Navigating ESG in Treasury Operations: A Conversation with Etienne Chalmagne
Welcome to a deep dive into the interplay between treasury functions and Environmental, Social, and Governance (ESG) principles. As professionals in the treasury field, we must keep abreast of shifts in business landscapes and understand how these changes affect our daily operations.
ESG principles, once considered separate from the financial world, have now taken center stage in corporate decision-making. But what does this mean for us as treasury professionals? How do we navigate this new ESG-centric business landscape, and what are the potential implications for our roles?
To answer these questions, we turn to an insightful conversation with Etienne Chalmagne, an expert in the field. Drawing from his wealth of experience and knowledge, we delve into the nitty-gritty of ESG and its role in treasury operations.
By reading this article, you can expect to learn
- What Is ESG?
- How Would ESG Apply to Treasury
- What Are the Investment Instruments That Are ESG Themed
- Can An RCF Be Linked to The ESG Performance of a Company
- What Is the Role of The Treasury When It Comes To ESG
- The Role of Rating Agencies in The Whole Process
- And All About Etienne’s Experience Throughout His Amazing Career
- And Much More
So, let’s embark on this journey to understand the marriage of ESG principles and treasury operations.
Introducing Etienne Chalmagne: A Pioneer in Financial Markets and Treasury
Etienne Chalmagne’s experience spans over 23 years in financial markets and treasury, characterized by three distinctive pillars: a thorough engagement with debt and financial market innovation, a strong academic background, and a commitment to stepping out of his comfort zone.
An Innovation-Driven Career in Financial Markets
The first pillar is Etienne’s profound connection with financial markets and treasury, particularly focusing on debt. Etienne’s professional journey has been diverse, covering various aspects of debt, including trading, credit analysis, syndication, and sales. His fascination with debt instruments and innovations led him to manage and trade a range of products, including lower tier two, upper tier two solvency products, and tier one products.
As an issuer, he ventured into raising convertible bonds with equity-linked components, such as non-dilutive convertible bonds. Recently, Etienne was involved with Sustainability Linked Bonds (SLB) and Sustainability Linked Loans (SLL), this affirms his innovative approach in the financial markets.
A Passion for Knowledge Sharing: The Academic Pillar
Etienne’s second career pillar is his continuous involvement in academia. Etienne, with a teaching streak, started his Ph.D. in finance in 2009. Since then, he’s been teaching various financial courses at universities and business schools, passing on his knowledge and experience to the next generation. This year, he teaches financial instruments and technology at IESEG, a business school in Lille. He also teaches about: introductions to derivatives, credit risk management, and international finance.
Teaching, for Etienne, serves a dual purpose: sharing knowledge and challenging his understanding. This constant engagement with academics allows him to keep abreast of the evolution of financial knowledge.
Continually Pushing Boundaries: Getting Out of the Comfort Zone
The third and final pillar of Etienne’s career is his inclination for risk-taking. He has a knack for stepping out of his comfort zone, allowing him to expand his knowledge and skills continuously. His career journey is a testament to his ability to adapt to different environments, moving from one country to another and transitioning from the banking industry to the corporate sector.
As the Director of Financial Markets at Aliaxis, Etienne is responsible for treasury management and funding. As a part of the global head of treasury, he’s not just dealing with finances; he’s also working on transforming the treasury.
Exploring ESG in Treasury: What it is and Why It Matters Now
Etienne Chalmagne dives into the concept of ESG, explaining its relevance in today’s treasury landscape. ESG stands for Environmental, Social, and Governance factors, essential considerations for sustainable corporate operations and investments.
The ABC of ESG
ESG represents a shift in perspective from solely focusing on financial performance to considering a company’s wider societal impacts. This holistic evaluation approach has its roots in the concept of ‘People, Planet, Profits’ (PPP), developed in the 1990s, which suggests that another model than capitalism may exist.
- Environmental (E): This component assesses a company’s environmental stewardship. It encompasses broad aspects like climate change and carbon emissions and specifics like water pollution, biodiversity, and waste management.
