Letter number 141 of January 2022

  • NEW

News : How the greening of the economy is changing corporate finance (part1)

The greening of the economy is the realisation by companies that the energy and social transition is inevitable, and that they must adapt to it as quickly as possible if they are to survive, which is their primary goal. The greening of the economy does not date back to 2021 or 2020, it dates back to the early 2010s. It has accelerated considerably though over the last 12 months with increased awareness of the climate crisis. For example, of the 40 largest French groups, five in 2018 had set targets of zero net emissions or carbon neutrality by 2050. There were nine in 2019, 17 in 2020, and there will be even more when the accounts are drawn up at the end of 2021, especially as at the end of 2020, they all committed to achieving a high level of financial transparency on climate risks. As an illustration, the cost of carbon neutrality for ArcelorMittal is estimated at between €15 and €40bn, for a company worth €25bn on the stock market. Among large groups and intermediate-sized enterprises, 18% have already made this commitment and 24% are planning to do so. Among SMEs, the figures are 12% and 11% respectively, and more surprisingly, 13% and 10% of VSEs[1].

These commitments cover not only direct emissions linked to the combustion of fossil fuels necessary for manufacturing a product (Scope 1), or the indirect emissions linked to the consumption of electricity, heat or steam necessary for manufacturing a product (Scope 2), but also those upstream and downstream of its manufacture: supply, transport, use and end of life (Scope 3). In most cases, Scope 3 emissions are the most significant: for Danone, the breakdown is 3%, 2% and 95%. For TotalEnergies: 8%, 1% and 91%. This means that groups will have to work with their suppliers and even their customers to achieve their targets. And given the knock-on effect, all companies of a certain size are involved, in other words, most companies in terms of volume of activity.

Total did not adopt the name TotalEnergies in 2021 just for the fun of it. This is because the group has gone from being a producer of hydrocarbons to becoming a producer of energy from fewer and fewer hydrocarbons. In order to survive.

In 2021, for the first time, several companies submitted a non-binding vote on their greenhouse gas reduction policy to their shareholder at the AGM. These resolutions were overwhelmingly adopted (98%, 97% and 92% respectively). It is likely that this practice will become more widespread and that, alongside the Say on Pay[2] on executive remuneration, which was initially optional and then became mandatory, the Say on Climate will follow the same path.

And we'll end this non-exhaustive review of the greening of the economy in 2020-2021 by noting that more and more companies are integrating a carbon cost into their internal calculations 23% of the 2,600 groups surveyed by McKinsey[3] were doing so in 2020, and 22% were planning to do so in the next two years. In the energy sector, 40% of companies already do so, 30% in building materials and 29% for financial institutions. This means that 22% of greenhouse gas emissions are covered, compared to 15% in 2017. On the other hand, the average price chosen for a tonne of carbon, $40, is lower than what many experts recommend ($100) to keep the increase in temperature to well below 2%, as foreseen by the Paris agreements.

The continual rise in the price of carbon since the end of 2020, tripling its price to €80 a tonne in January 2022, should help. This increase is mainly due to purchases made by investors confident that future carbon prices will be significantly higher, especially as free carbon credits are likely to disappear in the future. By pushing up the price of carbon credits, financial investors are pushing manufacturers to reduce their carbon emissions, which are becoming increasingly expensive to offset.

Since the autumn of 2020, we've seen a surge of financial products for companies incorporating ESG dimensions. Until now, treasurers seeking to enhance the value of their company's ESG efforts or find ad-hoc financing to make green, sustainable and responsible investments only had access to green bonds, intended to finance energy transition investments, social bonds or sustainable bank loans whose interest rate is partially indexed to the achievement of environmental or social goals.

Although in September 2019, the energy company Enel was the first to issue a sustainability-linked bond, transposing the practice of sustainability-linked loans to the bond field, it was not until September 2020 that this product saw an explosion in its volumes by companies from all sectors and all countries (the luxury goods group Chanel, the pharmaceutical group Novartis, the Brazilian paper manufacturer Suzano, the American electricity producer and distributor NRG Energy, etc.) And since then, the sustainability-linked bond has become the norm for corporate bonds, just as the sustainability-linked loan has become the norm for their bank loans. Their financing products are thus aligned with their overall strategy, as the criteria for margin development are chosen from among the more global ESG targets that the company sets itself. The company's communication in this area is therefore more readable for investors. The criterion is simple: to reflect only a part of the company's ESG policy (CO2 emissions and the share of renewables for Enel, CO2 emissions for Suzano, the proportion of low-income patients for certain therapies for Novartis, greenhouse gas emissions and the use of electricity produced from renewables for Chanel, greenhouse gas emissions for NRG). Qualitative targets or those that are more complex to measure cannot be captured, but that doesn't matter.

