How ‘sustainable’ and ‘finance’ can go hand in hand
‘Sustainability’ and ‘finance’ can sound like a contradiction. Hydro Chief Financial Officer, Pål Kildemo, talks about how to combine the two for the benefit of investors, companies, and society.
Can finance become combined with sustainability? What is, in your view, sustainable finance?
That is a good question. I do know that typically the thoughts among many finance and economy people has been that finance or profitability and sustainability do not necessarily go hand in hand.
Why has that been the case?
I think it is because many business cases for investments with a long-term aspect have not been as easy to calculate as traditional cases, which may be “less sustainable.” In the long-term though, I am quite sure there is most likely a strong relationship between profitability and sustainability.
What has changed?
Well, what has typically changed is likely the consumer interest in sustainable products, leading to the fact that we are now seeing an increased readiness to pay for products which are sustainable. This has made it easier to combine the two elements.
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Whose responsibility is it to drive sustainability, and how can the finance sector drive sustainable investments?
Well, before we go into that, I would like to focus on what sustainable finance really is. As with any topic on sustainability, which typically generates a lot of interest, there are challenges and opportunities for business and many different definitions, often tailored to fit the need of the person or entity talking about the topic. In my view, there are two elements of sustainable finance. One is finance in the marketplace, which is products that are made available with a sustainability aspect. For example, green bonds, green stocks, or other products or elements of sustainability. The second one is reporting driven transparency elements, which includes sustainability reporting, green P&L, and third-party sustainability ratings. Therefore, when we talk about finance and sustainability, we need to focus both on the market side as well as the transparency side.
Whose responsibility is it to drive sustainable financing then?
I think both the companies from the transparency and reporting side, and the financial markets from the market side are. If we purely focus on making reports available, on benchmarking, and on visualizing data for investors and analysts, and these elements are not turned into products for the markets to invest in, then this movement will be slower than if both parties work on it.
Have you seen a change in investors’ interest in sustainability? You have been in Hydro for a long time, in positions within investor relations and Aluminium Metal as well as now as the CFO. What have you seen during these years?
There has been a big change in external interest. Some years ago, when I worked in investor relations, we would typically spend three to five minutes of a meeting on sustainability related topics. Now, in the same meeting, we can spend 40 to 45 minutes of an hour-long meeting on it. This shows there is definitely a greater interest. We see more and more funds and similar investing being driven by a sustainability perspective. We are also getting more and more challenging questions on the topic. So, there has clearly been a shift, which can also be perceived in the pricing of sustainable companies. Smaller, greener companies are now trading at a much higher multiples and premiums compared to companies which are not viewed to be sustainable.
What type of questions are you receiving from investors?
These can range from our plans within the different UN sustainability criteria, to what we are doing for life above water, below water, for the climate in general as well as for employment, schooling, etc. It is across the board. Typically, it varies a bit from investor to investor.
Do you find investors are skilled in these questions?
There has been a huge increase in skills here. Typically, you have departments within the larger investor houses which focus on this. So, if the general analyst is not all the way up to speed on the topics, they always have someone with an extra level of competence, who ensures they are asking the right questions.
How do we ensure with certainty what is really a sustainable investment?
That is one of the most difficult questions because today we have many different, what you would call taxonomies, when it comes to what sustainability is. You would think it is easy to say whether something is sustainable or not sustainable. However, what might be defined as sustainable by one company is not necessarily seen as such by another.
If you look, for example, at Hydro, we are emitting CO2 from our smelters. If you were to only focus on that part of our operations as an external party, you might deem us a non-sustainable company. But we produce hydro power, and we produce aluminium based on hydro power, which has a completely different footprint than a lot of the world's operations producing based on coal. In that manner, you could say, ‘Well, maybe Hydro is a bit more sustainable than a coal fired producer.’ You then have the full life-cycle aspect - our products, they are lighter, they reduce weight when put into cars, they are infinitely recyclable. If you put that into the equation as well, there is also the aspect that aluminium is more sustainable than other types of material.
It is not straightforward landing on what is sustainable and what is not, but accounting rules were not either when they were first set up, for example, when IFRS (International Financial Reporting Standards) first started. You have a frame and then you gradually developed it over the years. I think the same thing will happen for sustainable metrics.
Do you often get into discussions with investors about what you would call sustainable and are you then challenged on that?