- Social (S): The ‘S’ focuses on people and relationships. It evaluates customer satisfaction, gender diversity, human rights, employee well-being, labor standards, and data protection.
- Governance (G): The final component, governance, analyzes the internal standards and processes of a corporation, including board composition, remuneration of directors, and matters relating to political contributions and corruption.
Similar, but Different: ESG, SRI, Impact Investing, and CSR
While often used interchangeably, terms like ESG, SRI (Socially Responsible Investment), impact investing, and CSR (Corporate Social Responsibility) have subtle differences.
- ESG: ESG serves as guidelines for assessing a corporation’s risk and performance concerning environmental, social, and governance aspects.
- SRI: SRI takes ESG a step further. For instance, fund managers may use ESG guidelines and make investment decisions based on ethical factors, possibly excluding certain industries or companies.
- Impact Investing: Impact investing aims to contribute to social, economic, and environmental benefits. It’s a step further from SRI, focusing on causing change and shaking the status quo.
- CSR: CSR differs from ESG in that it is seen as more internal and qualitative, while ESG is considered more external and quantitative.
The Rising Relevance of ESG
You might wonder why ESG is suddenly such a hot topic. Etienne points out that since the early 2000s, the world has undergone a significant shift. There is now indisputable evidence of climate change, prompting corporates, governments, and other stakeholders to take action. ESG has emerged as an integral part of these actions, essential to future growth and stability.
One major catalyst for ESG’s rising importance was the Paris Agreement 2015 (COP21), which set a global target to limit global warming to under 2 degrees Celsius. This commitment required significant investment – about $3 trillion per year – to achieve the target by 2050, calling for a significant increase in ESG investments.
In conclusion, understanding ESG is not just an academic exercise but a necessary step for corporations to align their strategies with global sustainability efforts. As Etienne indicates, ESG has evolved from a consciousness-raising initiative to a critical part of corporate and investment decision-making processes.
How Does ESG Apply to Finance and Treasury Specifically?
Guillaume asks, “How does ESG apply to finance and treasury?” Etienne provides a detailed explanation, highlighting the effects of ESG on finance, its relationship with different business sectors, and its specific relevance to treasury departments.
ESG and Its Impact on Finance
According to Etienne, as businesses adopt and implement ESG practices, these changes will inevitably ripple across the financial landscape. Why? Because a company’s shift towards ESG impacts its profit and loss statement (P&L) and balance sheet. In other words, ESG’s influence on a company’s financial health is quite direct.
This effect is not limited to a company’s overall financial control. Etienne mentions that other departments like tax, treasury, and even Mergers and Acquisitions (M&A) will feel the impact of these ESG changes.
Now, you might be wondering: what does ESG have to do with treasury in particular?
The Connection Between ESG and Treasury
When we think of treasury and ESG, two primary activities come to mind:
- Financing: As businesses shift their focus to ESG, treasury departments can contribute by raising ESG-linked or pure ESG financing.
- Investing: The investment aspect of treasury also ties in directly with ESG.
But the connection goes a bit deeper than this. When it comes to ESG financing, Etienne shares that there are two main types to consider:
- Use of Proceeds: These are funds raised for specific ESG projects or objectives. When a company raises money, those funds will be dedicated to ESG purposes. Most of the time, these purposes are green, but we’re seeing more instances of social purposes and what’s referred to as “transition.”
- General Corporate Purposes: These are funds raised for regular business needs, like refinancing existing debt or working capital. However, these funds can be linked to ESG through Key Performance Indicators (KPIs). Penalties may be applied (usually a coupon set-up) depending on the performance of these ESG-linked KPIs at a certain time.
In short, while the ESG movement pushes businesses to consider their actions’ environmental, social, and governance impacts, it also directly affects how they raise and invest funds.
What Does Investing in an ESG-Compliant Way Look Like for a Treasurer?
In the next part of the discussion, Hussam asks Etienne, “What would investing in an ESG-compliant way look like for a treasurer?” This is an interesting question because it helps treasury professionals like you understand the practicalities of ESG investing.