Since then, almost all tools that the corporate finance manager uses can now incorporate an ESG dimension. Here's a list, which is not intended to be exhaustive, with an example of companies that have used them: sustainable (FM Logistic), social (Icade) or green bank loans, green (Neoen) or sustainable (Schneider) convertible bonds, sustainable high-yield bonds (Rexel), green (Engie) or sustainable (Ocea) hybrid securities, sustainable RCF (Decathlon), Sustainable Euro PP (Korian), green or sustainable Schuldschein and Euro PP, ESG reverse factoring (Puma), social securitisations, ESG derivatives to manage foreign exchange risk, ESG deposits enabling the banks that receive them to finance ESG projects, SRI investments, guarantees or letters of credit with sustainable criteria, conversion of existing bonds into green bonds (Gecina), private debt with impact covenants (Lumibird), sustainable LBO, mezzanine or unitranche debt (Talan), green LBO fund financing lines(cap call)(ICAMAP), and even impact share buyback programmes (BIC) where the difference between the actual market buyback price and the average market price is donated to NGOs

If the cumulative amount of sustainable bond issuance (green, social and sustainability-linked bonds) took almost 12 years to reach $1,000bn in mid-2018, then less than 2 years to reach $2,000bn in October 2020, it then took less than 8 months to reach $3,000bn in June 2021.

 Until 2019, green products by far accounted for the majority of financing products with an ESG dimension (bonds and loans), across
 all issuers. Since 2020, this is no longer the case:

This development is explained by the disadvantages of green financing:

  • companies with low capex cannot issue green bonds or take out loans, even if they had a proactive ESG policy. The green finance market is thus largely reserved for utilities, industrial and real estate groups;

  • the issuer's green or sustainable investments would certainly have been made, whether or not they were financed by green bonds. Accordingly, investors do not necessarily contribute to a more ESG-focused policy at a company;

  • even if the general ESG policy of the company were considered by buyers of these products (a company with an unprincipled approach to ESG wouldn't be able to issue a green bond), the instrument itself is not linked to this general policy, but to a specific project(s);

  • finally, these bonds require additional work from the finance and ESG teams to monitor, document and report on the investments made. This workload comes on top of monitoring the overall ESG targets that the company sets and communicates to the market. Although initial adhesion enables the teams to get on board and to align their objectives, the follow-up over time, with contacts that change internally and newcomers who only see the extra work without having got the glory of the initial communication, is sometimes problematic.

In general, financing with an ESG dimension is a few basis points cheaper, between 0.05% and 0.1% lower interest rate, than traditional financing of the same duration (the greenium). This is better than a few years ago when the spread was at best zero, with lenders arguing that, ESG or not, the credit risk of the borrower was the same to justify their position. If the company does not meet its ESG targets, then the cost of its financing is typically increased by 25 basis points, which is a significant financial penalty, especially when interest rates for European companies are around 1%. And lenders are increasingly concerned that the ESG targets chosen by the issuer are ambitious ones, which cannot be taken for granted from the outset.

Otherwise, lenders may refuse to underwrite the financing, as Picard found out the hard way in May 2021 when it tried to place €1.7bn of sustainability-linked high yield bonds, even though the market was very buoyant, and Rexel's sustainability-linked bond was seven times oversubscribed the following week. Weak demand led Picard to withdraw its issue led by Goldman Sachs and Credit Suisse. The lacklustre ESG ambitions, i.e. to reduce energy consumption by 6% in 2023 compared to 2019 and by 10% for the logistics/distribution network, while the French energy transition law imposes an annual reduction of 2.5% (i.e. 9.6% over the period in question), is surely not to blame!


The second part of this article will be published in the February issue



[1] Business leaders and carbon neutrality: beyond the good intentions, what's really happening? Mazars 2021.

