Treasury goes green
Xylem’s treasury team has been able to integrate sustainable finance practices with traditional capital management, demonstrating a flair for innovation in both.
Pressure for companies to operate in a sustainable manner is increasing. At Xylem, the $5.2 billion US-headquartered global water technology company, awareness around this issue is heightened by the fact that all of its products address a variety of water issues. Against this backdrop, the company’s treasury team had to find a way to embed ESG goals into finance.
“We started looking at our funding strategy to see how we could align our financing with our company’s mission of solving water and infrastructure challenges and supporting a sustainability future” says Henry Wang, assistant treasurer at Xylem. “When we came to the refinancing of our revolving credit facility, we knew we wanted to expand this and looked at the prospect of green financing. Our banking partners were very supportive in developing this for us”.
Xylem refinanced and grew its senior unsecured revolving credit facility, going from $600 million to $800 million with the ability to increase to $1 billion, reflecting the growth of the company in the time since the initial revolver was established. More critically, the pricing on the entire facility was linked to sustainability.
“The new revolver ties our sustainability performance to the revolver pricing” says Wang. “We proactively approached our banks and told them we wanted to create this sustainability element in the pricing”.
The revolving credit facility was entered into with a syndicate of lenders arranged by Citibank, JPMorgan Chase, ING Bank, BNP Paribas Securities, and Wells Fargo Securities. The ESG score that the funding cost is tied to is provided annually by Sustainalytics, an independent global provider of ESG ratings of listed companies.
“If we improve our ESG rating by three points, our funding cost will reduce by 2.5 basis points” he explains. “If the score increases by 6 points, the cost is reduced by another 2.5 bps. Conversely, if our performance drops we will be penalised to have a higher cost of funding”.
The execution of the new revolver occurred in March this year as first-of-its-kind sustainability-linked revolving credit facility in the general industrial sector. In December last year, Sustainalytics rated Xylem with an ESG score of 78%, which puts it in the 98th percentile for an overall ESG score. Xylem is also rated AA by MSCI and has a CDP score of A- in Climate Change.
“We had worked with Sustainalytics previously on a developing green bond framework so we trust their services, and their rating framework is comprehensive” says Wang. “While we are already in a leading category for an industrial company in the ESG score, we do have room for improvement. The best way to improve our performance is to have this third party scrutiny of our ESG practices and tie our performance to our funding rate”.
Using derivatives to fund in euros
In addition to tying funding costs to sustainability, Xylem’s treasury has also reduced its cost of debt using derivatives.
This opportunity came about when the European Central Bank deposit facility interest rate became negative on 11 June 2014. Today the ECB deposit rate stands at -0.4%. Even though the Federal Reserve finally cut US rates this month, these still stand at 2%, meaning that borrowing in euros is far more advantageous. As a US-based company, however, it is easier for Xylem to borrow in dollars. In order to solve this fiscal conundrum, treasury moved to put in a cross-currency swap, something that has paid off for the company.
“We did a cross-currency swap back in 2015” explains Wang. “It was a very beneficial transaction for us to swap our dollar bond to a euro bond, because the carry is close to 200 basis points with BBB debt”.
At the time, doing a forward swap such as this would provide the company with cash flow benefit of interest savings with hedge accounting treatment, but there would be no impact to profit and loss (P&L).
Since early 2018, however, the hedge accounting policy changed with the introduction of new FASB ASC815 rules for net investment hedges, so now companies can benefit in both regards. Xylem has seen the benefit of extending its cross-currency swap activities.
“Our swap counterparties are some of the leading banks in our portfolio, including Citi and JPMorgan” says Wang. “We have a significant amount of operations in Europe, and so this is an effective way of hedging our euro asset exposure. We extended the 2015 swap last December for two more years to maturity and did another trade in May and expanded our horizon with additional banks given their support and helpful input”.
Xylem’s total notional amount of derivative instruments designated as net investment hedges was $426 million as of 31 December 2018, down from $446 million the previous year.
In total, the swaps have saved Xylem’s interest payment by 200 basis points on the swapped debt balance and effectively lowered the weighted average interest rate by 50 basis points on Xylem’s $2.4 billion total debt portfolio.
Hear more about how treasury is changing at International Treasury Management