Sustainable financing is gaining ground in corporate Russia as firms look to improve their environmental, social and governance policies ‒ but can the country’s notorious polluters really go green?
The country is one of the world’s largest producers of hydrocarbons and has an unenviable reputation for environmental carelessness, weak governance and indifference to the wellbeing of workers.
Yet, in the corporate world at least, there are signs that attitudes are starting to change. For the first time this year, the St Petersburg International Economic Forum, Russia’s top business event, featured a panel on sustainability.
Consultants are ramping up their environmental, social and corporate governance (ESG) teams in Moscow. The country’s biggest industrial group has sponsored sustainability equity indices and an increasing number of firms are touting their ESG credentials in lengthy sustainability reports.
Perhaps surprisingly, the charge is being led by metals and mining companies. The websites and annual reports of precious metals producers Polymetal and Polyus, steelmaker Severstal, aluminium firm Rusal and its parent group En+ all feature ESG front and centre.
Even Norilsk Nickel – now rebranded as Nornickel but still the world’s largest producer of sulphur dioxide – is attempting to position itself as a champion of sustainability.
The sector has also been responsible for Russia’s first sustainability linked loans, with a flurry of deals emerging over the last 18 months.
The most obvious reason for the emergence of Russian metals and mining firms as ESG champions is ownership. Most of the largest companies in the industry are internationally listed, with large private-sector shareholders. This means that – unlike their peers in the state-dominated energy sector – they have incentives to maximize value, which increasingly means meeting the demands of western investors for ESG accountability.
Across the board, Russian metals and mining firms report a sharp spike in interest in sustainability topics over the last two to three years, with the majority of pressure coming from European investors and sovereign wealth funds.
At Severstal, investor relations head Vladimir Zaluzhsky reports that his team now spends as much as half of any meeting with European funds discussing ESG issues. By contrast, he adds, “when we mention the topic in the US, they say: ‘I’ll tick the box, but I’m not really interested.’”
“There’s a perception that when it comes to environmental and social issues, if it’s not in the US then Americans don’t care,” says a senior Russian executive.
Others say the big US emerging-market and sector funds are starting to follow the lead of their European counterparts.
“They are asking more questions about ESG,” says Vyacheslav Solomin, chief operating office at En+. “They operate internationally, so they can’t ignore this topic.”
David Nicholls, a senior analyst at regional specialist investor East Capital, agrees: “Two or three years ago, the only ESG topic that was mentioned in meetings with Russian companies and other investors was governance.
“Recently we met with a large oil company in company with some US investors and we spent most of the meeting talking about ESG, emissions and the relative carbon intensity of Russian and US oil.”
Opinions also vary on the relative enthusiasm of debt and equity investors for the topic. Zaluzhsky says buyers of Severstal’s bonds are more interested in yields than sustainability.
“In a world where interest rates in Europe are negative, they are under a lot more pressure than equity buyers,” he says. “They have to look for high-yielding bonds, and there aren’t that many issuers globally with solid balance sheets, good disclosure and a strong track record.”
Other Russian firms, however, report scrutiny from fixed income investors on ESG. When Sibur, Russia’s largest privately owned petrochemicals firm, sold a $500 million Eurobond in September, the topic was raised in at least half of investor meetings, according to debt financing director Denis Rozhok.
He adds that the company saw equal interest in sustainability from investors in Europe, the UK and the US.
Buy-side pressure – real or perceived – also helps to explain a recent rush by listed Russian companies to engage with ESG rating agencies. Investors themselves remain divided on the utility of these ratings, with many preferring to do their own due diligence. East Capital, one of the early leaders in ESG investing, is on the side of the sceptics.
“There is huge variance in how ESG agencies rank companies, and the approach tends to favour box ticking,” says Nicholls. “As investors, that’s exactly what we don’t want companies to spend their time on. We want them to focus on improving material things rather than completing endless information requests on issues that may or not be relevant for the company.”
“We focus on speaking to managers and understanding their thinking on ESG issues and whether it is important to them,” says Nicholls.
