Businesses will go to great lengths to convince the markets that they are a safe investment. But it might come as a surprise that one of the best things a company can do to boost its investment credibility is voluntarily publish details of its environmental impact.
Businesses could be saving big bucks on debt interest by disclosing carbon emissions.
That's according to emerging research from academics at Maastricht University in the Netherlands and Oxford University in the U.K., which found that companies can save millions on the cost of debt interest by volunteering data on their carbon emissions.
For several years, pressure has been mounting on companies to be more transparent about their environmental impact on the world. November saw the Royal Society warn the world's financial markets and reporting rules need a major overhaul in order to adequately tackle climate risks.
Meanwhile, an impending EU directive, due to come into force in 2017, will require large European companies to publish a range of non-financial information — including environmental information such as greenhouse gas emissions — alongside their financial reports. It follows similar moves in the U.S. to require listed firms to report on material risks, including environmental and climate risks.
"The Carbon Spread" report suggests companies that preempt these regulatory pressures will reap impressive financial rewards. The paper, which has not yet been published, looks at the impact voluntary carbon emissions disclosure has on the cost of corporate debt for public companies.
The analysis is based on the spread levels of bank loans, which show how much above the interest rate benchmark a company has to pay on debt. Co-author Michael Viehs said the paper reveals two key findings.
"First, we find that firms that voluntarily disclose their greenhouse gas or CO2 emissions enjoy more favourable lending conditions, with lower interest costs, than companies that don't," he told BusinessGreen.
Second, the paper also looked at a firm's actual emission levels, adjusted for the firm's location, industry and size.
"There we find that those companies in a given industry who perform relatively badly have to pay a significantly higher interest rate cost," Viehs explained.
And we're not just talking a difference of a few thousand dollars. On average, companies that voluntarily report their carbon emissions can save $1.5 million every year in interest repayments, Viehs calculates.
Meanwhile, companies with relatively high actual carbon emissions are forced to pay a higher interest rate for debt when the loan arranger is a signatory of the CDP initiative (formerly known as the Carbon Disclosure Project).
More than 800 of the world's biggest banks and institutional investors — including JP Morgan and Citibank — are CDP signatories, controlling an asset base of $95 billion. In these cases, a 1 percent increase in CO2 emissions was found to cause an average increase in interest costs of $1.3 million every year.
To look at it another way, a company can save $1.3 million each year for every 1 percent reduction in its carbon dioxide emissions, just from interest costs.
Reaping the financial rewards of reporting
Clearly these two findings, in some cases, can cancel each other out. If a company with relatively high carbon emissions compared to others in its sector published its figures, then the interest discount can turn into an interest cost, Viehs explained.
"It could be that the real effect of choosing to disclose is only valid for those companies that are not the highest polluters," he said.
The study is one of the first of its kind to focus on the "fixed income instruments" marke, rather than the equity market, Viehs said. Its key insight for companies is that proactive, voluntary action can reap significant financial rewards.
"Regulation can provide a kind of benchmark or minimum standard for companies to disclose, but we actually found that doing something voluntarily is more beneficial for companies these days," Viehs said.
This reflects financial markets' increasing interest in accessing more granular information about the environmental performance of companies, Viehs said. He argued a rising number of companies definitely feel the need to proactively disclose their sustainability practices.
In recent months major brands, such as Tesco and H&M, have called for carbon reporting to be made mandatory, presumably in a bid to stop competitors from getting away with not disclosing their performance.
Viehs believes this movement has the potential to trigger changes in the reporting behavior of other companies, which may erode the current benefits of self-disclosure.
If more companies begin self-reporting environmental data, or if the banks or other market players step in to formally price carbon emissions, then the financial benefit identified by the report may fall away, he said. However, for the time being there is a "kind of market inefficiency" that savvy companies can start to exploit by disclosing environmental information, Viehs argued.
Businesses should not just see the research as a way to save money, Viehs added. By disclosing their environmental impact companies also can start to proactively reduce their climate risk and prepare themselves for potential future climate change regulation.
He also expressed hopes the research will prompt banks and institutional lenders to look more closely at a company's environmental reporting standards when assessing their credit worthiness. His comments echo recent calls from the Chartered Institute of Internal Auditors, which last month called for the environmental information provided by firms to be subjected to closer analysis by auditors.
As the business case for a low-carbon economy grows ever stronger, climate change is transforming from an ethical issue into a business imperative.
Just last week the Economist Intelligence unit warned that global inaction on climate change could cost the world economy $43 trillion by 2100 — a third of all manageable assets. Meanwhile, eminent economist Lord Stern has described a low-carbon economy as "attractive in its own right," saying it would deliver a path of development that was cleaner, quieter and more efficient than our current model.
The latest evidence that environmental disclosure coupled with a credible emission reduction strategy can deliver hard cash benefits might well convince a few more firms to take up the environmental gauntlet.