Oh, yes, all the time. This is not a discussion in a negative sense, but rather an enlightenment process. What is clear for us internally at Hydro is not clear when you first look at the company from the outside. So, again, if you only look at the total tonnes of CO2 emissions, then you might have one view. When you see the full story, then that changes a bit. This is very important for us to work on towards the EU, towards other authorities, in order to ensure that when we define a common taxonomy, that taxonomy is relevant for all companies, and not focused on a particular group or segment of a company.
From a Hydro point of view, can you give some examples on how you work with sustainability in finance and how you prove the sustainability of operations?
We have many different examples, and I would like to start with one which is very much finance related. As you know, we need to finance our operations from time to time. In December of 2019, we signed a revolving credit facility, which is basically funds available to draw on if the markets move against us. Here, we decided to link the margin we pay for gathering this money if we needed to for the reductions of CO2 targets, we have. So, if we are able to deliver on our CO2 reduction targets, then we pay a lower landing fee than if we are not able to deliver on them.
How much can you save by doing this and reach your sustainability targets?
You can save some basis points when it comes to the margin calculation. Of course, at the end of the day, it is not what tilts the company in one direction or the other. It is rather the more incentives like this you put into place, the greater the link between sustainability and profitability becomes, and the easier it is to ensure we push through with the sustainability investments.
Do you see an increased interest in those kinds of relationships in the financing side?
Oh, yes, definitely. During the pandemic, for example, we discussed whether the bonds we were issuing should be green bonds and what the potential is for us doing this going forward. Then again, you come back to the taxonomy discussions and the lack of a clear alignment on taxonomy on what green bonds are or are not. That is why we also need to move fast to ensure there is a way of measuring sustainability in an aligned way so not everyone can call bonds ‘green’ bonds.
When you discuss these kinds of financing with banks and others, who is initiating such a relationship? Is it Hydro a company or is it the banks themselves?
When it comes to the revolving credit facility, we initiated it. It fit well under our new sustainability and profitability setup. When we had the last bond road show, it was some of the investors that initiated it. Basically, they said that we would love to lend to Hydro, and we would like to do it with a greener perspective. We believe that a lot of the targeted improvements you are doing under the sustainability heading is something which would qualify for green lending. This means, sometimes it is us, sometimes it is the markets, and of course, sometimes it is third parties.
In setting a European framework for sustainable finance, what might be the challenges in designing a taxonomy with sustainability objectives?
I think it is a bit back to the topic we touched upon earlier, that sustainability can be different between different companies. Seen from a sustainability perspective, becoming a bit less unsustainable is also most likely the right thing to do. I think the fear is that you may end up with taxonomies and definitions only favoring those companies which are 100 percent sustainable across the value chain, thereby losing the potential to use these measures to have companies change. I also think that is an interesting topic to touch on because you can approach sustainability and financial sustainability in two ways. You could either exclude all companies which do not match a certain part of the criteria. That may work well in parts of the world, where there is no alternative to attract capital from outside that region. On the other hand, this approach may not work in markets, where financing from other regions is an option, if maybe at a higher cost. In that case, excluding companies would not necessarily drive change.
So, the idea is to drive a change in behavior rather than to only reward those who already changed?
Exactly. The exclusion principle is one. The other principle is basically to say that we want to use these measures to help companies change, so you will have access to sustainable capital and similar, given that you do this, this and this. You could take it a step further. You could say that there is a lot of passive capital sitting around these days and basically if that capital were to be invested with sustainability in mind, then that capital could influence decisions made by Boards of Directors or in other arenas to ensure the companies actually do change rather than just excluding them.
Is there a need for regulations to drive interest in sustainability from the investors’ side and from the finance sector? And basically, is sustainable finance hype? Or is it here to stay?
In general, I am not a big fan of enforced market regulations. I think based on what we have seen in recent years sustainable finance is probably not a hype, but rather something changing the marketplace. Companies perceived as greener or less green have not fallen to a higher or lower degree compared to one another during the COVID-19 pandemic. For example, as opposed to differences in how the market reacted to different types of companies after the burst of the dot-com bubble. I think one could say that there is an underlying desire to drive this forward, even if markets move a bit against it. So, at the end of the day, I am more positive in putting the power into the markets and not necessarily try to enforce this.