Navigating the Transition: Financial Strategies for Sustainability Consultants

Last week in Cental London, I met with a group of sustainability consultants who work with mid-sized UK and European companies that are undergoing business model transformation. Half of their clients are in carbon intensive (polluting), which are essential, hard to abate sectors. Most of their clients have already implemented some energy efficiency measures and have invested time and effort in emissions accounting. Climate disclosures, sustainability KPIs and reporting systems are in place for every client, and the respective consultant has been working with the client for over a year on the troublesome topic of transition planning, particularly its implementation.

Their mission? To guide their clients on the path to net-zero emissions, however, this must lead to substantial cost reduction. However, with pressures from the unions and the fear of antagonizing the workforce, this can't lead to job cuts. They can make a distinction between 'quality jobs' and the 'dead end ones', but any transformation exercise leads to losing the quality roles and ends up retaining several dead-end ones.

By integrating financial expertise with sustainability strategies , they can be the unsung heroes contributing to a greener and more resilient future. We discuss this in detail, over what was originally a breakfast session, spilling into us deciding to order a 'light lunch' at the same venue. The discussion was getting heated, but quite interesting. I realize that the gap is not too big, however it opens a potential area of project development, which 'kindly' fell through the cracks. We all agree that the next time we meet (online or in-person), we should get a handful of project developers who can collaborate with them, in unlocking the future for their clients.

The Art of Assessing Financial Viability

One of the consultants, Sarah (all names have been changed for privacy), is explaining the importance of assessing the financial viability of transition projects. "Making informed decisions is crucial," she says, "and there are several methods and considerations we use." However, she says that it is an area of finance, that she can't address on their own, yet she feels it would be a valuable additional service that could be offered as part of a bouquet.

Development Appraisals: The Residual Valuation Method

Another consultant, Matt, begins with development appraisals, a method that involves deducting development costs from anticipated proceeds to determine viability. He explains the Basic Residual Method, which includes elements such as Gross Development Value (GDV), Total Development Costs (TDC), Developer Profit, and Residual Land Value. "If costs exceed GDV," he warns, "the scheme is unviable." He knows this from his prior experience of working at a bank, however, doesn't have the detail behind these.

Financial Feasibility Study: A Comprehensive Evaluation

Next, we talk about conducting a financial feasibility study. This involves evaluating revenue projections, costs, cash flow, and overall financial performance. "It's like a health check for the project or business," Sarah says.

Sustainability-Linked Instruments: Tying Finance to Performance

Sarah then introduces the concept of sustainability-linked instruments, which she says that large corporates can utilize. These include Sustainability-Linked Bonds/Loans (SLB/SLL), which tie interest rates to sustainability performance, and Use-of-Proceeds Instruments, which allocate funds explicitly to sustainable initiatives. However, we all agree that one transition project can't be tied to a sustainability parameter that is at the corporate level. That would only be possible when there are highly capital-intensive projects that would influence the entire corporation.

Land, Value, and Collaboration

As the discussion progresses, other consultants chime in. They talk about land value assessment, residual value analysis, and the importance of collaborating with financial institutions. They also stress the need to consider the policy and regulatory context, including government incentives, grants, and tax breaks. This is often quite time-consuming, and a lack of a system means that in most cases, we default to Microsoft Excel, for its flexibility. One of the consultants suggests using Causal to build the models, but we all unanimously agree that having a tool that combines emission metrics, financial models, sustainability parameters and lets you collaborate with a wide range of professionals is the way to go.

Risk Assessment and Cash Flow Projections

Risk assessment is another crucial topic that we touched upon. The group discussed the need to evaluate risks related to market fluctuations, technology adoption, and project execution. They also highlight the importance of cash flow projections to assess liquidity and financial stability. One of the challenges they say is that, in most cases the tech is available and is at scale but hasn't been operationalized. Matt talks about Manufacturing Readiness Level (MRL) being used just like TRLs. So we can really classify the transition project on both TRL and MRL. Those that are TRL high and MRL high are the candidates for financing (if they are financially viable). Often, we see TRL high, MRL low projects being projected as the solution that a client would implement; however the project fails to attract finance.

Scenario Analysis: Preparing for the Unexpected

"Scenario analysis is like preparing for a journey," says one consultant. "We model different scenarios to understand project sensitivity and assess financial resilience under varying conditions." Again, we delve into how clients perceive scenarios, and we underline the concept of 'plausible, yet severe scenarios' to be considered. I bring up the concept and I am told that most clients would only identify the scenarios they are aware of. Science and Business haven't mixed well since the Industrial Revolution, I am told. Science is only considered 'necessary' by business leaders if it will deliver higher shareholder returns. We delve into ACT methodology and how climate transition scenarios are to be considered.

The Comprehensive Approach

The consultants agree that a comprehensive approach—combining financial expertise, sustainability knowledge, and risk assessment—is essential for accurate viability assessment.

Leveraging Transition Finance Instruments

As the meeting draws to a close, the consultants discuss how they can strategically leverage transition finance instruments to support their clients' net-zero journey. They talk about advising clients on transition bonds and loans, promoting sustainability-linked instruments, facilitating green equity investments, navigating mezzanine financing, and highlighting use-of-proceeds instruments. We challenge several assumptions in the market research report by Helix.Earth however this is the only one that computed a market size based on actual financial instruments being used, rather than a generic number based on aspirations.

Collaboration, Reporting, and Impact

We then stressed the importance of collaborating with financial institutions, emphasizing reporting and disclosure, and considering the social and economic impact of transition finance. They also highlight the need to stay informed, educate clients, and advocate for policy support. We then looked into the entire bouquet of services available in the market and highlight that the current cottage industry of incomparable services, based on standards that are as diverse as possible, means that clients get easily distracted by transparency and accountability versus action. It is a challenging task to keep clients on the course.

As the meeting ends, the consultants are ready to continue their vital work. They are the unsung heroes of the net-zero journey, guiding their clients towards a greener and more resilient future. And as they leave the room, they carry with them the knowledge and strategies that will help shape a sustainable world.

Would you like to join us next time? Let me know .