ESG Risk | The impact of the growth in ESG disclosures on M&A

The Importance of ESG
Environmental, social and governance (ESG) factors are a set of standards that can influence the performance of companies. ESG criteria are especially used in the financial industry to assess how well a company performs on ESG metrics that the investor or financial institution considers favorable. A successful ESG strategy promotes positive stakeholder engagement and is increasingly viewed as a significant driver of value.

In this article, we highlight how ESG risks can be minimized in M&A (documentation). If you are interested in how ESG risk and value are assessed, we have a separate article on our website for you.

E - The E in ESG, environmental criteria, covers the energy a company takes in and the waste it puts out, the resources it uses, and the consequences it has on living things.  So, the E is about a company's compliance with environmental laws and permits.

S – The S in ESG, social criteria, addresses the relationships a company has and the reputation it fosters with people and institutions in the communities where they do business. S includes labor relations and diversity and inclusion.

G – The G in ESG, governance, is the internal system of practices, controls, and procedures a company adopts in order to govern itself, make effective decisions and comply with the law.

ESG Risk- The impact of the growth in ESG disclosures on M&A
While ESG factors were prevalent before, the COVID-19 pandemic – including Black Lives Matter, Me Too, and Fridays For Future – proved to be a strong catalyst as the importance of ESG issues sprung up even further. Corporate practices are now under heightened the relevance of public scrutiny – reputation damages, litigation or shareholder activism are looming if ESG is taken too lightly. Also, the financial consequences to a company of miscalculating ESG Risk can be severe. A company´s failure to understand and properly address key ESG factors in its business is increasingly viewed as a significant risk to a company´s long-term value. If a company fails to adequately consid-er ESG factors, it can have adverse consequences not only for reputation, but also risk litigation, shareholder activism and non-compliance.

The buzz surrounding ESG factors in investment and M&A decisions is stronger than ever. The impact of the growth in ESG disclosures on M&A cannot be underestimated. In the near-term, ESG performance will be incorporated into company valuations and risk assessments, and acquirers and targets will be expected to factor in ESG performance when evaluating the impact of potential transactions.

All aspects of a M&A transaction will be affected. A few are highlighted below:

• Selection of Targets and Business Partners
  ESG factors are expected to increasingly influence the selection of potential targets and business partners.
  
  It is becoming apparent that partnerships with companies that have strong ESG profiles, such as those focused on renewable energy or with strong innovation records, can enhance a company's ability to deliver long-term sustainable value to its stakeholders.
  
  Companies, with strong ESG profiles can gain a competitive advantage and potentially demonstrate their attractiveness to acquirers looking to develop or complement their own capabilities. Similarly, consolidation within sustainability-focused industries is expected to continue in order to achieve or improve economies of scale. New sub-sectors are likely to emerge in some industries, such as those focused on managing assets with specific ESG objectives or monitoring ESG performance. Boards will need to consider the ESG impact of potential transactions in addition to their profit impact.
   
• Reactions of shareholders
  As investors and shareholders increasingly question a company's ESG performance and investment decisions are increasingly made based on ESG performance, companies will need to be mindful of how they address investor and shareholder concerns in deal launches, investor presentations, press releases and analyst meetings. Boards and management need to demonstrate how ESG concerns have been managed in the context of M&A decisions and be prepared to speak proactively about such issues.