Russian corporates, however, see tangible benefits from acquiring or improving ESG ratings. Zaluzhsky notes that some funds can’t invest in companies without an ESG score or with scores below a certain threshold.
Victor Drozdov, head of investor relations at Polyus, says such metrics can also provide a point of entry to the Russian market for outsiders, particularly from the West.
“It’s essential to have primary data available on ESG so analysts and investors can do their own due diligence,” he says, “but ratings are also important because they’re the first thing people look at when they’re thinking about covering or investing in the company.”
The good news for Russian companies that have engaged with the ESG agencies is that, surprisingly, there are easy gains to be made. Polymetal, the precious metals miner founded by Alexander Nesis, is the acknowledged pioneer in the field. The firm first focused on ESG ratings as early as 2014 and today boasts the highest score in Russia from most leading agencies.
“The key to our success was that we were very proactive with the rating agencies,” says Daria Goncharova, who was appointed chief sustainability officer in 2015.
It also helped that, like many other Russian metals and mining companies, Polymetal had a surprisingly good story to tell on many aspects of ESG.
Sergey Sedov, director of investment banking at Renaissance Capital in Moscow, notes that Russian corporates have faced intense scrutiny from investors on governance issues since they first started engaging with international investors.
“Initially the focus was on shareholders and management, then later it turned to the proper structure of boards, independent directors and the representation of minority shareholders,” he says.
Russian companies also tend to be strong on the social side. Compared with other emerging markets, regulation is relatively strict, while one of the positive legacies of the communist era is a tradition of corporates providing social infrastructure.
Large Soviet enterprises were responsible for everything from schools and hospitals to sporting facilities in the towns and cities in which they operated, particularly when these were single-industry centres or ‘monotowns’.
“With the rise of ESG, this is now being reinvented in a more market-oriented framework,” says a Moscow executive. “The immediate impetus has come from the West, but it’s not something new for Russia.”
In the city of Cherepovets in Vologda Oblast, for example, where Severstal is headquartered and has its main production facilities, the steelmaker’s social initiatives include a project to place children from orphanages with foster families and a small-business development programme to help workers laid off due to automation.
“In the past, we were slightly embarrassed about all the things we did on the social side and even divested some assets – but now the rest of the world is coming round to the socialist way of thinking,” says Zaluzhsky.
Sedov says the main difference between Russian corporates and their international peers on ESG is disclosure.
“Companies have to comply with a lot of environmental and social regulation in Russia, but most people outside a specific industry are not familiar with it,” he says. “That’s what everyone is trying to do right now, catch up on the disclosure side.”
Solomin at En+ agrees. “The majority of our ESG agenda consists of things we were doing anyway,” he says. “We already had projects aimed at increasing our operational efficiency and cutting emissions. We had a system of environmental KPIs [key performance indicators] for our management teams, and we were running charity and social programmes. We just didn’t think of it all as ESG activities and thus of interest to investors.”
As a result, Russian companies have been able to boost their ESG ratings substantially by publishing sustainability reports or, in some cases, simply translating them into English.
Other gains have come from understanding where to fill in the gaps in rating agencies’ checklists. The example cited most frequently is child labour. Very few companies had previously thought to publish a policy on the issue because it has never been a phenomenon in Russia.
On the flipside, Russian companies are often marked down for areas over which they have no control. Most leading ESG agencies apply a country rating of B- or C for Russia, which affects all entities operating in the jurisdiction.
“When it comes to ESG ratings, one of the hardest tasks is combating negative perceptions of Russia,” says Goncharova at Polymetal. “We face many questions on political risk and sanctions. We get marked down because HIV rates in Russia are higher than in Europe or because of human rights concerns related to regions where we don’t have operations.”
Some firms have gone on the offensive, writing angry collective letters to the agencies and publicizing what they see as discrimination. Nornickel devotes five pages of its 25-page ESG presentation to “assessment controversies”, including MSCI’s rating of Russia as a higher risk for labour disputes than South Africa and Sustainalytics’ alleged failure to recognize improvements in the World Bank’s Doing Business score for Russia.
Others are more philosophical. At Polyus – which has not been involved in any of the ESG protests – Drozdov says being marked down for being Russian is “just something we have to live with.
