Published: July 26, 2023
Tough times coupled with a raft of concerns over ESG, not least the cost of initiatives and the reputational risk of making mistakes, are causing treasurers to think twice before committing to debt financing in support of low-carbon projects.
Corporate engagement with ESG has surged over the past decade but there are now signs that hard times and growing circumspection over the merits of investing in ESG initiatives are leading to a cooling of interest in sustainable finance among treasurers.
Growing caution around ESG is one of the major conclusions to be drawn from a survey of treasurers at 88 large FTSE-listed UK corporates by law firm Herbert Smith Freehills (HSF) in partnership with the Association of Corporate Treasurers (ACT). The survey, Corporate Debt and Treasury 2023, is HSF’s latest annual snapshot of trends and the outlook for corporate debt and growth of ESG and sustainability in the debt finance space.
Kristen Roberts, Partner, HSF, says that, as was the case with last year’s survey, ESG and sustainable finance is “the topic of conversation” in corporate treasury circles and one of the most likely to be discussed in any financing. The findings of this year’s survey, however, indicate a distinct “mood shift” on ESG among treasurers as they contend with a number of headwinds.
He continues: “These drags vary from the pressure to get deals done in uncertain times and the very real challenges in completing sustainable finance transactions from a multitude of angles. Corporates are also questioning whether sustainable finance really does move the needle on their ESG journey to make it worthwhile.”
On the plus side, the survey shows a strong cadre still advocating ESG, and a growing sense among corporates that they will have to toe the ESG line one way or another. But it also shows growing circumspection is feeding through to sustainable finance decision-making.
The findings reveal, for instance, that contrary to predictions last year when 70% of respondents expected to enter into sustainable finance this year, fewer respondents have a sustainability framework (26%, down from 29%) or sustainable finance in place (18%, down from 20%).
Roberts says: “The results might be explained by a change to the debt market landscape or treasurers prioritising conversations on pricing, liquidity, and speed of execution ahead of incorporation of sustainability features. However, we believe these findings at best signal a stalling in what many had anticipated would be a persistent continual upward trend for sustainable finance.”
Which of the following ESG/Sustainability linked financials are you likely to enter into in the next 12 months?
Source: Herbert Smith Freehills, 2023
Roberts says that sustainability-linked loans (SLLs), which are connected to the borrower’s ability to meet performance targets and have proved especially popular in recent years, illustrate changing treasurer sentiment towards sustainable financing very well. “Here, the overlay of risk and regulatory concern has meant financing terms have proved a drag on deal timetables and resulted in increased costs associated with both external advisory and gathering and reporting internal information.
“In the past 12 months we have seen an explosion in the growth of bank policies, ESG committees, KPI verification processes, KPI negotiation, and a raft of additional contractual rights and protections. The view of many respondents we spoke to is that the approach has become too heavy-handed and disproportionately burdensome for what is intended to be achieved.
“Those kinds of worries, coupled with their reputational concerns around accuracy of reporting and risk of allegations of greenwashing, are causing corporates to pause and to ever more carefully consider next steps. Indeed, a number of respondents queried whether now is the right time to embark on sustainable finance.”
Roberts points to the hurdles facing corporates when attempting to reduce Scope emissions as an example of the issues associated with ensuring accurate reporting. While Scope 1 and Scope 2 performance targets remain highly popular among corporates, those for Scope 3 emissions are proving “very challenging” for organisations to commit to given they demand the capture of emissions data from across the value chain, from suppliers to customers.
The HSF report also notes a growing sense of unfairness among companies that had enthusiastically embraced ESG early on and made significant strides with their low-carbon mission before implementing sustainable finance programmes. These firms believe they are now being effectively punished as the incremental gains they are able to make are smaller than banks are seeking.
Stacey Pang, Senior Associate, HSF, says that while there is growing caution around sustainable finance among treasurers, it is important to bear in mind that it is still early days in the evolution of ESG instruments. She adds: “The market has deepened over the past few years, there is no doubt about that, but it is some way off maturity yet and corporates, banks, and other participants are still grappling with certain elements of the process.”
Pang also notes that over the past year, HSF has seen banks operating in the sustainability loans market doubling down on the contractual terms of SLLs. “In our experience this development, alongside the challenge of parties agreeing on KPIs, is a key factor driving corporates to be more cautious. Having early clarity on both of these is critical for treasurers to evaluate whether this is the optimal option to pursue.”
Still, SLLs remain the mainstay of the sustainable finance universe for corporates, reflecting the flexibility in the use of such loans versus ‘use-of-proceeds’ green loans that must be tied to projects providing clear environmental benefits. Despite the impediments and difficulties highlighted by Pang and Roberts, the survey reveals corporates continuing to view SLLs as an attractive option. Half of all survey respondents said they are likely to enter SLL financing over the next 12 months. By contrast, there was a noticeable drop in the proportion of respondents reporting that they expect to enter into ESG use of proceeds bonds – down to 12% this year from 28% last year for green bonds; and down to 12% from 17% for social or sustainable bonds.
