incentives
Private debt investors have been innovating in how they structure incentives to ensure ESG progress is embedded throughout the value chain.
- At the portfolio company level, many private debt investors are incorporating ESG or impact-linked covenants into loan agreements. Some even include ESG-linked margin ratchets: if the company achieves pre-agreed ESG or impact KPIs (such as reducing carbon emissions, increasing access to health services, or improving workforce diversity), it receives a reduction in its interest rate - a direct financial incentive for company management to prioritize sustainability goals, turning impact performance into a lever for value creation.
- At the fund level, some firms are linking the carried interest of the investment team to ESG or impact performance across the portfolio. At Kartesia, if fewer than a threshold number of ESG or impact targets are met across investments, a portion of the team’s carried interest is reallocated to a philanthropic initiative. While being a motivation enhancer for investment teams to engage actively with companies, provide hands-on support, and help drive sustainability improvements over the holding period, this system also allows to contribute to more sustainability in alternative ways despite not meeting the set targets.
Such dual incentive systems reinforce the idea that ESG integration is no longer a niche or risk-management afterthought, but a critical lever for competitive advantage, resilience, and value creation in the private debt market.
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[1] Source: Preqin, 2024