Investing with an ESG Focus
Firstly, when you, as a treasurer, find yourself with excess cash, Etienne suggests you aim to put that money to work in an ESG-compliant way. How? You might choose to deposit with banks with a strong ESG stance or invest in money market funds or commercial papers with an ESG component for short-term investments. Bonds with an ESG focus can also be an option for long-term investments.
Now you’re probably thinking, how do I measure the success of these ESG-compliant investments?
The Role of Key Performance Indicators (KPIs)
To measure the success of ESG investments, you can use KPIs – those important measures that help you understand how well your company is achieving its ESG goals.
These could be KPIs related to reducing carbon emissions, cutting down on waste, promoting gender diversity, and so on. You might even use an index composed of various indicators as your KPI. The sky’s the limit – there are numerous possibilities as long as these are measurable, have sufficient data backlog and perceived as ambitious by the investors.
Let’s look at an example to make this clearer. Etienne shares how they did it at Carrefour in 2019. They refinanced their revolving credit facility with an innovative ESG mechanism. The KPI used was a Corporate Social Responsibility (CSR) index of 17 indicators spanned environmental, social, and governance factors. The performance of this KPI was analyzed each year, and depending on the outcome, a contribution from banks/Carrefour or carrefour alone was triggered.
Aligning Investments with ESG Objectives: Exploring Options and KPIs for Treasurers
These KPIs’ results are to be scrutinized and verified at a certain date in the future and to be compared with the Sustainable Performance Target, orSPT (the original objective of the KPI to reach at that time. If the performance of the KPI is above the SPT (in this case a certain defined threshold (in %) of the CSR index), both contribution from banks and the issuer were triggered. If it below, penalties can be applied to the issuer alone.In both cases, the money was dedicated to feed ESG projects related to Food Transition.But other alternatives exist like allocating funds to NGOs, charities, or specific funds to improve the company’s ESG standing for example.
As a treasurer, you have a wide array of options to invest in an ESG-compliant way, with different types of investments and KPIs to choose from. The key is understanding what’s best for your organization and aligning your actions with your company’s ESG objectives.
Understanding KPI-Based Investment and the Role of Sustainable Performance Target (SPT)
Guillaume asks about the nitty-gritty of KPI-based investments and how these affect interest rates and repayment schedules. Etienne Chalmagne dives into this complex topic with a straightforward explanation.
A KPI-based investment is a unique form of investing where the focus isn’t just on profit. Instead, companies set Key Performance Indicators (KPIs) linked to Environmental, Social, and Governance (ESG) goals, like reducing carbon emissions or increasing gender diversity for example.
KPI-Based Investments
Here’s how it works:
- Setting a baseline: Companies set a baseline for their KPI, usually with a minimum of observable backlog data (3 years is reasonable). This helps understand the ‘starting point’ or the current level of performance on the KPI.
- Setting a target (SPT): Next, the company sets a Sustainable Performance Target (SPT) for a future date (like three, five years or even longer ahead). The purpose of the company is to reach and exceed this SPT in the future, in order to avoid paying a penalty (usually a coupon step-up) and show the ESG commitment and actions taken by the company.
- Verification: The trajectory of the KPI towards the SPT needs to be checked and confirmed by an external party every year. This ensures transparency and that the company isn’t just saying they’re on track without proof.
The Implications of KPIs and SPTs on Investments
When a company receives an investment based on a KPI, the expectation is that the KPI will meet or exceed the SPT. If this happens, it’s business as usual, with no penalties for the company.
However, if the company falls below the target, there’s a penalty. Usually, this means the interest rate on the borrowed money increases. For example, a bond issue might see a 25 basis point increase in the interest rate.
Interestingly, this penalty has increased over time due to concerns about “greenwashing” – when companies make weak commitments to ESG goals. So now, a company might face an increase from 25 to 50 basis points or even more each year if they fail to meet their targets.
The Role of the SPT in KPI-Based Investments
To clarify, the SPT (Sustainable Performance Target) is the goal for the KPI. For example, if a company sets a KPI of reducing carbon emissions, the SPT might reduce emissions by 50% based on the baseline by 2030. The SPT measures how well the company reaches its KPI goal.