Interestingly, the survey reveals a marked pick-up in momentum behind the sustainability-linked US Private Placement (USPP) market. This market mainly involves large US insurance companies, and a handful of UK insurers, as investors, and a combination of US middle-market companies, private firms, and larger foreign businesses as issuers. In its most basic form, a US private placement looks like a hybrid between a public bond issue and a syndicated loan.
Nearly 20% of respondents – up from just 8% last year – indicated that they would enter the USPP market within the next 12 months. Pang says this is a notable development because US markets have been perceived to be lagging behind their UK and European counterparts in the sustainable finance space. She believes this fresh momentum behind the USPP market may be due in part to a continued push by issuers to align sustainability or ESG features in their USPPs with those in their bank loans and other debt products.
How do you see ESG/Sustainability evolving in corporate treasury?
Source: Herbert Smith Freehills, 2023
When considering factors likely to shape the evolution of ESG and sustainability within corporate treasury, 85% of survey respondents pointed to increasing reporting requirements as likely to have the biggest impact on their functions. A significant 60% pointed to an increasing range of ESG/sustainability debt products becoming available, while 60% believe standardisation of sustainability frameworks, targets, monitoring and reporting will also have a major impact on their operations.
Pang says that on the reporting front, respondents complained that the volume of documentation that was expected to be produced for their creditors, in addition to the corporate’s own ESG reporting compliance requirements, has become “staggering”.
She adds: “As ESG performance becomes more and more a normalised part of a lending process, not pursuing sustainable finance does not mean corporates can avoid dealing with due diligence questions about it. Corporate treasury teams are feeling the strain as they are also increasingly expected to synthesise financial and accounting data for the purposes of ESG reporting for their creditors from their ESG colleagues in other parts of the organisation.”
More broadly, Pang observes that just a few years ago it was thought that treasury teams would help drive the sustainability agenda within organisations, but it has become clear that this is not happening. She explains: “Corporates now will likely have ESG teams dedicated to driving the ESG agenda for the company. That forward momentum, however, is not necessarily influenced, at least not to any great degree, by whether or not sustainable finance has been issued. Market-facing, publicised ESG targets and investor and board expectations play a significantly bigger role.”
Echoing Roberts and Pang, Sarah Boyce, the ACT’s Associate Director, Policy and Technical, also says the report shows that the general tone towards ESG, the sustainability element within financing in particular, is cooling among treasurers.
Boyce adds: “While widely recognised as the direction of travel, sustainability financing, in all its forms, is proving very challenging for non-financial corporations. This is due to a variety of reasons but can broadly be summarised as lack of a positive reason for doing it. Here, I am thinking particularly of the considerable incremental cost and resource required; the potentially huge reputational risk from getting it wrong; and lack of consistent disclosure requirements.”
One key finding of the survey is that despite the general and accelerating market shift and focus on sustainability linked lending, appetite among corporates has yet to return to 2021 levels. Back then, the survey found that sustainable finance via syndicated and bilateral bank debt alone accounted for 64% of new debt and refinancings. That compares with 51% in 2022 and 57% this year. While hard times, increased cost of debt, and need to focus on liquidity have clearly been important contributory factors impacting this lacklustre performance, the report also suggests growing disenchantment among treasurers over solutions being offered by banks and lenders’ motivation.
Commenting on an anonymised basis in the report one treasurer says: “Banks are very aware and smart on ESG points but they are trying to invert the priorities in a financing, trying to make ESG the main point of the transaction instead of the cherry on the cake.”
Boyce believes that this treasurer’s concern about banks is widely held and stems from “banks themselves being under immense pressure to be seen to be doing something on ESG and sustainability financing specifically”.
At the same time, however, Boyce, a former Director of Treasury at confectionary giant Cadbury, senses “widespread confusion” between approaches to financing and wider corporate strategy. “They are not necessarily linked and surely the priority should be that the organisation develops a strategy to support the adoption of sustainability or net zero or however you wish to define it. Using financing as a proxy for corporate strategy is at best unhelpful, I would have thought.”
Commenting more generally on what the report reveals about key challenges ahead for treasurers over the short to medium term, Boyce says it is clear inflationary pressures have generally resulted in increased pressure on working capital. “Ensuring access to liquidity will therefore become an increasingly important focus for treasurers – the era of easy money would seem to be slowing if not ending.”
Add the war in Ukraine and mounting geopolitical tensions and it is not surprising that the majority of survey respondents – nearly 80% – hold a neutral to negative view on business outlook for the current year, up from 70% in last year’s review.
On a rather more encouraging note, however, Boyce points out the survey also indicates that after several years of intense firefighting, corporate treasurers are beginning to regain their poise. Notwithstanding industry-, sector- or business-specific differences, treasurers interviewed by the report authors “generally felt that their businesses were more resilient to unforeseen shocks”. The report suggests this renewed confidence reflects much greater focus within corporates on shoring up liquidity buffers and evolving their risk management processes so they are fit for purpose.
“That is a very positive message from the survey,” says Boyce. “Treasurers are finally beginning to feel they are in a place where they are able to treat uncertainty as business-as-usual. They feel they have developed more resilient processes to ensure that they can deliver as required by their organisation. After the extremely difficult recent years, that can only augur well for treasury teams.”
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