“Arguing with rating agencies is a bit like arguing with the media,” he adds. “People have their opinions, and you have to accept that. We have good scores and we don’t yet feel we’ve been unfairly treated.”
Where Russian corporates are often genuinely weaker in terms of ESG is on the environmental side. Here the Soviet legacy is less positive, consisting of a long tradition of waste, pollution, secrecy and denial.
It has taken time for companies to understand that this approach does not work with international investors – as Nornickel found in 2016, when contaminated water from its Nadezhda metallurgical plant in Norilsk turned the Daldykan river blood red.
Nornickel repeatedly tried to disclaim any link to the incidents, before eventually being forced to admit responsibility for the spillage.
“They were completely in denial,” says a banker in Moscow. “The market reaction made them realize that the number-one priority for investors is to know what’s going on.”
Since then, Nornickel has made big strides in both communication and action. The firm has set targets for the reduction of sulphur dioxide emissions and in April appointed Evgeny Shvarts, former director for conservation policy at the World Wildlife Fund Russia, to its board.
Other listed metals and mining companies are much further ahead when it comes to local pollution – but even the most advanced are still lagging in developing long-term strategies for cutting carbon dioxide emissions.
Again, this is partly a cultural issue. In a cold and largely landlocked country, climate change has traditionally been seen as a fallacy, a joke or even a twisted opportunity.
“There’s a harmful stereotype that Russia would benefit from global warming because there would be more land for agriculture,” says Drozdov.
Policymakers have also tended to be dismissive, preferring to focus on more politically sensitive environmental issues such as local pollution and waste disposal. President Vladimir Putin is famously a climate change sceptic – as recently as July, he highlighted the supposed dangers to birds and worms posed by wind turbines.
There are signs, however, that attitudes are changing, both in government and at grassroots level. Locals say a succession of extreme weather events – including devastating wildfires and floods in Siberia this summer – has alerted the Russian population to the risks of climate change.
“These events have started to draw attention to the problem,” says Josh Tulgan, head of external relations at Russian conglomerate Sistema, which controls mobile operator MTS and listed retailer Detsky Mir. “They have exposed the threat under which many of these communities live.”
Anecdotally, Russians report that the country’s younger citizens are as interested in the environment as their Western counterparts.
Meanwhile, companies such as Polyus are raising awareness of the risks posed by climate change to the permafrost that covers 55% of Russia.
“We operate in permafrost areas, so if that starts to melt, we would have major problems with infrastructure,” says Drozdov.
Government officials are also paying attention. In October, Alexander Krutikov, deputy minister for the Far East and Arctic development, told Bloomberg that warming in the Arctic is already costing Russia between R50 billion ($782 million) and R150 billion a year.
A month before, Putin had finally ratified the Paris Agreement on climate action. The news met with a muted response from international analysts, who noted that the targets set will actually allow Russia to increase emissions over the coming years.
“We’re very happy that Russia signed the Paris Agreement,” says Zaluzhsky. “We want Russia to be recognized as a nation that cares about the environment and understands the global agenda.”
There were hopes that a new federal law on emissions, due to be ratified by Russia’s parliament this year, would go further.
As originally drafted, the bill included mandatory CO2 reporting, with audits for large emitters, and the introduction of carbon quotas, targets, trading and penalties within five years. In November, however, the economy ministry announced that “specific regulatory requirements” would be dropped from the draft law.
The proposals had been strongly opposed by the Russian Union of Industrialists and Entrepreneurs. The union, which represents more than 1,000 of Russia’s largest companies, had argued that they would raise costs for consumers and deter investment.
Nevertheless, some leading firms are taking unilateral action on carbon emissions. En+ is heavily involved in promoting a line of low-carbon aluminium and already provides voluntary disclosure of its carbon footprint.
“We also have an internal price of carbon in the company, which we use to estimate the feasibility of new projects,” says Solomin.
Others in the industry are following suit. Severstal and Polyus are among a handful of companies that have promised to publish long-term carbon strategies within the next 12 months.