In essence, KPI-based investments and SPTs are tools to ensure that companies be more sustainable or ethical – they’re taking steps to make it happen. The financial implications ensure companies have a strong incentive to meet their goals. This powerful combination of finance and sustainability is paving the way for a greener and more equitable corporate world.
Understanding ESG Themed ETFs and the EU Taxonomy for Sustainable Activities
Guillaume asks Etienne about Exchange-Traded Funds (ETFs), particularly those with an ESG theme, and the EU taxonomy for sustainable activities.
What is an ETF, and Do ESG-themed ETFs Exist?
Etienne explains that an ETF, short for Exchange-Traded Fund, is similar to a mutual fund. However, unlike mutual funds with a value (NAV – Net Asset Value) calculated at the end of each day, ETFs are traded like stocks, and their prices fluctuate throughout the trading day.
Three main factors make ETFs attractive:
- They’re less expensive, with relatively low fees.
- They offer flexibility as they can replicate any investment type, such as a stock index. For example, an investor cannot directly purchase the S&P 500 index but buy an ETF that mirrors the S&P 500.
- They make market segments easily accessible to a wide array of investors.
Like in other areas of the financial world, ESG considerations are making their way into ETFs. There is an increasing number of ESG-themed ETFs, regardless of whether they consist of bonds or stocks.
What is the EU Taxonomy for Sustainable Activities?
Etienne then delves into the EU taxonomy for sustainable activities. It’s a term you hear often, especially if you’re a treasurer or involved in regulations related to ESG.
Introduced in 2020, the EU taxonomy is essentially a classification system. It’s designed to clarify what we mean when we discuss ESG or sustainable projects and activities. The classification comes from the European Green Deal, which sets targets for the European Union to be climate-neutral by 2030 and 2050.
The main goal of this Green Deal is to reduce carbon emissions by 55% by 2030. To achieve this, the EU taxonomy focuses on six environmental objectives:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems
While there have been discussions about an EU social taxonomy, this has been put aside for now. When we talk about EU taxonomy, we mainly discuss the environmental aspect.
The EU taxonomy has numerous implications. For instance, the European Central Bank (ECB) uses these six environmental objectives to determine whether a bond issuance is eligible under its Key Performance Indicator (KPI) limit. If a company wants to issue a sustainability-linked bond, they need to have this KPI related to one of the six environmental objectives. If so, the ECB will consider it eligible, and investors can use it as collateral for repurchase agreements or directly buy through the Corporate Sector Purchase Program to support issuers in moving towards ESG.
However, Etienne notes that starting back in 2022, the ECB will only reinvest in investments maturing from the past, meaning they won’t make net investments to support the sustainability-linked bond segment (as no longer part of the quantitative easing policy).
ESG-Themed Financial Instruments and Their Utilization in Revolving Credit Facilities
Simply put, An ESG-Themed Financial Instrument is a tool for investment or funding designed with the principles of Environmental, Social, and Governance (ESG) in mind. These are available for treasurers to invest in or use for their financial operations.
The Role of Revolving Credit Facilities (RCFs) in ESG
Etienne explains that an RCF is a credit facility, often spread among a group of banks, which provides the flexibility to draw funds as needed. These facilities are generally used to finance short-term needs like working capital. In this context, the term ‘revolving’ means that you can reuse the credit as you repay it.
A significant advantage of these facilities is that they provide a ‘Backup‘ liquidity capacity for corporates, which credit rating agencies value.
Introducing ESG into RCFs
Etienne then explains how ESG can be incorporated into these facilities. He introduces us to the Sustainability Linked Loans (SLLs) concept, which can form part of a facility. In this type of loan, an ESG-related Key Performance Indicator (KPI) is linked to the loan.
The example of the retail company Carrefour is cited to illustrate this concept. In 2019, Carrefour set up a mechanism in which a portion of the commitment fees (based on undrawn funds) would finance ESG projects within the company. This mechanism kicks in depending on the performance of a specific ESG index.
