1/ SOME EMBLEMATIC FACTS

Here are some recent facts, among others, which illustrate this acceleration in ecological, social and sustainable awareness in the financial world:

1. Financial analysts from the largest sovereign wealth fund in the world, Norway’s oil fund, which manages around €1,133bn, are now accompanied by environmental, social and governance (ESG) analysts when they hold meetings with managers of any of the 9,123 companies in which the fund is a shareholder or is considering becoming one;
2. Danone (in 2020) and Kering are now presenting new financial tools (decarbonised earnings per share for Danone and environmental income statement for Kering) to measure the impact of the group on carbon emission or environment;
3. In 2018, the CEO of Blackrock – the largest asset manager in the world with close to €7,400bn in assets under management – wrote in the annual letter to the CEOs of major groups worldwide in which Blackrock has invested money:
   
   • “Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate”.
   • As early as 2016, Larry Finck wrote in his annual letter to the CEOs: “Over the long term, environmental, social and governance issues – from climate change to diversity and including board efficiency – have real and quantifiable financial impacts.”
4. In March 2018, the European Commission published its “strategy to bring the financial system to support the European Union’s climate and sustainable development agenda”, which will involve:
   
   1. “– establishing a common language for sustainable finance, i.e. a unified EU classification system – or taxonomy – to define what is sustainable and identify areas where sustainable investment can make the biggest impact;
   2. – creating EU labels for green financial products on the basis of this EU classification system: this will allow investors to easily identify investments that comply with green or low-carbon criteria;
   3. – clarifying the duty of asset managers and institutional investors to take sustainability into account in the investment process and enhance disclosure requirements;
   4. – requiring insurance and investment firms to advise clients on the basis of their preferences on sustainability;
   5. – incorporating sustainability in prudential requirements: banks and insurance companies are an important source of external finance for the European economy. The Commission will explore the feasibility of recalibrating capital requirements for banks (the so-called green supporting factor) for sustainable investments, when it is justified from a risk perspective, while ensuring that financial stability is safeguarded;
   6. – enhancing transparency in corporate reporting: we propose to revise the guidelines on non-financial information to further align them with the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD).”
5. In 2019, a large European bank, Natixis, introduced a voluntary mechanism for the internal allocation of prudential capital, which lowers the cost of financing with a positive impact on the environment, to the detriment of financing with a negative impact, thus increasing its cost. Moreover, it directs its commitments towards actors with a positive approach in this area.

2/ OLD OR RECENT ROOTS

We may well wonder why this is happening now and not five or ten years ago, or in four to five years’ time. It’s difficult to say. Like all groundswell movements, it started as the result of several factors, has been developing gradually and slowly over time and now that has gained momentum, it’s shaking up the whole system.

Environmental urgency is another factor: the depletion of the earth’s resources, which may well turn out to be a surmountable problem given human ingenuity, and global warming, which it is to be feared may well be a problem that we have underestimated.

It is undeniable that the 2007–2008 financial crisis had a major impact on how we see the world, probably more so than any other financial crisis, apart from the 1929 crisis. It naturally impacted on the way finance directors exercise financial management.¹ It also had a major impact on the general public who discovered that a financial product, sub-primes,² involved getting clients to borrow more than what was reasonable while getting others to take on the risk in order to get rich at their expense, with no regard for the consequences. This is now seen as morally unacceptable. Never again.

Finally, a disenchantment with ideologies and the growing difficulties that governments are experiencing in maintaining their traditional post-World War II roles of protector and distributor of resources, mean that individuals are now seeking meaning in what they spend most of their lives doing, which is working. Young people in particular want a mission in life and not a job, a mentor rather than a boss, and they want to make an impact and see meaning in what they do. Today, a lot more is expected from companies than in the past. More and more corporate people think that the company has a purpose and that it contributes to the common interest.

Without being cynical, we should also not overlook the phenomenon of lemming behaviour which is something we’re very familiar with in the world of finance. Companies seem to be competing against each other in the increasingly ambitious ESG statements that they put out. This is not cause for complaint, but now they’re going to have to deliver.

1/ THE EMERGENCE OF GREEN AND RESPONSIBLE FINANCING

When it comes to financing of companies, volumes of green or sustainable financing are still marginal at this stage, but have increased sharply. Today we get green bonds (Section 20.4), green loans (Section 21.2) and social bonds (Section 20.4).

Green bonds are conventional bonds in terms of their financial flows so the innovation here is not financial! Their green status stems from the issuer’s undertaking to use the funds for investing or spending that is positive for the environment (as defined by the company, which is generally assisted by an independent firm). Social bonds finance socially responsible projects.

Monitoring spending and allocating a source of financing to a particular use requires a specific type of organisation that financial departments are not accustomed to. And it has a cost, borne by companies as long as investors are not prepared to pay more for green bonds than for conventional bonds.

Standards for green, social and more generally responsible bonds are established by the ICMA,⁶ which publishes the Green Bonds Principles and Social Bonds Principles. This is important as investors rely on these standards in order to demonstrate that their investments are SRI compliant and that these bonds are eligible for inclusion in their funds or their asset portfolios dedicated to such investments.