[2] For more on this, see chapter 41 of the Vernimmen.

[3] J. Fan, W. Rehm, G. Siccardo, "The state of internal carbon pricing", McKinsey Quarterly 2021.


Statistics : More than $12,000bn raised by companies in 2021

This graph, published by the Financial Times, highlights several elements:

Firstly, how different the pandemic crisis was from that of 2008, of financial origin, which had dislocated the financial markets and led to a halt in financing operations for several weeks (bond debts, even bank loans) or several months (capital increases and IPOs). This was not the case here, with issue volumes almost 17% higher than in 2020, which itself was 7% higher than in 2019.

Secondly, the stability of the split in debt financing between those provided by the bond market and those granted by banks, 51% - 49% in 1998 as in 2021. This world average hides important disparities between the United States, which is at only 34% in bank financing, and the euro zone, at 80%[1].

Finally, for those of our readers who are surprised by the low relative weight of equity capital raised compared to debt, we would remind them that debt is repaid one day or another, and therefore needs to be regularly renewed, which is not the case for equity capital, except through share buybacks. Moreover, profitable companies automatically generate new equity, to the extent of their results not paid out in the form of dividends, whereas they do not automatically generate new debts, that must be obtained from banks or bond markets.



Research : Entrepreneurial financing: the choice between business angels and venture capital funds

With the collaboration of Simon Gueguen, lecturer-researcher at CY Cergy Paris University


Venture capitalists are key players in entrepreneurial financing and are the subject of many academic studies in Europe and the United States. Academic research on business angels (also called angel investors or simply angels) is rarer, due to the difficulty of obtaining sufficiently rich data to feed empirical studies. While venture capital funds are professional investors who invest their clients' funds, business angels are individuals who invest in their own name and commit their personal wealth or that of their family. The article we present this month[1] is an exception in this respect. It uses data from a business support programme in British Columbia, a state on the Canadian west coast. The data cover the period from 1995 to 2009 and include both business angels and venture capital funds that financed the companies concerned (469 start-ups). The wealth of this database enabled the authors to study the following question: are business angels and venture capital funds complementary or substitutable? Their empirical results point to substitutability.

This goes against the prevailing view of entrepreneurial financing, which sees the two forms of financing as complementary. According to this vision, business angels provide the capital to finance the company in the early stages of its development, and in the event of success venture capital funds take over to finance growth. The company benefits from the complementary fit between, on the one hand, business angels who are attracted by the initial idea and can mobilise their funds quickly, and, on the other hand, venture capital funds which have greater resources and can commit their clients' funds when the signs of success appear. This is the model on which Google and Facebook have developed, and this is probably one of the reasons why it is considered the natural model for entrepreneurial funding.

However, there is another view, supported by the article, that these two forms of funding are substitutable. According to this view, businesses financed by business angels tend to keep this mode of financing when they develop, even if it means calling on networks (angel networks) that enable them to access the necessary funds. At the same time, some companies only use venture capital funds. So, business angels and venture capital are in competition, and the choice between these two modes of financing depends more on the specific characteristics of the company than on its stage of development. Receiving business angel funding at a certain stage increases the likelihood of further angel funding by 30% and decreases the likelihood of venture capital funding by 25%. The effects are reversed in the case of venture capital financing. As Hellmann et alii put it, there is a "negative dynamic effect" between business angels and venture capital funds in the financing of start-ups.

Once substitutability has been identified, Hellmann et alii study its source. One possible explanation is that investors direct future funding steps to investors of their type. A business angel pushes the company in which he or she has invested to finance its development by calling on other business angels (and similarly for venture capital funds). Using an econometric test[2], Hellmann et alii rule out this possibility. It seems that the choice between the two financing methods depends mainly on the characteristics of the start-up itself.

The strength of this article lies in the original sample, which makes it possible to test effects that are difficult to measure on all companies. This is also one of its limitations: the companies in the sample are all located in a limited geographical area, and almost all are in the same sector (high technology) because of the goals of the support programme. The results, if generalised, would however have very concrete implications. If business angels are substitutes for venture capital and are better suited to certain companies, then policies to promote start-up financing should encompass both methods of financing.