The innovative part of this mechanism is that the company contributes to the ESG project regardless of whether the KPI targets are met. In other words, both in success and failure, the company is committed to contributing to ESG projects.
Etienne concludes by noting that facilities dedicated entirely to green or social projects are also available, where the funds are exclusively used for specified ESG-related projects. He observes that these financial tools are becoming more popular in the financial world.
The Role of Sustainability in Bond Issuances
Let’s dive into how companies can incorporate ESG goals into their bond framework and the different types of bonds available.
Incorporating Sustainability into Bond Frameworks
Etienne states that companies aiming to issue bonds with an ESG theme need to set Key Performance Indicators (KPIs) and targets related to sustainability. These goals need to be ambitious enough to appeal to investors.
Typically, a company would establish an ESG framework detailing the chosen KPIs and the Sustainability Performance Targets (SPTs). This framework forms the basis for raising funds through various instruments such as bonds or commercial papers or other debt products.
Bond Issuances with an ESG Focus
Companies can issue different types of bonds under this framework. The Sustainability-Linked Bonds (SLBs) that Etienne mentions are one option. These bonds have their financial performance tied to achieving predetermined ESG goals.
Green bonds and social bonds represent another type of instrument. The funds raised from these bonds are specifically earmarked for environmentally-friendly or social projects.
Etienne acknowledges the increasing popularity of these instruments, particularly green bonds. He estimates that the number of outstanding green bonds could increase fivefold from 2018 to 2023, indicating the market’s growing interest in sustainable finance.
However, Etienne also notes that some investors have shown grown hesitation toward SLBs. The ambitious nature of the targets these bonds set can sometimes be met with skepticism. Therefore, these targets must be continuously evaluated and validated to meet investors’ expectations and remain feasible.
Deciding Between ESG Financial Instruments
Hussam probes deeper into the factors influencing the selection of ESG financial instruments. Etienne Chalmagne helps us understand the impact of corporate needs and ESG considerations on this choice.
Choosing Instruments Based on Unique Corporate Needs
Etienne underscores that the corporate’s specific needs play a significant role in choosing financial instruments, ESG included.
For instance, a revolved credit facility (RCF) typically involves funds from banks, whereas bonds and commercial papers source funds from the broader market. Therefore, a corporation might initially lean on bank loans, gradually venturing into bonds and commercial papers as they establish financial transparency and credit ratings.
ESG’s Influence on Financial Instrument Selection
Transitioning to the ESG perspective, Etienne highlights a shift in the perceived value of Sustainability-Linked Bonds (SLBs). Initially, SLBs offered scant economic benefits due to their novelty and lack of comparative metrics.
But as ESG commitments grow more common, treasury professionals view these instruments as valuable tools with the potential to lower financial costs. Etienne suggests that non-ESG companies could face additional costs, emphasizing the role of ESG as a value creator and a means to achieve financial benefits.
Why ESG Instruments are Gaining Financial Attraction
To Hussam’s question about the growing financial attractiveness of ESG instruments, Etienne indicates that incorporating ESG goals can improve business processes and financial metrics. As he points out, banks and investors now consider these ESG metrics in credit or investment decisions.
ESG in Financing Activities
Finally, in response to Hussam’s query about the role of ESG in financing activities within the Treasury Department, Etienne highlights various financial instruments. RCFs, bonds, Private placements, and Commercial papers can all incorporate an ESG component. Including ESG components across financial instruments suggests an industry-wide shift towards sustainable and responsible financing.
Role of Rating Agencies in ESG Implementation
Etienne discusses the significant role of rating agencies in ESG implementation, shedding light on their function, the challenges faced, and the need for standardization.
Assessing ESG Through Rating Agencies
Etienne emphasizes that many ESG rating agencies exist, each with a unique methodology and focus area. These agencies, distinct from traditional credit rating agencies, evaluate a company’s ESG performance.
The ESG score from these agencies can range from zero to 100, or even a letter score, depending on the agency’s methodology. These agencies help investors decide whether to invest in a particular ESG-compliant company.
