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Timely adaptation is difficult for large companies
Help! The climate is threatening my loan
The consequences of climate change are far reaching. Even entrepreneurs are being affected in their business operations. Simon Hardonk, advocaat in the Corporate Restructuring & Insolvency department explains why sustainable financing is a good way to anticipate climate risks.
Why are climate risks so important when financing transactions?
'The Dutch Central Bank sees climate change as a systemic risk for the financial sector, and illustrates that something must happen. Climate risks must be appraised better and discussed more often with customers. The consequences can be huge, for company financeability or for refinancing. When we discuss these risks with our clients, we distinguish between physical risks, transition risks and liability risks.
Physical risks are a.o. the consequences of extreme weather, such as flooding damages. If flooding, for example, becomes an annual problem due to a warmer climate, it can lead to a higher insurance premium. We now carry these costs collectively but, if extreme weather becomes 'the norm', they might become an individual risk. It is therefore important that banks and insurance companies perform skilled risk analysis. Blue Label is a new initiative that helps people, companies and governments gain digital insight into the climate risks for specific buildings or areas.
Transition risks are seen when shifting to a new system, such as from oil and gas to sun and wind energy. However, they can also be about the public opinion. The ban on lignite is a transition driven by regulation, but change can also be driven by consumer preferences, such as the transition to meat substitutes that reduce the need for livestock farming. Companies should use their antennae because it's all about your social licence to operate. Ensuring public support can prevent many problems. This is especially important for companies that operate in populated areas, such as Tata Steel or KLM. But for large companies, timely adaptation can be difficult: changing existing processes, depreciating large investments or changing the entire working method takes time.
Liability risks are risks that have to do with unjust sustainability claims, also called greenwashing. Due to new regulations, empty claims can be labelled as misleading advertising in the future, with dire reputational consequences.
These are all risks that not only affect financial institutions but also the companies that they finance.'
How have you seen that greening is becoming a factor in (re)financing?
'It is not yet a strict requirement for every financing deal, but partly green loans are on the rise and also have clear advantages. The initiative for green financing now usually comes from the beneficiary, such as for a sustainable project or a specific sustainability goal that has been formulated by the company and accepted by the lender. While the motivation to opt for sustainable financing used to come from a concern with regard to company reputation, I now see that it has become intrinsic. Sustainability now feels more authentic and is no longer laughed at, like it was a few years ago.
We, at CMS, have also received questions with regard to how green we as a company are, especially when we are part of a supply chain. The company's carbon footprint is starting to play a role and simply complying with new or existing rules and regulations is not enough. It is better to look ahead and anticipate, to what is going on in society and to the future wishes of consumers. A strategic view, for example from someone outside of your organisation, can give insight.'
What are the advantages of Sustainability Linked Loans (SLLs) and have these been communicated enough?
'SLLs are loans or credit lines with an incentive for documented sustainability goals and are a good tool for large companies. SLLs have certain requirements, such as sustainability performance targets that are agreed upon with the loan provider, and measuring and reporting. The advantage for both parties is that this form of financing makes their business operations greener. For the borrower, there are also the advantages of a possible lower interest rate and access to providers of sustainable financing. In the same way, sustainability can yield financial benefits for private individuals; if you insulate your house or purchase solar panels, lower mortgage interest rates are sometimes applicable. This is interesting for companies providing the mortgage as their portfolio then also becomes greener.
What I see is that loan providers have an additional advantage when working with companies that are focused on sustainability. These companies usually have a better business model and are more loyal with repayments. They also often work more consciously with their business model and thus pose a lower risk for financiers.'
What concrete tips can you give with regard to making company loans more sustainable?
'I always recommend that companies take a good look at what subsidies are possible. For example, through the Rijksdienst voor Ondernemend Nederland (RVO – Netherlands Enterprise Agency) it is possible to receive financing and subsidies for sustainable investments. Since the government wants to stimulate innovative projects, there are also various tax benefits. The Expertisecentrum Financiering Duurzame Energieprojecten (Expertise Center for Financing Sustainable Energy Projects) helps those with innovative techniques that have not yet been proven successful and Invest NL was founded to support startups and energy transition projects. Their mission is clear: to help make the Netherlands more innovative and sustainable. The Netherlands is leading the way, partly because we have the means to do so. But it is also something we can be proud of.'
More to read: Sustainability Linked Loan Principles – APLMA & LMA May 2020