[1] T. Hellmann, P. Schure and D. H. Vo , "Angels and venture capitalists: substitutes or complements? "Journal of Financial Economics, vol. 141, no. 2, Aug 2021, pp. 454-478.

[2] Hellmann et al use the fact that certain financing methods were favoured from a tax point of view over the period to distinguish between the two possible explanations (the "instrumental variable" technique).


Q&A : Is the net present value of an investment project the same when discounting its pre-tax flows at a pre-tax rate or when discounting its post-tax flows at a post-tax rate?

In general terms, one should not confuse the concept and the method of calculation. All too often, we retain the latter, and then the method of calculation makes us forget the concept, which sometimes results in increasingly complicated calculations, arithmetically correct, but disconnected from a simple financial reality that has been lost sight of.

So, let's get back to the basics. The net present value measures the creation of value that an investment should allow. It naturally pre-exists its measurement in the same way that a patient's temperature pre-exists its measurement by a thermometer.

There are two ways to calculate this value creation. One can take a rate after corporate tax and apply it to cashflows after corporate tax to be consistent. You can also take a pre-tax rate and apply it to pre-tax cashflows. But whatever the calculation, this value creation cannot be rationally different, unless you think that the measurement modifies the object to be measured, which can happen in the field of physics, but it is difficult to see why in terms of value creation. Thus, when you weigh yourself on a scale calibrated with kilos, your weight is the same as when you weigh yourself on a scale calibrated with pounds, the figure is simply different with a different unit.

Simply, the pre-tax rate will be a higher rate than a post-tax rate. So in an illustrative example, which we have available to our readers[1], with an investment limited to 10 years, a pre-tax rate of 8% corresponds to an after-tax rate of 3.3% for an investment limited to 10 years. Indeed, a pre-tax rate is necessarily higher, as it will have to remunerate for part of the tax administration which was set aside by deciding to reason on pre-tax flows.

Contrary to misleading appearances, the pre-tax rate is not 6% (8% x (1 - 25%). This is because the discount function is not linear (it is a curve and not a straight line which depreciates distant sums proportionally more than close sums), because investment projects have a finite and not infinite duration, and because the post-tax free cash flow is not the free cash flow before tax x (1 - tax rate), because the tax applies only to one of the components of the free cash flow (the operating result) and not to all of them.

To move from the post-tax discount rate to the pre-tax discount rate, we do not know of any general and simple formulas. To find the equivalent of the pre-tax rate to an after-tax rate, our advice is to calculate the net present value at the after-tax rate, applied to cash flows incorporating corporate tax at the operating profit level. Then look for the pre-tax rate that results in the same net present value calculated on cash flows with a 0% corporate tax rate.

In our experience, we feel that the pre-tax rates that are used are a bit out of the blue and arbitrary.

That's why discounting pre-tax flows with a pre-tax rate is relatively rare, even if it's not stupid. And if you want to objectify the calculation, which requires using after-tax rates, then you might as well use the after-tax rate all the way through! It is more natural, simple and logical.

However, pre-tax rates are not without interest. For example, we know of a large group that continues to use pre-tax rates to calculate the depreciation of its goodwill (for a time, IFRS required that a pre-tax rate be applied to flows calculated before tax). Thus, in its sector, where the duration of investments can be short, it apparently displays a rate that seems demanding, 8%, whereas the reality is very different from this initial impression, 3.3%...


[1] Just ask in the mail box of the Vernimmen.com website by clicking here.

New : Comments posted on Facebook

Regularly on the Vernimmen.com Facebook page[1] we publish comments on financial news that we deem to be of interest, publish a question and its answer or quote of financial interest.
Here are some of our recent comments.


Interest rates and high-tech shares

For those of our readers who are surprised by the size of the drop in the stock market over the last 4 weeks for US tech companies, - 16% for the Nasdaq, we would remind you that these companies are characterised more than others by cash flows that are distant in time, and therefore more sensitive to a change in interest rates. Indeed, their duration is longer due to free cashflows arriving later. The rate of return on 10-year US bonds has jumped in recent weeks from 1.4% to almost 1.8%. 

It should also be noted that while the Nasdaq fell by 16%, the price of technology companies that are not yet profitable fell by an average of 30% over the same period, because compared to the average Nasdaq share, their duration is even higher.