The European Green Deal was presented by the European Commission on 11 December 2019 with the aim that the members of the European Union reduce their net emissions of greenhouse gases to zero by 2050. A key component for achieving the political goals stated in the Green Deal Concept is sustainable finance. To date, the Green Deal has mostly kept the banking world busy. However, it is also becoming increasingly clear in corporate treasury that, on the one hand, this opens up fresh opportunities for action, and on the other hand, it presents new operational challenges and increases the responsibility of the treasury regarding the company’s overall market presence.
What does ESG actually mean?
The term "sustainable finance" refers to the mechanism of incorporating environmental, social, and governance related aspects into investment decisions. This is intended to lead to economic activities and projects are geared towards the long term and sustainable. Therefore, this mechanism, often titled by the three letters E (Environment), S (Social) and G (Governance), is one of the fundamental components of the ambitious European Green Deal. By ESG, the European Union basically means the following:
Environment: ecological considerations pertain to mitigating and adapting to climate change as well as to the wider environment, for example conserving biodiversity, preventing pollution and creating a circular economy.
Social: social considerations include issues of inequality, inclusiveness, work relations, investment in human capital and communities, and on human rights issues.
Governance: the management of public and private institutions – including their management structures, relationships with employees and executive compensation – plays a vital role in ensuring that social and environmental considerations are part of the decision-making process.
The corporate treasury unit, as one of the key gateways of a company to investors and capital markets, is particularly exposed to these new developments. ESG ambitions are fuelling the development of new products and placing new requirements on market players. This results in special challenges for Corporate Treasury.
Establishment of new vehicles for refinancing
Green bonds, green loans and in Germany also green promissory notes constitute a still relatively new but nevertheless well-established market for new refinancing products.
The underlying principle of these (re-)financing products is to use the corresponding revenues for sustainable products or projects. The prerequisite is therefore that the related corporate activities are tailored in a way that they meet the ESG criteria. As the relevant criteria are defined by the company itself, it has quite some leeway to do so. Usually, the company also obtains a second party opinion from a sustainability agency. By the way: further information on this topic can be found in our Newsletter article no 107 of December 2020.
New requirements equal new challenges?
ESG can act as a valuable lever to facilitate access to capital markets and obtain attractive terms with contractual partners. Apart from these new opportunities created by sustainable finance, the last year and a half has seen considerable additional information needs being imposed on companies by the institutional sector. In this regard, the banking sector in particular serves as a multiplier for the EU: key bank regulatory papers have and continue to embed ESG-specific topics in internal bank processes that directly impact the customer relationship between the bank and the company. By way of the credit institutions, bank customers are then also affected by the repercussions. Currently, the requirement of banking regulatory authorities (part of the EBA Guideline Loan Origination and Monitoring (LOaM)) to provide for embedding ESG risks in lending decisions should be highlighted. The specific design of this embedding is left to the credit institutions themselves, but many institutions will include an ESG score or ESG rating in their customer terms and conditions with significant consequences for the companies:
- In future loan negotiations, institutions will have to meet additional information requirements.
- The provided ESG-relevant parameters will have an impact on the terms and conditions of the negotiated loans. Over time, companies whose ESG-specific rating is negative, will have much more difficulty to offer competitive terms to lenders. This in turn makes it more difficult to access borrowed capital.
- ESG-related indicators are also playing an increasingly important role during the loan term, for example in the context of covenants.
Beyond regulatory issues, companies listed on the stock markets in particular are noticing that sustainability and ESG issues are currently "en vogue" among (potential) investors. Here, too, an increasingly large demand for information must be satisfied – from the company's bank, lenders or directly from investors – in order to remain attractive on the capital market.
Impact on Corporate Treasury
In particular, the increased need for information must be managed by the corporate treasury departments. However, the developments described above also have an impact on the treasury in a range of different aspects:
- As a direct internal interface to lenders, treasury needs to understand how banks assess the company in terms of ESG criteria. This provides the opportunity for targeted measures to optimize bank valuations and continue to maintain attractive access to debt capital. The treasury unit in its role as an internal adviser is therefore moving more into focus when it comes to the company’s strategic orientation. With the aim of optimizing the valuation of the company by lenders and therefore remaining competitive.
- Efficiently serving the newly emerging external and internal information needs has an impact on the existing IT and reporting infrastructure. This for instance involves the rapid identification of transactions that are related to sustainable products or projects. The analysis of "green components" of Capex/Opex or revenue is also relevant, i.e. the identification of components that already meet ESG criteria.
- An intensification of the interfaces in the areas of sales, purchasing, controlling but also investor relations is necessary in order to collectively face the challenges.
In other words, ESG will initially confront corporate treasury departments with new tasks that were not previously anchored as part of the traditional treasury function in many companies. The main responsibilities of Treasury will remain in the areas of liquidity, funding and risk management. However, the drive to position itself as a consulting and collaborative entity within the company will increase with growing demands regarding ESG issues. This is why ESG offers an even greater opportunity to strengthen the self-image of corporate treasury departments as an internal advisor and value-adding corporate function.
Source: KPMG Corporate Treasury News, Edition 113, July/August 2021
Authors: Nils Bothe, Partner, Finanz- und Treasury-Management, KPMG AG; Anna-Lena Remmel, Managerin, Finanz- und Treasury Management, KPMG AG
Nils A. Bothe
Partner, Financial Services, Finance and Treasury Management
KPMG AG Wirtschaftsprüfungsgesellschaft