“The oil and gas companies have been slower to move,” says Nicholls. “One large oil company recently told us they are working on a long-term CO2 reduction strategy, but were unlikely to produce anything before 2021. That’s too long.”
Analysts and investors say firms in the sector are generally more reluctant to engage, partly due to the fact that most are state controlled. An exception is Gazprom, which has linked managers’ remuneration to emissions reduction, reportedly in response to demands from customers in its main export markets in Europe.
Maxim Remchukov, head of Sibur’s new sustainable development department, says global fast-moving consumer goods companies with sustainability goals are putting “major pressure” on their supply chains.
“Their key goals are to involve recycled material in their packaging and make sure their packaging is recyclable,” he says.
Solomin notes that En+ began getting questions from customers on topics such as the firm’s environmental stance, social responsibility, engagement with local communities and gender balance a couple of years ago.
“Up to 40% of our products go to Europe, and we are seeing increasing interest from customers there in our ESG agenda,” says Zaluzhsky.
“There are also discussions among European steelmakers about lobbying for a border tax adjustment based on ESG measures. We want to improve our disclosure, ratings and environmental standards now to ensure that we are not subject to any future tariffs.”
“Generation Z wants companies to make a positive impact on the planet rather than just focusing on profit, in Russia as well as globally,” says Zaluzhsky.
This is particularly relevant for firms such as Severstal, which are investing heavily in digitalization.
“We need younger workers, particularly on the technology side, so we have to ensure that we are attractive enough to compete with tech companies for talent,” adds Zaluzhsky.
International banks are also doing their bit to drive change in Russia’s corporate sector by promoting sustainable finance. Again, Polymetal was the pioneer in this field, leading the way with an inaugural sustainability linked note in April 2018. The $80 million loan from ING featured a coupon linked to the company’s Sustainalytics rating score.
“Companies were asking us how we got such a high ESG rating and how to engage with rating agencies on the topic,” she says.
Polymetal met the targets for coupon reduction on its initial transaction and followed up with a second sustainability linked facility in September this year. The loan – the first extended to a metals and mining company by Societe Generale – linked interest payments to ESG targets including implementing a comprehensive climate management system, reducing fresh water use and supporting local communities.
Rusal has also notched an ESG finance double, signing Russia’s first sustainability linked pre-export finance facility in September – with ING, Natixis and Societe Generale – and its first international syndicated loan in the format, for $1.1 billion, in October. In the same month, Metalloinvest arranged a $100 million bilateral credit line with ING linked to the steelmaker’s rating from ESG agency EcoVadis.
Stephanie Clement de Givry, global head metals and mining finance at Societe Generale, says several Russian firms are keen to follow suit.
“These companies have done a lot of work on ESG and made commitments to a long-term strategy,” she says. “These deals offer a way to reinforce the message.”
“We are very interested in ESG-linked bilateral loans,” he says. “They are a great way to communicate to the market that the company is focused on proper disclosure and improvement of ESG ratings, and at the same time offer commercial benefits.”
Severstal is also in discussions with banks about a loan linked to the firm’s ESG rating, which it expects to improve substantially over the next two or three years. At the same time, Zaluzhsky says cost of funding will not be the primary consideration.
“It’s not clear that we will be able to obtain a lower rate than on our public debt,” he says. “But we want to start building a reputation in the ESG space because it gives us access to a new source of financing.”
Companies in other sectors are also eyeing sustainability linked products. Sibur is following the development of the market very closely, according to Rozhok.
“We have set up a sustainability development unit, we plan to invest in ESG compliance and we are working on a sustainable development strategy,” he says. “Once we have all that in place, then sustainability linked financing could be interesting and could offer a way of raising our ESG profile.”
Meanwhile, more advanced ESG players are looking at opportunities to tap into the growing pool of sustainable project finance. Polymetal has already launched a pair of pilot renewable energy plants and has lined up a range of other eligible projects, including replacing diesel transportation with electric.
To date, the vast majority of ESG-related financing in Russia has been provided by European banks, but there are indications that domestic lenders are preparing to enter the market. In September, leading private-sector lender Sovcombank became the first Russian signatory to the UN Environment Programme Finance Initiative’s principles for responsible banking.
