Green or sustainable financing has been around for a while, with its origins going back to the United Nations Framework Convention on Climate Change of 1992. Since 2000, and with the EU's decision to become the first climate-neutral continent by 2050, the so-called Green Deal, sustainability awareness has increased significantly among the general public. Alongside legislators and standard setters, there is also increased interest from customers, business partners, rating agencies, investors and capital providers in how companies contribute to the three dimensions of sustainability (environmental, social and governance).
ESG also impacts the financial market and is increasingly being taken into account in this area as well. Demand for sustainable financial products has been growing for over a decade and continues to expand. Looking ahead, the green financial market is projected to grow significantly, and companies and their treasury departments should prepare for this. Companies will not only have to deal with new products and requirements for their own processes and guidelines, but also with direct issues related to the valuation, accounting and reporting of these.
So which ESG financial products are trending?
A range of products that fulfill sustainability objectives or aspects or are linked to them are already available on the market. These include high-quality green bonds, for which the EU has already issued its own regulation (EU) 2023/2631 in the form of the EU Green Bond Standard, and green loans, which earmark the funds for specific ESG projects or measures, for example.
More flexible for the borrower are sustainability-linked loans, whose funds are not earmarked for a specific purpose, but whose interest rate is linked to the borrower achieving certain ESG targets. With a view to potential greenwashing, it is particularly important to design meaningful performance indicators that do not cause any further accounting issues.
Green derivatives are another category of green financial instruments. These are financial instruments whose value depends on a sustainable underlying, such as embedded ESG components, carbon credits or green electricity certificates. Another example are long-term power purchase agreements, which play a central role in ensuring a sustainable energy supply today.
That said, this list merely highlights a few select products. The list of financial instruments already available is both longer and constantly growing, with each instrument having its own aspects that need to be considered.
Which aspects are relevant for the valuation and accounting of green financial products, green derivatives or embeddeds?
One of the main challenges for companies in terms of valuation and accounting is the wide variety of financial product designs. Factors to be considered here include regulatory requirements and standards, product design and the availability of sufficient market data on certain financial instruments. Suppliers such as Bloomberg, LSEG (formerly Refinitiv), MSCI and Sustainalytics already offer a wide range of data and analyses on sustainable financial instruments and ESG data that can be used for valuation purposes. Even so, getting the valuation right can be inherently complex, depending on the structure of the products.
And the actual accounting can be complex too.
Even the actual accounting can be complex here. Issues typically addressed include compliance with the so-called SPPI criterion (IFRS 9.4.1.2(b)), the separation of embedded derivatives, the application of the own-use exemption (IFRS 9.2.4), the treatment of ESG-related share-based compensation programs (IFRS 2) or the presentation of green electricity certificates and EUAs.
Integrating the relevant financial products into hedge accounting and valuation units is the ultimate goal here, with the aim of protecting the income statement. Some of the potential stumbling blocks in this regard are component hedges, proxy hedges or underlyings that relate to stochastic expected values. What is more, hedges of business risks, which may include risks related to sustainability aspects, do not qualify for hedge accounting. This means that it is also important to take this into account when drawing up the contract.
Treasury: What new processes are needed to manage sustainability risks?
With the growing popularity of the green financial market, the parallel increase in requirements for ESG-compliant action and the relevance of sustainability goals, treasury departments will be significantly more involved in managing financial risks related to sustainability as a key part of the risk management system. Green financial instruments and derivatives carry specific risks and these must be analyzed and mitigated in risk management.
In all likelihood, managing sustainability risks and green financial markets will mean incorporating them into the departments' guidelines and processes. In the same vein, it is necessary to work closely with the accounting department to properly reflect the new products in the financial statements and to analyze the impact on the company's KPIs.
Also, an even greater interlocking with the actual operational core processes will be necessary. Only then will it be possible to monitor the performance indicators that can now have a direct impact on treasury-related risks and control parameters, such as available working capital, financing costs and liquidity management, in a timely and comprehensive manner.
What is Treasury's role in meeting the requirements of sustainability reporting?
Beyond financial KPIs, the disclosure of environmental impacts and sustainability efforts is also becoming increasingly important. Now that the CSRD has come into force, and with the requirements of the European Sustainability Reporting Standards (ESRS), companies in the EU will face significantly increased reporting requirements from 2025 onwards. For the time being, the ESRS E2 already requires information on companies' emissions budgets, which, for example, already requires disclosures on carbon credits. Although explicit requirements and disclosures for financial products are not yet included here, further disclosures on financial instruments with an ESG dimension are also being considered. We recommend that treasuries prepare for this change in order to be ready at the right time.
Please do not hesitate to contact us if you have any questions. Whether you need support with modern processes and guidelines, accounting and valuation of ESG-related financial instruments, or tailored reporting, we can help you to smoothly implement the treasury challenges of tomorrow.
Source: KPMG Corporate Treasury News, Edition 148, October 2024
Authors:
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Yannic Diefenbach, Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG