The emergence of ESG as a driving force of business and finance in recent years has created new demands on companies, investors and regulators alike. The ever-evolving regulations bring significant challenges for project sponsors to address, as part of their day-to-day management. Often, the response has been to add capacity and capability, develop new sources of expertise and create departments that can respond to the new requirements.
Push – but also pull
It's not just about meeting increasingly stringent standards in the terms of a compliance exercise. There are also material business benefits that can be generated for companies that take the lead in adopting ESG processes. These are not only reputational (which aids recruitment), but market-leading ESG policies that give project sponsors an edge in the auction process. There is a proven 'greenium', when doing green financings (such as Sustainability Linked Bonds (SLBs), and green bonds). There is also the less-directly measurable, but still positively-correlated, equity performance which comes from adding liquidity to a company's potential investor base, as ESG-mandated portfolios are able to invest.
However, while ESG undoubtedly brings new demands to all sorts of organisations, they shouldn't be managed in a newly-created department or independent vertical. These environmental and social rules and regulations themselves fall under the governance aspect of ESG – and this is nothing new to any organisation. Therefore, project sponsors need to respond to the new ESG demands, but manage this process within the existing "traditional" framework of risk, cost and compliance.
When ESG first emerged as a concept, the 'G' of governance was the focus. This focus laid the foundation for the environmental and social evolution to come. In recent times, many may have felt that the environmental part of ESG has dominated Better reporting was also introduced to improve transparency, thereby reducing and mitigating carbon impact from projects/companies. There has also been a tightening of the broader environmental impact of projects, such as those that are required for licences and permits, particularly with regards to impacts on biodiversity.
However, this focus on environmental concerns also simply reflects the fact that the governance had already advanced. Meanwhile in some regions, such as in Latin America, there has been arguably an even more rapid advancement in the social aspects of ESG in the last couple of years. The demonstrable impact of a project on indigenous groups, on gender diversity, and on improving the quality of lives of lower socioeconomic groups, for example, has become a huge project finance focus. The increasing priority placed on social issues such as these has been for the same reasons that drove environmental issues – with projects that go beyond avoiding creating harm, and instead are able to point to the positive benefits of projects in regard to these social issues, rising up the agenda.
Inter-connected
There are many similarities and overlaps between the developing ESG regulations, such as a drive for transparency. However, in many cases there is direct reinforcement under each of the 'E', the 'S' and the 'G' factors, when assessing the specific impact of a project. For example, many projects improve environmental and social aspects at the same time – indeed they should both always be factored into projects to optimise results. A new electric transit system that connects a low-income neighbourhood to a city centre is, at the same time, lowering carbon emissions and lowering pollution. However, it is also improving the health of the local community and enabling individuals to travel more quickly to employment, improving productivity and helping family and social cohesion. In this case, which is more important? The E or the S?
As documentation and collateral agents, TMF Group helps our global partners manage all the additional ESG-led documentation workload. For example, some of this task requires new regular reporting and updating (e.g., when managing, or using SLBs, there is a need to be almost constantly monitoring the KPI targets and their impact on coupon payments to creditors).
However, our approach is to enhance the existing reporting and compliance frameworks we have, to integrate all new ESG requirements within those – as a seamless ESG-compliant – services, rather than create new ESG workstreams. We believe the best way to succeed in this area is to understand the inter-relationships: all elements of ESG are connected to one another and the accountability of these projects comes from the transparency of accurate and complete data reporting sharing true project impact on environmental, social and governance issues.
Project finance: How can TMF Group help?
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