Companies have another financial tool they can use for ESG policy implementation: green or responsible revolving credit facilities (RCFs⁷). Unlike bonds, these facilities do not require funds to be used for ESG projects (this would be complicated as for large groups, these facilities are mostly back-up undrawn credit lines). Their ESG aspect comes from the fact that their cost (and thus the banks’ remuneration) depends on the company achieving ESG goals. The relevance of these goals is initially validated by an independent agency and is subject to monitoring while the credit facility is active. We note that these products entail an ESG cost both for the company and the bank financing it! At this stage, the variability of the credit margin, which is dependent on whether the ESG goals are achieved or not, is still only a few basis points.

Notwithstanding the above, ESG-type financing products are also used to mobilise employees internally given that ESG goals become more concrete since failing to achieve them results in a (small) financial penalty and has a psychological impact that is certainly not negligible.

2/ ESG STANDARDS ARE NOT YET STABILISED

This development has brought its own problems. How do we go about assessing, rating and ranking companies on the basis of ESG criteria? What are the most relevant criteria and for whom are they relevant? Clearly, assessments should be sector-based as an agri-food business will not face the same ESG challenges as a power generating company. Agencies that rate companies on the basis of their ESG policies (Vigeo Eiris, Cicero and Sustainalytics) are emerging, the traditional rating agencies and audit firms are also seeking to get in on the act as are the certification agencies (Bureau Veritas, SGS) while standards (ISO) will soon be developed.

One of the problems that companies are having to face remains the lack of a uniform and dynamic method for selecting these criteria. New criteria are continually arising (sometimes in response to the latest trends or because new controversies have emerged) and companies are having to be agile if they want to hang onto their ratings or certifications.

One of the problems raised by green or social bonds is that funds raised must be used for ESG investments. This means they are easy to issue for very capital-intensive businesses (energy, real estate, etc.), but much trickier for knowledge-based industries (what sort of investment by an advertising agency could be classified as green or social?) So, in today’s world, these companies are unable to make use of this tool even if they happen to have impeccable ESG credentials.

This highlights the difference between the holistic and the targeted project approach to ESG. The former is clearly more ambitious but difficult to measure, standardise and grasp for anyone outside the company. There is the fear that companies may indulge in communication one-upmanship and greenwashing without taking any real action, all in the interests of political correctness. The latter approach is more concrete for investors, but involves a risk of financing companies that generally do not have very impressive ESG ambitions and only communicate on a few projects.

3/ A TOUGH CONSTRAINT

But let’s not deceive ourselves. This is most definitely not just a passing trend to which homage should be paid for a short time, before returning to the way we used to do things in the good (or rather bad) old days!

The good news is that the long-term view doesn’t seem to be exclusively focused on financial performance. From the point of view of companies, the Boston Consulting Group⁸ shows that, out of a sample of 343 groups in 5 sectors, companies with a high ESG score have higher margins than others. The direction of causality still needs to be determined. The fact that companies with higher ethical standards are more attractive to employees is one explanation. Other explanations also highlight better risk management as a result of ESG issues being factored in and the creation of opportunities. As an example, ArcelorMittal has announced that a new technology for treating gas produced by its Gand plant will enable it to transform gas into bio-ethanol that it will be able to sell.

1/ THE FINANCIAL MANAGER IS FIRST AND FOREMOST A SALESPERSON AND A NEGOTIATOR

2/ THE FINANCIAL MANAGER IS ALSO A CONTROLLER

3/ THE FINANCIAL MANAGER IS ALSO A STRATEGIST

The corporate financier is also a strategist who, because they constantly assess the risk and profitability of the company’s activities, and therefore, as we shall see, their value, is in a position to suggest a review of their scope. The company will thus be able to sell to better placed third parties, assets on which it is unable over time to generate the required rate of return in view of their risks, in order to concentrate on the best performing divisions that can be developed through acquisitions.

We are far from the CFOs of the sixties who were mainly top-of-the-class accountants! Nowadays they are required not only to perfectly master accounting and finance, but also to be gifted in marketing and negotiation, not to mention tax and legal issues, risk management, and to be able managers of their teams. The best of them also have a strategic way of thinking, and their intimate knowledge of the company and its human resources allows them to be serious candidates for the top job. As an illustration, the current CEOs of Siemens, Danone, Expedia, Sony and Tata Consulting are all former CFOs of their companies.

* * *

We’re going to leave you with these appetisers in the hope that you are now hungry for more. But beware of taking the principles briefly presented here and skipping directly to Section III of the book. If you are looking for high finance and get-rich-quick schemes, this book is definitely not for you. The menu we propose is as follows:

• First, an understanding of the firm, i.e. the source of all the cash flows that are the subject of our analysis (Section I: Financial analysis).
• Then an appreciation of markets, because it is they who are constantly valuing the firm (Section II: Investors and markets).
• Then an understanding of how value is created and how it is measured (Section III: Value).
• Followed by the major financial decisions of the firm, viewed in the light of both market theory, organisational and behavioural theories (Section IV: Corporate financial policies).
• Finally, if you persevere through the foregoing, you will get to taste the dessert, as Section V: Financial management presents several practical, current topics in financial engineering and management.