“We are no altruists,” he says. “We believe this is profitable. Customers and more importantly employees care about the impact you have on society and the environment. Ultimately banks will not be able to be successful unless they share those values.”
Sovcombank is now looking to finance projects in sectors including renewable energy, waste management and energy-efficient technologies, as well as issuing green and infrastructure debt under the Moscow Exchange’s new sustainable bond framework.
Corporates are less keen on green rouble bonds, for which they see little appetite among Russia’s limited domestic investor base. More surprisingly, there is little interest in green Eurobonds, despite the success of Russian Railways’ debut issue in May.
The €500 million deal – the first green bond from the former Soviet Union – was nearly three times oversubscribed. Proceeds will finance the purchase of electric passenger trains.
Russian Railways’ first deputy chief executive, Vadim Mikhailov, says the transaction was not prompted by investor demand.
“We believe we are doing the right thing by using these bonds to purchase eco-friendly assets and promoting rail as a form of clean transportation,” he says. “We weren’t doing it to be fashionable.”
He adds that the firm is keen to return to the green bond market and is looking to expand the use of proceeds. “We have a huge amount of assets we need to acquire and replace as part of our long-term development programme, including electric trains and energy-saving equipment,” he says.
Other issuers are less enthusiastic. As Drozdov notes, even the most ESG-compliant metals and mining firms will struggle to find projects large enough to warrant the $500 million deal size required by most Eurobond buyers – and even if they do, the potential investor base is limited.
“The universe of investors focusing on green bonds is very small, and the number who can invest in metals and mining green bonds or Russian green bonds is even smaller,” he says.
“It is a very complex process,” says Zaluzhsky. “The reporting requirements are very onerous and there is a high level of scrutiny from both banks and investors.”
Nevertheless, Societe Generale’s Clement de Givry is confident that Russian corporates will come around to the idea.
“A large number of the companies we work with in Russia are regular bond issuers,” she says. “When it comes to sustainable financing, most will likely prefer to start with loans because they understand the instrument better, but once the right framework is in place it’s very possible that they will also want to look at green bonds.”
For the moment, however, Russia’s ESG champions are focused on traditional investors. Listed companies see sustainability as a way of attracting new investors and telling much-needed positive stories about Russia to counter the relentless flow of sanctions and geopolitics-related headlines.
“With so many factors making it harder for Russian companies to find investors, it makes sense to formulate an ESG strategy,” says Sistema’s Tulgan. “It provides another talking point with investors, another way to engage them.”
“These days, a good ESG rating is a must for any issuer that wants to be well positioned in the capital markets.” notes Rozhok. “If you are ESG-compliant and committed to improving your ESG profile, you open up to more investors – and the more investors that are willing to invest in your company, the more price traction you can get.”
The next question is whether or not other Russian firms will follow the lead of the metals and mining companies and other ESG pioneers.
Certainly, there is general agreement that the topic has become an increasingly important part of the discourse in corporate Russia over the last two or three years. Locals say most investor events in Moscow now include an ESG panel, while the likes of KPMG and Deloitte are building up their sustainability advisory capacity in the Russian capital.
Investment banks such as Renaissance Capital have also started advising clients on how to build their ESG profile.
Climate change is a particularly hot topic, with even unlikely candidates such as coal mining companies looking to cut carbon emissions, according to Solomin.
“People are seeing the climate agenda as an opportunity rather than a threat,” he adds. “Younger people are coming into the workforce and bringing different values. Everyone is switching from being defensive to finding out how to work in this environment.”
At the same time, locals say there are still plenty of hold-outs against the sustainability agenda, particularly among second-tier and mid-sized Russian companies.
“Smaller firms that want to grow and want to be compared to global peers understand that they need to have a sustainability agenda,” says a banker in Moscow. “Those that still have a Soviet mindset are unlikely to change until it’s time to retire and want to find a strategic investor to buy their businesses.”
“As a society, we are used to having unlimited natural resources, plus we have a huge territory with a relatively small population,” he says. “There will always be a temptation to be irresponsible.”
