The sustainable treasury

Green or sustainable financing is no longer a novelty, but has its origins in the United Nations Framework Convention on Climate Change in 1992. In the years since 2000 and with the EU's decision to become the first climate-neutral continent by 2050, the so-called Green Deal, sustainability has clearly moved into the focus of the general public. In addition to legislators and standard setters, customers, business partners, rating agencies, investors and capital providers are also showing an increased interest in companies' contribution to the three dimensions of sustainability (environmental, social and governance).

ESG does not stop at the financial market and is also increasingly making inroads here. The market for sustainable financial products has been growing for over a decade and is constantly expanding. The outlook for the future shows a significant increase in the importance of the green financial market, for which companies and their treasury departments should prepare themselves. This is accompanied not only by new products and requirements for their own processes and guidelines, but also by direct questions in connection with the valuation, accounting and reporting of these.

At present, there are already various products on the market that fulfil or are linked to sustainability purposes or aspects. High-quality green bonds, for which the EU has already issued its own regulation (EU) 2023/2631 with the EU Green Bond Standard, as well as green loans, earmark funds for specific ESG projects or measures, for example.

Sustainability linked loans, whose funds are not earmarked for a specific purpose but whose interest rate is linked to the achievement of certain ESG goals by the borrower, are more flexible for the borrower. Of particular relevance and attention, especially with regard to potential greenwashing, is the design of meaningful performance indicators that do not cause any further problems in terms of accounting.

Another category of green financial instruments are green derivatives whose value depends on a sustainable underlying, such as embedded ESG components, carbon credits or green electricity certificates. However, long-term power purchase agreements also play a key role in ensuring a sustainable electricity supply and, due to their special features, require close cooperation between procurement, treasury and accounting.

However, this list only shows a few selected products; the list of financial instruments already available is longer and is constantly expanding, all with their own aspects that need to be taken into account.

The diversity in the design of financial products poses a significant challenge for companies in terms of valuation and accounting. In addition to regulatory requirements and standards, the design of the products and sufficient availability of market data for certain financial instruments must also be taken into account. Various providers such as Bloomberg, LSEG (formerly Refinitiv), MSCI or Sustainalytics already have a wide range of data and analyses on sustainable financial instruments and ESG data that can be used for a valuation. Depending on the design of the products, the topic can nevertheless be inherently complex in order to arrive at an appropriate valuation.

The actual accounting can also be complex. Typical issues include questions relating to 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 payment programmes (IFRS 2) or the presentation of green electricity certificates and EUAs.

The supreme discipline here is the inclusion of corresponding financial products in hedge accounting and valuation units in order to minimise the impact on the income statement. Component hedges, proxy hedges or underlyings that relate to stochastic expected values are just a few of the potential stumbling blocks in this respect. Hedges of business risks, which may not include risks in connection with sustainability aspects, also do not qualify for hedge accounting. It is therefore also important to take this into account when drafting contracts.ESG does not stop at the financial market and is also increasingly gaining ground here. The market for sustainable financial products has been growing for over a decade and is constantly expanding. The outlook for the future shows a significant increase in the importance of the green financial market, for which companies and their treasury departments should prepare themselves. This is accompanied not only by new products and requirements for their own processes and guidelines, but also by direct questions in connection with the valuation, accounting and reporting of these.

As a result of the increasing popularity of the green financial market, the parallel increase in requirements for ESG-compliant behaviour and the relevance of sustainability goals, treasury departments will be much more involved in the management of financial risks related to sustainability as an important part of the risk management system. Green financial instruments and derivatives entail specific risks that need to be analysed and mitigated in risk management.

The handling of sustainability risks and green financial markets will most likely need to be incorporated into departmental guidelines and processes. Close cooperation with the accounting department is also necessary in order to properly reflect the new products in the financial statements and to analyse the impact on the company's KPIs.

Closer integration with the actual operational core processes will also be necessary in order to be able to monitor the performance indicators promptly and comprehensively, which can now have a direct impact on the treasury-relevant risks and control parameters, such as available working capital, financing costs and liquidity management, as a result of the new product types.

Non-financial KPIs as well as disclosure requirements for environmental impacts and sustainability endeavours by companies are also becoming increasingly important. With the entry into force of the CSRD Directive and the requirements of the European Sustainability Reporting Standards (ESRS), the reporting obligations for companies in the EU will be significantly increased from 2025. At present, ESRS E2 already requires information on companies' emissions budgets, which already requires information on carbon credits, for example. Explicit requirements and disclosures on financial products are not yet included here, but there are already indications that further disclosures on ESG-related financial instruments may be included. Treasuries should prepare for this change in order to be ready at the right time.

Please contact us if you have any questions. We will support you in the smooth implementation of tomorrow's treasury challenges, be it in relation to modern processes and guidelines, the accounting and valuation of ESG-related financial instruments or customised reporting.

Source: KPMG Corporate Treasury News, Issue 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

Ralph Schilling