What drives the ESG alignment imperative?
There has been a cultural shift in society as more and more individuals commit to living sustainable lives. These people – whether they are consumers, employees or other industry stakeholders – now expect companies operating in their communities to operate more sustainably as well.
The larger context
At the international level, the United Nations 2030 Agenda has established 17 Sustainable Development Goals (SDGs) requiring urgent action. The SDGs include a goal of access to “affordable and clean energy” and the development of “sustainable cities and communities” but also emphasize “decent work” for all through “economic growth”.
These goals have a direct impact on long-term policy decisions by governments and industry, and shift the reallocation of global capital away from unsustainable activities towards ESG-aligned businesses.
Why is ESG relevant for companies?
ESG is a framework for assessing an organization’s performance with respect to its environmental impact, its relationships with local communities and its compliance with applicable regulations.
Companies that ignore the importance of ESG considerations not only perform poorly when assessed against environmental, social and governance criteria, but will often be seen by financing providers and potential investors as posing a risk. higher credit.
In other words, companies that are not ESG aligned may have a harder time accessing bank loans or attracting equity investors.
The link between ESG factors and credit risk manifests itself in several ways, for example:
- Environmental: Companies engaged in carbon-intensive activities are exposed to the risk of “stranded assets”, i.e. when assets lose value or become unable to produce viable financial returns as a result changes associated with the transition to a low-carbon economy. economy.
- Social: Failure to align a company’s strategy and operations with social considerations leads to the risk of employee disengagement, loss of customers, and alienation from other stakeholders (e.g. regulators or regulators). donors), which ultimately results in lower income.
- Governance: Any business without clear and focused goals risks financial decline, but, in addition, deficiencies in corporate governance present a real danger that business units may engage in undesirable (or even illegal) activities due to lack of proper oversight or misaligned incentives, leading to the possibility of fines or other penalties.
While climate change rarely makes the headlines, the “environmental” branch of ESG may seem to be given higher priority than the other “social” and “governance” strands. However, the three pillars of ESG are equally important.
Companies with a holistic ESG strategy that targets long-term sustainable financial growth, high stakeholder engagement and strong governance represent a much safer opportunity for a bank lender or equity investor and therefore benefit from a better access to finance – and on better terms.
Financing ESG projects
Companies can use ESG to raise funds by identifying an ESG-aligned project that can be funded through external funding. For example, if a manufacturing company wants to upgrade its production facilities to replace single-use plastic packaging with an environmentally friendly alternative, a clear statement on how loan proceeds or capital investment is aligned on ESG factors would make the opportunity more attractive to potential lenders or investors.
After all, it is not just business enterprises that implement ESG strategies. Banks and other finance providers are also increasingly scrutinized by their own lenders and regulators to ensure their activities are sustainable, as decisions are increasingly assessed through an ESG lens.
ESG funding for day-to-day business activities
For businesses that need to raise funds for general corporate purposes or working capital, it may not be practical to earmark or delineate loan proceeds or equity investment for a specific aligned project. on ESG.
However, ESG considerations also have a role to play in the financing of day-to-day business activities. For example, finance providers may be open to including “margin ratchet” provisions linked to ESG-related key performance indicators (KPIs) in finance agreements.
Margin clickers incentivize companies to improve identified KPIs throughout the life of a financing agreement to benefit from reduced financing costs, such as a lower interest rate on a loan.
ESG-related KPIs are qualitative or quantitative measures that must be subject to certification or external verification. They can be based on environmental benchmarks, such as carbon emissions, or on more innovative measures such as increasing diversity and inclusion statistics within a workforce, closing gaps pay between the sexes or a drop in the volume of customer complaints.
Data and reports
Incorporating ESG into financing agreements typically means increased reporting requirements and a need to share information with a financing provider about the non-financial aspects of a company’s business.
Reporting is a two-way street and can highlight both successes and failures. Companies should be honest and realistic about their ESG alignment and resist the temptation to overstate their ESG performance.
More attention is being paid to cracking down on “greenwashing” in financial services – where unsubstantiated claims are made about the environmentally friendly nature of a product, service or activity. Similarly, companies that report on the non-financial aspects of their business need to ensure that all data they provide is accurate.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.