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How can ESG be worked into M&A due diligence best practices?

Practitioners need to consider the right questions to ask on ESG due diligence

2020 disrupted the traditional way M&A due diligence has been conducted in the past, but the requirement for robust due diligence remains crucial.

Negotiations and due diligence activity shifted into the virtual environment and while uncertainty around Covid-19 put pressure on deals, there was still enthusiasm if the opportunity was right.

Separately, buyers have also started to factor in a wider range of concerns when carrying out due diligence. Concerns around bribery and corruption or financial crime risks continue to be prominent, but increasingly the focus has been expanding to include ESG issues.

A study last year by Datasite surveyed 860 M&A practitioners, the majority of whom anticipated that ESG factors would be critical to closing deals by 2025. Over 80% of those surveyed had worked on deals that fell through due to ESG concerns. These predictions are being validated by the actions of EU legislators who have been introducing ESG reporting requirements into regulations governing financial institutions in the bloc. In the US, the Securities and Exchange Commission has also brought ESG into focus with a task force established and a public consultation opened on climate change disclosures.

In practice, incorporating concerns around areas such as sustainability, carbon emissions, or ethical procurement in the due diligence process is not straightforward. Similar to best practice in anti-corruption due diligence, practitioners now need to consider the right questions to ask on ESG due diligence:

  • Have ESG principles been integrated into the target entity in an effective manner?
  • Does the target entity have appropriate employee training, whistle blowing policies and case management when it comes to ESG issues?
  • Is the quality of the ESG information fit for purpose, especially as very few standardised measures currently exist?
  • Is ESG data from overseas operations reliable and fit for purpose?
  • Has the target entity considered the ESG risks in its supply chain and have these concerns been addressed prior to the merger or acquisition?
  • How can the ESG metrics be integrated post closure into existing or new operating models, especially when varying measures may be used by the buyer and the target entities?
  • Will the post-acquisition entity be able to meet ESG targets and deadlines set by management?

See also: – Message from America: Advice firms focused on ESG become acquisition targets

The final consideration above is key. Merged or acquired entities must be aligned with management’s commitment to ESG targets as a business priority, as shareholders and investors will increasingly hold management accountable.

In recent weeks, the IPO of food delivery firm Deliveroo, was marred by a series of investors declaring, in advance, that they would not be investing due to concerns over couriers’ employment rights. We can expect to see more of the same if ESG issues are not effectively analysed by M&A practitioners and concerns not appropriately addressed by management.

It is important to devote sufficient time and specialist resources during the M&A process to interrogate the ESG data to ensure both regulatory compliance and shareholder satisfaction.

Natalie Kenway

Natalie is global head of ESG insight for ESG Clarity. She won Editor of the Year at the Aviva Investors Sustainability Media Awards 2021. Winner of Aegon Asset Management's Institutional Journalist of...