Corporate TreasuryFinancial Supply ChainThe ESG needle is moving and treasurers must react

The ESG needle is moving and treasurers must react

A combination of investor interest, regulatory development and comprehensive approach in the EU warrants a change in the corporate strategy

Environmental, Social and Governance (ESG) reporting has garnered significant interest from investors and as such continues to have a growing direct and indirect impact on the remit of corporate treasurers.

Investors are increasingly interested in measuring the environmental and social impact of companies’ activities, with regulators in the European Union (EU) and the UK imposing stricter reporting requirements and implementing better guidelines for rating corporate sustainability.

“There are more and more calls from the client side to institutional investors to do so, which in turn increases the demand for ESG reporting by corporates, independent of the taxonomy that the EU regulators are pushing for.” Mark Veser, Senior Manager Climate Change and Sustainability Services at EY Switzerland said.

Indirect impact of ESG disclosure rules on treasurers

Earlier this year, the EU Parliament and EU member states proposed a new regulatory framework for sustainability disclosure rules which will require institutional investors to disclose the following:

  • The internal processes they have in place to ensure that environmental and social risks are factored into their investment decisions;
  • information on how ESG-related risks will impact the profitability of their investments; and
  • eliminate ‘greenwashing’ by providing evidence to support the environmental merit of any sustainable investment product or portfolio.

“The EU is fully committed to implementing the Paris agreement and leading the global fight against climate change,” EU Vice-President for the Euro and Social Dialogue and in charge of Financial Stability, Financial Services and Capital Markets Union said in a statement.

“We are making sure that the financial system works towards this goal,” he added. “The new rules on disclosures will enable investors and citizens to make more informed choices so that their money is used more responsibly and supports sustainability.”

While the new rules will impact asset managers, pension funds and other money managers directly, they also stand to have a significant indirect impact on corporate treasurers too. After all, as institutional investors must ensure the sustainability of their investments, treasurers will in turn wish to minimise their exposure to climate risks so as to not negatively impact their financing opportunities.

Standardising ESG data

Another key component of the wider sustainable finance agenda being implemented across Europe that has a far more direct impact on treasurers is the EU taxonomy.

‘The EU taxonomy plans to define how corporate activities are classified as green,” explains Matthias Beer,Senior Manager, Climate Change and Sustainability Services at EY. “There is already a green bond standard that the EU has setup and published legislative proposals on as well as low-carbon benchmarks. All of this will effect corporates directly in terms of how they will be evaluated and rated by financial market participants and this will certainly impact their access to finance over the medium term.”

The taxonomy will establish performance thresholds for different areas of the economy, with the EU focusing on implementing a new set of ‘technical screening criteria’ across carbon emission intensive sectors, such as agriculture, manufacturing, energy and transport, with more sectors to follow.

“If responsible investment is to prove its mettle, it is right that we measure the sustainability of the economic activities we finance,” Will Martindale, Director of Policy and Research at the PRI said in a blog post. “This will allow us to better allocate capital to economic activities consistent with the Paris climate agreement.

“The EU taxonomy is a tool to bridge the gap between international sustainability goals, like the Paris climate agreement, and investment practice. To mobilise private finance, European policy makers understand that they need to translate climate targets into tools that investors can use.”

The new EU taxonomy will create a standardised methodology that will provide clarity on a far more granular level for what constitutes an environmentally sustainable investment. Essentially, the taxonomy will create a common language between investors, issuers and policymakers, with the purpose of improving investor confidence that investments they make are consistent with the policy commitment EU leaders made with the Paris Agreement on climate change.

There is already a green bond standard that the EU has setup and published legislative proposals on, as well as low-carbon benchmarks. All of this will affect corporates directly in terms of how they will be evaluated and rated by financial market participants and this will certainly impact their access to finance over the medium term.

Ultimately, standardisation will not only assist investors in making better informed investment decisions, but will drive corporates to adopt new and adapt existing ESG reporting practices to ensure that they are viewed favourably by environmentally concerned investors and ensure access to the burgeoning sustainable finance market.

In 2018, the sustainable finance market grew quartered in size, with a record $247 billion worth of sustainability-themed debt instruments raised during the year, according to BloombergNEF‘s research. Green bonds issuance rose to $182.2 billion in 2018, while sustainability-linked loans reached $36.4 billion.

Europe leading the sustainable finance revolution

On a global level, the EU is certainly leading the way in terms of standardisation of ESG reporting guidelines and sustainable financing generally. What sets it apart to other major markets like North America, Asia and Australia is its far more comprehensive approach to incorporating the financial services sector in helping it to achieve its wider climate goals.

The Governor of the Bank of England (BoE), Mark Carney, set out new rules on climate risk reporting for banks, insurers and investment firms. During a speech on sustainable finance hosted by the EU Commission in Brussels late last year, Carney said that companies will be ‘expected to embed fully the consideration of climate risks into governance frameworks, including at board level’.

“Carbon emissions have to decline by 45% from 2010 levels over the next decade in order to reach net zero by 2050,” he later said in an open letter on climate-related financial risk. “If some companies and industries ail to adjust to this new world, they will fail to exist.”

In this regard, the UK is arguably a step ahead of many of its European counterparts when it comes to embracing the sustainable finance journey. Overall though, the EU (and the UK) has moved the ESG needle away from simply reporting to something that is of increasing strategic relevance for corporate finance and, therefore, should be at the forefront of C-level executives minds.

As such, there is a need for treasurers and corporate finance actors to respond to this new world and ensure that climate change becomes fully incorporated into their corporate finance strategy, as it will become crucial in accessing future financing, particularly carmakers and members of the energy sector in the near-term.

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