Solomin, however, argues that ESG will soon become a prerequisite for all corporates, in Russia as elsewhere.
“Regular finance will be what’s now green and the cost of financing will likely be dependent on ESG scores and ratings,” he says. “The sooner we start working in this area, the better-prepared we will be for the future, because at some point it will be mandatory for everyone. It’s a new religion.”
Russia’s leading stock exchange this year launched its first range of sustainability products in a bid to develop ESG (environment, social and governance) investing in the country and enhance its appeal for foreign funds.
“We were seeing a lot of interest in the topic from big international investors,” says Gleb Shevelenkov, head of debt capital markets at Moscow Exchange (Moex). “At the same time, we realized that Russian corporates had developed over the past decade to the point where they were ready for this.”
In April, Moex signed up to the UN Sustainable Stock Exchanges initiative. It also began publishing sustainability indices in collaboration with the Russian Union of Industrialists and Entrepreneurs (RSPP), which represents the country’s largest companies.
The Moex-RSPP Responsibility and Transparency Index comprises 22 companies that – according to RSPP – lead the way in ESG disclosure, while the Moex-RSPP Sustainability Vector Index features 15 that show the greatest year-on-year progress in ESG.
Moex is also hoping to foster the development of a sustainable bond market in Russia. In August, the exchange launched a framework for the issuance of bonds in three categories: green, social and ‘national projects’.
Green and social bonds will be certified by Icma and the Climate Bonds Initiative. National projects will cover bonds, “where the spirit of borrowing is almost the same,” says Shevelenkov.
“We have a lot of national and federal projects focusing on improvements to the environment and social infrastructure, especially outside of Moscow,” he adds.
The national projects category was created to allow fund-raising in these areas – seen as key to obtaining policy support for the sustainable bonds initiative – without devaluing Moex-listed green and social bonds in the eyes of international investors.
The first bond under the new framework was issued on November 15 by Center-Invest Bank, a lender based in Rostov-on-Don with a long track record of sustainable banking. Proceeds from the R250 million ($4 million) deal will be used to finance and refinance loans for energy-saving initiatives, renewable-energy sources and green transport.
The bank says: “Sovcombank plans a pilot bond issue of R500 million for a project of modernization of water supply infrastructure in one of the Russian single-industry towns in which pipelines have not been replaced for 60 years.”
Small developers and companies focused on waste management could also be among the earliest issuers under the new framework, according to Shevelenkov, as well as other smaller commercial banks.
He adds that Moex’s sustainable bond framework is already attracting interest from international investors.
“We have received a lot of questions about the initiative, particularly through the Russian subsidiaries of big European houses,” he says.
Some locals remain sceptical about the potential for sustainable investment in Russia, given the limited depth and breadth of the domestic investor base.
“The market just isn’t there yet,” says a senior executive at a large private-sector industrial firm.
Shevelenkov admits there is little demand for ESG instruments from Russian domestic investors but is confident this will change.
“Ultimately we believe we will see a green buy side in Russia, which in turn will decrease the cost of borrowing and make the format more attractive for issuers,” he says.
Locals say this will likely depend on the introduction of incentives for either buyers or issuers of sustainable bonds. This has been the subject of intense discussion in Moscow in recent months, with proponents – including Moex – advocating measures including compensation for green certification, tax breaks for institutional and retail investors in sustainable bonds, and lower capital requirements for banks.
Reports suggest at least part of this programme came close to approval earlier this year but met with pushback from parts of the government. Nevertheless, Shevelenkov says Moex will continue to press for change.
In the meantime, the exchange has seen a positive response to proposals to provide guidelines to help Russian issuers with ESG disclosure.
He also notes that it may not be optional if the Russian central bank moves ahead with proposals – currently under discussion – to add non-financial metrics to the list of disclosure requirements for companies.
The concern for Moex officials, he adds, is that the exchange is behind the curve on sustainable finance.
“The success of Russian Railways’ green Eurobond this year demonstrates the growing importance of this segment for our issuers,” he says. “We may have been a little slow getting going in this area, but we believe we are now moving ahead at a good pace.”
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