On the other hand, traditional credit rating agencies have started incorporating ESG components, influencing a corporation’s credit rating based on its ESG performance and potential risks.
The Reputational Risks of ESG Compliance
Hussam brings to attention the reputational risks tied to ESG compliance. If a company that claims to be ESG compliant uses a non-ESG instrument, it can harm its reputation, emphasizing the critical role rating agencies play in the process.
The Challenges of Transparency, Standardization, and Greenwashing
Etienne acknowledges the crucial role of rating agencies but also highlights criticisms concerning lack of transparency, standardization, and the issue of “greenwashing” – making misleading claims about the environmental benefits of a product or service.
For companies aiming for transparency, satisfying all rating agencies can be tough due to diverse methodologies and criteria. Attempting to meet one agency’s requirements might result in falling short for another, leading to potential penalties.
Etienne concludes a growing need for standard reporting and communicated information. This standardization will help investors and issuers, preventing unfair penalties and facilitating a smoother ESG implementation process.
The Broader Implications of ESG for Treasurers
Hussam and Etienne Chalmagne delve into various aspects of ESG that treasurers need to contemplate, moving beyond the finance and investment fields. They address the role of data collection, ESG improvement initiatives, and the potential balance between efficiency and ESG commitments.
Data Collection and ESG Improvement Initiatives
Treasurers play more roles than merely focusing on finance and investment tasks. Etienne highlights the importance of treasurers’ responsibilities in data collection, working alongside ESG departments, communication, investor relations, and contributing to the overall ESG purpose. It’s also interesting to note that ESG principles can influence more routine treasury operations, such as managing trade receivables or payables.
Here’s a practical example: by transitioning from paper-based methods (like checks) to digital payments, companies streamline their operations and positively contribute to their ESG performance. Innovations like virtual credit cards can further enhance this environmental benefit. According to Etienne, these steps could fall under a treasurer’s purview, helping their organization on its ESG journey.
As Hussam notes, these kinds of changes also benefit the treasury department. Moving away from paper makes tracking easier, enhances automation, and optimizes treasury processes. The fact that ESG and treasury optimization can work hand in hand is a positive development, showing they are not opposed but harmoniously intertwined.
Trade-off Between Efficiency and ESG?
A question arises: do treasury departments ever need to choose between efficiency and ESG? Do they need to compromise certain costs or efficiencies to adhere to ESG principles?
The answer, according to Etienne, is NO.
He firmly believes that as long as a company’s treasury and ESG strategies align, there is no need for a trade-off. Rather, adhering to ESG principles can increase efficiency and cost-effectiveness. So, far from being a hindrance, integrating ESG principles into treasury operations is a win-win move, fostering both ethical and financial gains.
Wrapping Up:
As we delve into the intricate relationship between treasury operations and Environmental, Social, and Governance (ESG) principles, it’s evident that these two areas are far from separate. They intersect and interweave in several critical ways, shaping the future of treasury operations.
Throughout this discussion, we’ve seen how ESG makes an ethical statement and brings tangible benefits to companies. From potentially lower financing costs associated with ESG compliance to improved investment returns, ESG principles are an ally rather than an adversary to treasury departments.
Moreover, we’ve highlighted the pivotal role of ESG rating agencies, shedding light on their varied methodologies and the need for increased standardization and transparency. These agencies provide key insights for investors and assist companies in maintaining their reputations.
Finally, we delved into the broader implications of ESG, extending beyond finance and investment. These principles affect everything from data collection to handling receivables and payables. Etienne Chalmagne’s insights reveal that ESG strategies can enhance efficiency and cost-effectiveness in treasury operations, further proving the integral role of ESG in the financial world.
In conclusion, as treasury professionals, embracing ESG principles and integrating them into our strategies is crucial. It’s more than a trend or a buzzword – it’s a significant aspect of modern business operations that carries ethical, reputational, and financial implications. By marrying ESG and treasury operations, we can ensure not only the growth of our companies but also their sustainability and resilience in a rapidly changing business landscape.
