Sustainability also plays a role in restructuring

Published by Börsen-Zeitung, Magazine for Financial Markets (Edition 20, January 29, 2022)

The regulations of the EU Green Deal are gradually phasing in since March of last year. Issuers are required to report on the sustainability of their business activities. Financial intermediaries need to inform their clients about the sustainability of financial products. Thus, incentives are created for institutional investors to invest sustainably, not just for equity investments but also in debt financing – redirecting the flow of capital into sustainable investments.

How the Law Operates

The central elements are the taxonomy and the disclosure regulation, also called SFDR (Sustainable Finance Disclosure Regulation). The taxonomy stipulates to what extent a business activity is classified as environmentally sustainable and how this sustainability is to be reported. The SFDR establishes disclosure requirements for the social and ecological sustainability of financial products. The objective is to give investors the ability to assess and compare the sustainability of financial products.

What does Environmental and Social Governance have to do with restructuring?

At first glance, there is no direct link between the Green Deal and restructuring. Restructuring regularly places the focus on the timely rescue of a business. By contrast, adapting business activities toward sustainability is a rather strategic and long-term effort.

But going forward, measures to increase sustainability will become an increasingly important success factor for restructuring. Even today, decisions to refinance, procure additional funding, attract additional investors or to sell the business, are influenced by sustainability aspects. Businesses that are already well-positioned in sustainability terms have a clear-cut competitive advantage: their chances of finding suitable restructuring partners who will support continuing operations are much greater. “Brown” businesses will pay a premium or may not be able to find sources of financing or investors.

Future turn-around concepts as well as restructuring plans, will need to include sustainability planning that contains coherent and realistic sustainability objectives and implementation measures. Specifically, investments with a view to establishing sustainability in the future may immediately qualify as sustainable and can as a result make the business “greener” or more “social” as it works towards higher sustainability. Investor requirements can then already be accounted for during restructuring.

The question frequently arises as to what level of sustainability outlook is required for this purpose. At what point do investors regard a loan or a stock as sufficiently sustainable?

Increasingly, the evidence suggests that 100% sustainability is by no means necessary – and would in many cases also not be practical.

Green Financing

Legal developments instead suggest that a 75% to 90% outlook is completely sufficient. Going forward, markets are expected to regard businesses that achieve this degree of sustainability as comprehensively sustainable and they will therefore enjoy significant refinancing advantages.

Other measures, such as the specific design of issued products, can be considered in parallel for achieving sustainability objectives. A completely green product may then be issued on a project-specific basis by emitting a Green Bond or with a Green Loan, regardless of the company’s current business activities, provided the proceeds are only used for green projects. The latter can specifically also represent measures for transforming the business model toward sustainability.

Spin-off as Option

There is a range of ESG-relevant options available. One of these could potentially be splitting the company into sustainable and non-sustainable parts. The non-sustainable part could then be designated as “dark” in regulatory terms, e.g., fall outside of the taxonomy scope. The company may then (no longer) be required to disclose ecological sustainability key performance indicators, thus saving regulatory costs. This is typically a consideration when this part of the company will be sold off in the near term or even wound down.

In summary, sustainability considerations play a key overall role in restructuring, specifically with the objective of ensuring the long-term viability of a business.

Bernd Geier is a partner focused on finance, regulatory law, and funds. His practice covers the entire spectrum of regulatory issues (compliance), with a focus on the financial sector, including FinTech. He advises clients on financial market regulation, transaction structuring and optimisation, outsourcing law, as well as on new technologies (cryptocurrencies) and sustainability requirements (ESG). Read more here.

Oliver Otto is a Partner in Rimon’s Frankfurt office. He focuses on restructuring, bankruptcies, as well as banking and finance in the finance, technology, energy, and manufacturing sectors. Mr. Otto advises clients on insolvency risk remote design of investments, on financial restructuring measures, non-performing investments and (exit) strategies as well as portfolio solutions, and debt trading. He represents creditors in formal insolvency proceedings as well as debtors in their crisis and debtor-in-possession proceedings, and provides counsel to corporates and directors in near-insolvency scenarios and advises on fraudulent insolvencies.  Read more here.