By Chloe Autran, Law Writer at the KCL Mergers & Acquisitions Society
Summary:
As Environmental, Social and Governance (ESG) considerations are increasingly shaping regulatory frameworks in the face of a post-pandemic era, the commercial world is transforming to meet ever-pressing sustainability and risk mitigation requirements. Mergers and Acquisitions are no different.
Exploring the depths of M&A, this article will evaluate how ESG factors are colouring different steps of a transaction.
“The impact of the growth in ESG disclosures on M&A cannot be underestimated. […] All aspects of M&A will be affected”. The context in which corporations are operating today, dealing with climate change whilst tackling the imperatives of a post-pandemic world, justifies the words of A. Brownstein, D. Silk and S. Niles. Environmental, Social and Governance (ESG) considerations are increasingly relevant when trying to understand the direction towards which the corporate world is heading. They cover an extremely broad landscape, including environmental (climate change, greenhouse gas emissions, energy, waste management, etc) social (human rights, health and safety, equality and diversity) and governance (bribery and corruption, tax, shareholder rights, customer engagement) factors. Standing at the heart of new rules framing companies’ operations, these considerations also drive investor, business and customer decisions alike. Needless to say, the commercial world is witnessing a megatrend. ESG factors are now considered by 88% of investors. Surprised? Me neither.
Of course, these factors are far from being new. The individual “E”, “S” and “G” have been part of business growth models for decades. It is their combination which today guides companies in a dual pursuit of sustainability and risks management, presenting somewhat challenging prospects for future business operations, but also undeniable long-term benefits. Focusing on ESG considerations in M&A transactions, this article will explore the effects of the trend for newly emerging corporate regulatory frameworks and their consequences on business transactions.
The increasing codification of ESG considerations: a prerogative for new regulatory frameworks
Companies had until recently the option to voluntarily abide to certain ESG principles, as was the case with the Task Force on Climate-Related Financial Disclosures (TCFD), supporting public companies and organisations in disclosing environmental risks and opportunities. However, recent normative changes regulating business operations are making ESG factors more than simple considerations. Not only is the TCFD evolving into a mandatory regulatory framework, but a general legal architecture is being designed to incorporate ESG in business transactions.
The “Mandatory Human Rights, Environmental and Good Governance Due Diligence” (MHRDD) framework is but one example. Although not yet implemented by EU Member States, a report published on March this year offered a set of recommendations to support the European Commission in its efforts to codify new ESG rules. More importantly, the report also included a draft version of the MHRDD, driven by the pursuit of a prospective EU-wide legal framework. Accordingly, Member States will be required to absorb the regulations into their domestic jurisdiction through new sanctions and liabilities regimes covering companies operating or domiciled in their territory.
If ambitious ESG regulations are materialising in the EU, it currently remains unclear whether the UK will implement the MHRDD. Focusing on sustainability, however, the Johnson administration is progressing in the same direction. In the context of the government’s 25-year environmental plan and upcoming COP-26, the yet to be applied Environmental Bill illustrates this point. Still subject to amendments, the bill is designed to hold private companies responsible for the implementation of environmental, human rights and good governance due diligence.
ESG strategies and M&A: advantages and a reason to be hopeful
Now that “businesses are provided legal certainty and clarity, at both national and supra-national levels”, the question remains as to how these changes are reflected in corporate operations, especially M&A transactions. Simply put, the consequences of ESG are significant. In the words of Trickett, companies are now “using M&A to improve their ESG credentials” which will ultimately equip them with competitive advantages. More specifically, 3 areas of influence must be considered to fully understand the ESG megatrend.
- Selection of target:
The acquiring corporation is essentially interested in the opportunities and risks involved in a transaction. Increasingly, target companies which comply with ESG standards attract buyers. For instance, almost 90% of target companies are now acquired after being subject to careful review of their ESG strategies. The regulatory frameworks subjecting businesses to a wider liability regime might help to justify this, as was the case for Fiat Chrysler’s merger with Peugeot, which enabled the former to avoid a $2 billion fine linked to the European carbon emission framework.
- Due diligence:
In light of new emerging law, companies will increasingly “be forced to know the details and actors within their supply chains to understand where they may be at risk” of causing adverse human rights, environmental or good governance impacts. Accordingly, due diligence now considers a combination of non-traditional factors. The “Weinstein Clauses” illustrate this increasing social consciousness in transactions, requiring the target company to report on allegations of sexual abuse. Ultimately, this will help the buyer to identify risks related to reputation, growth prospects and the structure of the deal.
- Financing:
ESG factors are key to measure the financial impacts of a deal as these now serve as a basis to rate corporate performance. According to Trickett, sectors such as “sustainable food innovation, waste recycling and electric vehicle infrastructure” are under the radar of private equity investors and represent opportunities for corporations to widen their offering prospects given the growth potential these represent. In this sense, if ESG laws constrain companies, they also fuel sustainable and ultimately profitable transactions.
Of course, this trend comes hand in hand with shareholder and customers’ expectations of an environmentally friendly, culturally diverse and transparent commercial world. “Negative ratings or public opinions on issues like environmental harm and human rights violations can have lasting impact on a company’s reputation and stock price”. As buyers and sellers are now also encouraged to engage in environmentally and socially safe M&A transactions, the corporate world might be doing its part in forging a slightly less grim future than the one we are accustomed to hearing about.
KCL Mergers & Acquisitions Society
The KCL M&A Society (KMA) was founded with the goal of providing students with valuable information and opportunities regarding the field of Mergers & Acquisitions. KMA aspires to provide students with a platform to learn and improve their skills whilst delving into the synergies of law and finance.
