The Tipping Point

ESG-Driven Equipment Finance and the Path to a Sustainable Future 

AS THE WORLD GRAPPLES with the pressing challenges of climate change and a changing environmental landscape, the public and private sectors alike find themselves at an inflection point. The urgency to adopt sustainable practices and respond to new regulations has brought environmental, social and governance (ESG) principles to the forefront. This paradigm shift presents a unique opportunity for businesses to unlock the full potential of ESG-driven equipment finance. Amidst the transformation, understanding the rise of ESG accounting is paramount and promises to reshape the industry for years to come.

Legislative bodies are gradually implementing policies that incentivize sustainable practices, such as the European Green Deal (supporting clean-tech investment for a path to climate neutrality) and the United States’ Inflation Reduction Act (provides for significant investment in climate and clean energy). These policies signal a clear shift toward a more sustainable economy, and businesses must adapt to remain competitive. Companies that embrace ESG principles are not only better positioned to meet regulatory requirements but are also more likely to attract investment from a growing pool of socially conscious investors.

The adoption of ESG-driven equipment finance enables businesses to unlock new opportunities in the market for green finance, as demand for environmentally friendly equipment grows. In addition, the rise of as-a-service and subscription-based business models facilitates the adoption of sustainable technologies by eliminating the need for significant upfront investments. These innovative approaches create a more flexible and cost-effective means for companies to incorporate ESG principles into their operations, allowing them to stay ahead of the curve in a rapidly evolving marketplace.

Crunching numbers for ESG

While the benefits of integrating ESG principles into equipment finance are numerous, the accounting impact of ESG in equipment leasing warrants further exploration. Some key considerations for businesses embracing ESG principles include:

• Impairment assessments: Not surprisingly, the market has seen an increase in financial instruments linked to sustainability. Sustainability linked loans, which tie a portion of the interest rate to a borrower’s ability to meet sustainability targets, present challenges in terms of impairment assessments (IFRS 9 and ASC 326) of the future cash flows. Judgement will be required to determine what the nature of the compensation in each case is, specifically where ESG related adjustments are larger weightage of the overall instrument. 
• Asset valuation and useful life: ESG considerations may influence the valuation and estimated useful life of leased assets. For instance, equipment that adheres to ESG standards may command higher valuations and longer useful lives. Conversely, non-ESG-compliant equipment may face obsolescence or regulatory penalties, leading to a decrease in value and a shorter useful life. Residual setting and Fixed Asset Book Value adjustments practice will need to be constantly reviewed.
• Enhanced reporting and disclosure: As investors increasingly demand ESG-related information, equipment leasing companies will need to improve their reporting and disclosure practices. This includes reporting on ESG performance, risks and opportunities within financial statements, as well as non-financial reporting standards like the Task Force on Climate-related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB). According to a new report from the International Federation of Accountants (IFAC) and AICPA & CIMA, 95% of large companies reported on ESG matters in 2021. This is without a universal set of rules that provide for what to disclose. 
• Tax implications: Governments worldwide are introducing tax incentives and subsidies for businesses that promote sustainability. By adopting ESG-focused equipment finance practices, companies can capitalize on these benefits, potentially offsetting some of the costs associated with transitioning to a more sustainable business model. However, this also requires careful consideration of the tax implications related to ESG investments and incentives.
• Lease classification and revenue recognition: The adoption of ESG principles and the use of as-a-service or subscription-based business models may affect whether these types of contracts meet classification rules of leases under accounting standards IFRS 16 and ASC 842. Companies must carefully evaluate the terms and conditions of these arrangements to ensure appropriate classification and revenue recognition.

As the equipment leasing and finance industry navigates the complexities of ESG integration, understanding and addressing the accounting impact is essential. By doing so, companies can effectively leverage innovative business models and seize the numerous opportunities that lie ahead. In the pursuit of a more sustainable future, businesses have the potential to become a driving force for change, developing new financing solutions and forging new paths in environmentally responsible business practices.

Innovation meets action

One notable example of such innovation is the increasing availability of specialized green loans and leases for electric vehicles (EVs) and renewable energy equipment. As companies like Tesla and SunPower continue to push the boundaries of sustainable technology, equipment leasing and finance professionals have been at the forefront of creating financing options tailored to these advancements. This has allowed businesses to invest in cutting-edge, environmentally friendly technologies while minimizing upfront costs and spreading expenses over time.

The integration of ESG principles has also led to the rise of as-a-service and subscription-based models for sustainable equipment and services. For instance, companies such as Schneider Electric have successfully adopted circular economy models, providing their customers with energy-efficient lighting and energy management solutions on a subscription basis. In IT, companies such as Lenovo have embraced global device-as-a-service programs to bundle hardware, software and services tailored to individual usage patterns. By offering these services, businesses reduce their environmental impact while maintaining financial flexibility.

By successfully adapting to the ESG landscape and overcoming the associated accounting challenges, equipment finance companies will not only fortify their positions in the market but also play a crucial role in shaping a more sustainable world for generations to come. As investors, customers and governments continue to emphasize the importance of ESG, equipment finance leaders who embrace this new paradigm will be better prepared to navigate an evolving industry and capitalize on the significant growth potential that lies ahead.

The future is bright

The adoption of ESG-driven equipment finance, combined with as-a-service and subscription-based business models, holds the key to future business success. By thoroughly understanding the related impacts ESG has had and will continue to have on finance and accounting, companies can unlock new opportunities and position themselves as leaders in a more sustainable, environmentally responsible world. The industry’s ability to adapt and evolve will be paramount in addressing the needs of an increasingly ESG-conscious market, requiring collaboration, innovation and a dedication to responsible business practices.

In this era of unprecedented change, it is incumbent upon equipment leasing and finance professionals to seize the moment, adapt to the evolving landscape, and drive the industry toward a brighter, greener future. By embracing ESG principles, developing innovative financial solutions, and navigating accounting challenges, equipment finance companies will not only achieve long-term success but also contribute to a global effort toward a more sustainable and prosperous world for all. Emulating the successful ESG-forward strategies of first-mover companies and new asset classes and products will further solidify the industry’s commitment to sustainable development and a greener future.