Bridging the Gap on ESG Performance and a Business’s Financial Profile

ESG performance evaluation is increasingly becoming an integral part of the refinancing process. They feed into the overall dialogue between investors and financial partners on the one hand, and issuers and assets in need of capital on the other hand. Driven by various regulatory imperatives and market forces, this multi-faceted process increasingly takes environmental, social and governance (ESG) factors into account in credit risk assessments and valuations, thus influencing refinancing conditions and results.

Integrating ESG factors into the assessment of a company’s financial profile

An ESG assessment may or may not enhance the credibility of a business plan

ESG factors are increasingly recognized for their impact on credit risk. Investors and financial partners of large companies, but also increasingly of SMEs, are integrating these factors to better understand and forecast the financial health of issuers. For example, environmental risks such as energy costs or water resource management can directly affect a company’s operations and asset value. In the experience of Covid, the quality of social dialogue and well-being in the workplace undeniably played a part in the way teams were able to reorganize and adapt to a constrained organizational environment. Conversely, in the face of such adverse shocks, companies with poor grounding have had to adapt to a more conflict-ridden and less productive environment. These examples demonstrate the extent to which ESG performance – translated into concrete, operational terms – either validates or puts into the shade the credibility of a balance sheet, an income statement or a business plan.

The funds which call on Ksapa to carry out ESG due diligence on targeted assets have clearly understood the benefits of this information in their valuations and negotiations. Companies – even SMEs – with major financing or refinancing projects turn to Ksapa to structure an ESG approach, because they have also clearly understood in discussions with their financial partners the substantial savings on the cost of credit that these ESG efforts can now yield.

The EU CSRD standardizes ESG data between issuers and financial partners – even when it comes to SMEs.

In a regulatory context in which EU CSRD is making progress towards committing large corporations and SMEs to the same set of ESG indicators, ESRS standards are simplifying and standardizing the way in which issuers can assess, publish and improve their ESG performance. This also applies to companies located outside EU markets that trade or finance with institutions subject to CSRD directly.

ESG is a means of fostering dialogue and transparency in the face of managerial complexity.

The ESG process is one of alignment and dialogue between companies and their financial partners

ESG issues are often complex, and even new to the management of many companies. Yet they are expected by a growing number of employees, customers and financial partners. These “stakeholders” do not expect simple, ready-made answers from management in their ability to grasp and integrate ESG issues into their strategic and operational processes. Maturity in the face of complexity, and the effort to make continuous progress, are much more highly valued in these dealings, and therefore a guarantee of credibility. Thus, dialogue between investors and financial partners and issuers aims above all to improve transparency and understanding of how ESG factors are integrated into credit assessments.

  1. Improved Risk Management: By integrating ESG factors, issuers can potentially secure better refinancing terms. Strong ESG performance is often associated with lower risk, which can lead to more favorable interest rates and terms from lenders.
  2. Investor Demand: There is a growing demand among investors for ESG-compliant investments. Companies with strong ESG credentials can attract a broader investor base, enhancing their refinancing options.
  3. Regulatory Pressures: Increasing regulatory requirements for ESG disclosures mean that issuers must be proactive in their ESG reporting. This compliance can positively impact their credit ratings and refinancing conditions.

Ultimately, not only the rating agencies that assess major companies, but also the day-to-day funds and financial partners that also work with SMEs are now integrating ESG factors into their credit ratings. This undeniably has an impact on the conditions and costs of refinancing operations, working capital requirements ceilings, and the attractiveness and valuation of assets.

How ESG is gradually infiltrating and transforming every part of the financial ecosystem

At Ksapa, we have unique cross-functional expertise that gives us an overview of these issues. On the one hand, we have worked with major banking institutions to update their sectoral policies. These policies set the pace in terms of ESG expectations, and have an impact on all our business lines. In the business lines, we regularly work on processes aimed at creating and developing banking products or tools to ensure that ESG issues are better taken into account in asset valuation, or in encouraging customers to make progress on ESG. Working alongside funds, we carry out ESG due diligence, enabling us to assess the ESG risks and opportunities associated with assets – which in turn feeds into investment decisions and asset valuations. With issuers – large corporations as well as SMEs – we design ESG strategies, ensure CSRD compliance or reinforce various ESG programs in action plans or concrete operational programs. In this way, we master a large part of the value chain.

The ESG approach offers a return on investment that is attractive to CFOs

Our experience has taught us a few valuable lessons: the return on investment from a strategic, practical and robust ESG approach is real. There are already considerable intangible gains. The quality of dialogue and the credibility of management and the company in the eyes of its customers, employees and partners. But the financial gains are much more tangible. Credit costs can be significantly reduced. Working capital thresholds agreed with financial partners can be increased, players gain in value u in resale leverage among other benefits of prime interest to the CFO.

Conclusions

For financial players and companies alike, who are constantly on the lookout for financing opportunities, ESG considerations are increasingly strategic, and can be boiled down to three points:

  • Improved risk management: By integrating ESG factors, issuers can potentially obtain better refinancing terms. Good ESG performance is often coupled with lower risk, which can lead to more favorable interest rates and terms from lenders.
  • Investor demand: Investors are increasingly demanding ESG-compliant investments. Companies demonstrating a solid ESG maturity and approach can attract a broader investor base, increasing their refinancing opportunities.
  • Regulatory pressures: Increasing regulatory requirements in terms of ESG performance and reporting mean that issuers, even SMEs, must be ever more proactive in implementing an ESG approach and collecting ESG information. This compliance can have a positive impact on their credit ratings and refinancing conditions.

Evaluating ESG performance in refinancing transactions is a dynamic and evolving practice that requires strong dialogue and cooperation between investors, issuers and rating agencies. Taking ESG factors into account not only improves risk management, but also aligns financial practices with broader sustainability objectives, ultimately benefiting all stakeholders. Ksapa works with all players in the chain – banks, institutional investors, funds on the one hand – but also with all types of issuers and assets – large corporations, SMEs, specific assets – all over the world. Ksapa has the expertise, networks and tools to help you assess, structure or reinforce an ESG approach that aligns the interests of these ecosystems. Contact us for more details!

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Author of several books and resources on business, sustainability and responsibility. Working with top decision makers pursuing transformational changes for their organizations, leaders and industries. Working with executives improving resilience and competitiveness of their company and products given their climate and human right business agendas. Connect with Farid Baddache on Twitter at @Fbaddache.

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