The role of ESG in corporate M&A
As world leaders gathered in Glasgow for COP26 at the start of November, businesses owners could not ignore the clear messaging about corporate social responsibility and ESG.
With not just governments but also regulators, customers, employees, lenders, insurers and investors now judging companies based on their ESG commitments, these themes are working their way onto the transactional agenda.
In a recent survey conducted by Trowers & Hamlins among a large number of business owners and dealmakers, it was clear that ESG is increasingly becoming a consideration in investment decisions. In all, nearly two-thirds of our respondents said that ESG was either a significant deal-making factor or was a factor to some extent, as investors become a lot more conscious of investing in sustainable businesses and digging deeper into company credentials on a range of ESG angles, often driven by pressure to do so coming from their own investors.
And it is not just investors but also lenders and insurance companies that are putting this front of mind. Alison Chivers, a partner specialising in corporate and commercial transactions at Trowers, says:
"The big banks and insurance companies are already factoring ESG risks into their pricing decisions, so if you’re going to be looking for new funding from lenders or a new insurance policy, you are going to be paying more if you are not able to demonstrate your credentials in these areas."
She adds: "ESG is an opportunity to set yourself apart from your competitors, and if you’re not doing it, you risk finding it harder to get investment, financing or insurance."
In the last few years, the push for sustainable finance and sustainability-linked loans has gathered momentum in Europe, with many large lenders now offering corporate borrowers the chance to reduce the interest rate they pay on a loan over time if they meet certain ESG performance targets along the way.
Other themes at the top end of the market will undoubtedly filter down to small and medium-sized companies over time too, as it becomes apparent that ESG is going to be a focal point for new legislation in the coming years. This year, premium listed companies will start having to report against the Taskforce on Climate-related Financial Disclosure (TCFD) recommendations in their annual reports, while companies of a certain size must already now report on their gender pay gaps and provide verifications on the absence of modern slavery in their supply chains.
Furthermore, Prime Minister Boris Johnson has reportedly already asked every government department to produce a ‘price’ for carbon emissions across all areas of the economy, raising the prospect of the UK’s carbon pricing being extended from its current focus on power generation, aviation and other energy-intensive industries.
Chivers says: "At the moment, the UK’s largest companies are having to do carbon reporting and climate data reporting, mostly using TCFD regulations. But where the big companies lead, others will have to follow, so we are going to see that filtering down."
She adds: "It is going to be increasingly important for all businesses not only to comply but also – going forward – to respond to investors, shareholders and other stakeholders on this. Businesses are not going to be attractive for acquisition or investment unless they are satisfying these criteria, and recruitment and customer relations is also going to be impacted."
If your customers are big multinational companies, they are going to be asking far more questions and auditing their supply chains, raising the prospect of businesses losing out on big tenders if they are not moving in the right direction on ESG.
Adrian Jones, another partner in the Trowers corporate department, says:
"We have seen situations where large companies inviting tenders are now asking more questions around ESG, covering everything from the carbon footprint of a supplier to the diversity of its workforce. Plus, we know that the next generation coming into the workforce are really passionate about this and want their employers to be taking it seriously."
It is also increasingly incumbent on businesses to take active steps to monitor the ESG credentials of their suppliers. "As a customer, you need to be asking these questions of your supply chain," says Chivers. "This is an evolving area – there is no common adopted reporting framework here at the moment. The TCFD is probably leading the way on climate-related disclosures but we are yet to see how that is going to be adopted across the market."
With a widespread trend towards more disclosure by corporates of their activities, in areas such as modern slavery and beneficial ownership, it is entirely feasible that companies might soon have to publicly disclose ESG information on things like their carbon footprint, use of packaging, commitment to recycling and diversity of leadership, and also share details of the credentials of suppliers.
At the moment, such requirements are at an early stage, albeit evolving fast. "This is not about implementing a comprehensive policy now, it’s about making a start on a process that is going to be iterative, but should be underway," says Chivers. "You may not be able to source all the data you would like today, but you can build on what you’re doing down the line and get increasingly sophisticated."
She advises business leaders to start by appointing a senior board member to take responsibility for ESG across the organisation and manage the approach. An audit is a useful next step, to take stock of the things already taking place across the company, the areas of greatest risk and the opportunities to tell a cohesive story. Often businesses are already doing a number of positive things but are not calling them ESG and not sharing them with stakeholders.
Another key task is to scrutinise your supply chain resilience and look closely at the activities of those that your day-to-day operations, and brand, rely on.
Supply chains are a particularly hot topic at the moment given the given the recent supply chain disruption and post-Brexit shift from a just-in-time approach to shipping across Europe and importing from China to a just-in-case, stockpiling trend.
"Today, a number of industries are dealing with critical supply shortages," says Jones. "We are seeing shipping problems globally and serious macroeconomic issues that suggest that going forward it may become much more normal to bunker stock ("just in case") and even to start moving supply chains back onshore and closer to home."
What is certainly clear is that a myriad of corporate stakeholders are now more interested than ever in how a company conducts its business and how its operations impact the environment, society and good governance. Businesses that are proactive on ESG will reap the rewards, whether through more investment, better exit opportunities, cheaper loans or more attractive insurance premiums.
"ESG is an opportunity to set yourself apart from your competitors," says Chivers. "If you’re not doing it, you risk finding it harder to get investment, financing or insurance. If you are taking the lead, you can expect to see the benefits."