The growing prominence of ESG in M&A

By Lesley-Ann Kenrick, Director UK

All eyes were on Glasgow last month as politicians from around the world butted heads at the UN Cop26 climate summit and reached an agreement to ramp up measures to tackle climate change. There is little doubt that commitments made in Scotland will impact the global economy, leading to tougher environmental, social and governance (ESG) rules that will shape the future of M&A deal-making.

One thing is certain, ESG is no fad – it’s where the market is going. Companies should develop a strategy that incorporates ESG factors in operational planning, while in the M&A process, ESG credentials will be carefully evaluated in the deal process and valuation. As ESG becomes an intrinsic part of corporate culture, divergences in the ESG philosophy of potential acquisitions will become just as important to consider as organizational and regional differences are when bringing two organisations together.

To varying degrees, businesses and investors are already adapting to an ever-greening regulatory landscape and to a marketplace increasingly concerned about corporate sustainability. But the screws are tightening, especially on companies that have engaged in greenwashing—the practice of misleading consumers about a company’s environmentally responsible image.

UK Chancellor Rishi Sunak recently announced plans to mandate recommendations by the Task Force on Climate-Related Financial Disclosures (TCFD) by 2025, forcing larger companies to prove their green credentials with an ESG score. Meanwhile, the European Union’s Mandatory Human Rights, Environmental and Good Governance Due Diligence (MHRDD) framework looks set to be codified into an ESG rulebook for companies doing business there, meaning sanctions and liabilities for non-compliance.

Adjusting to these new rules may seem cost-prohibitive, but a failure to comply could cost your company more than compliance, and even risk its viability. When asked about the future of ESG for companies at the 2021 Financial Times Global Deal-making Summit, Hernan Cristerna, managing director and co-head Global Mergers & Acquisitions at J.P. Morgan, said:

“There will come a point in time, I don’t know if it will be in two or three or seven years, where investors will not be able to invest in a company unless there is a specific ESG rating. That’s the direction of travel, there is no question that is where we are going.”

The fact is, increased government interventions are very much in line with consumer demand and reflect the growing public desire for a greener economy. The UK Treasury estimates that about 70% of the British public believes their taxes should be used to make a positive difference to people or the planet. Governments are listening, and investors are following suit.

The next generation wants to work for companies, buy from companies, and invest in companies with demonstrated ESG priorities, so more and more investors are scrutinizing a company’s ESG record. And since no one wants to acquire a bad reputation, ESG is also playing a significant role in decision-making on mergers and acquisitions, with M&A teams increasingly being challenged to target companies that advance an organization’s sustainability goals.

“The direction of travel is clear,” says Paul Davies, Partner and Co-chair of the ESG Task Force at UK Law firm Latham & Watkins. “ESG issues are taking a more prominent place in the boardroom as a rule, including in the context of acquisitions. The ESG literacy at various levels of companies has undoubtedly increased.”

The implications of ESG are far-reaching, presenting management teams with a wide variety of challenges – not least finding a balance between compliance and its financial burden. Organizations will have to identify, develop, and track key metrics to measure overall ESG performance. From the implied costs of greenhouse gas emissions to insurance premiums for operating in climate-sensitive areas, mapping your company’s carbon footprint is a ground-up process from production right through the supply chain.

Deal teams are now modelling for these costs and weighing them against the benefits.
Companies with high levels of corporate social responsibility are more appealing because they will take less time to satisfy all the regulatory checks and thus to complete acquisitions. And acquiring such firms will reassure the market when the deal is announced, potentially boosting share prices.

For years, Traditional Environmental Liabilities have been prominent due diligence issues, and even deal-breakers. Now, the scope has been extended, and broader ESG-focused due diligence is the new norm. According to Private Equity International’s LP Perspectives 2021 study, 88% of investors take a manager’s consideration of ESG factors into account while conducting due diligence, up 80% increase on 2020, while Empira Institutional Trends Survey reports that almost 70% of institutional investors now class ESG criteria as important or very important for investment decisions.

The future is already here – it’s time to move with it, or risk being consigned to the past.

About the Author

Lesley-Ann is a highly experienced & results driven HRD with deep experience in outsourcing/M&A (client and supplier side) international industrial relations, TUPE/ARD, organisational design, rightsizing, global HR shared service centre set up and HR transformation.

About Global PMI Partners

Global PMI Partners is a specialist consulting firm supporting our listed company and private equity portfolio clients with their inorganic growth strategies and M&A integrations and divestments. We provide expert, on-demand M&A services and resources, leveraging our market leading M&A approach & methodology.

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