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ESG is here to stay for M&A deal makers

© Shutterstock / William PotterPreparing documents for corporate disclosure.
Preparing documents for corporate disclosure.

ESG due diligence is an increasingly important factor to mergers & acquisitions (M&A) deal makers, but challenges still remain in terms of robust data, clear scope and quantification of results. But two-thirds say that deals could fall on ESG due diligence failures.

  • Identifying risks and upsides related to sustainability presigning and increased investors focus are the primary reasons for completing ESG DD in the past
  • 74% have ESG considerations as part of their M&A agenda, but only 51% possess a proper understanding of ESG in their area of investment.
  • 47% respondents highlighted that their ESG DD approach is reasonably mature and effective, but they are still learning, where financial investors specifically were somewhat ahead as compared to corporate investors.

KPMG has released an analysis of a survey of US mergers & acquisitions (M&A) actors, showing how the use of ESG criteria – and due diligence is particular – is having an impact on deal-making.

For the study, KPMG surveyed 200 US ESG practitioners including corporate investors, financial investors, and M&A debt providers. The survey found that three quarters (74%) of professionals are already integrating ESG considerations as part of their M&A agenda, with the identification of ESG risks and opportunities given as the top reason for conducting ESG due diligence, by 46% of respondents, followed by requirements by investors, cited by 19%, and preparation for regulatory requirements by 14%.

Market shift supporting ESG

Mergers and acquisitions (M&A) of companies occur more frequently particularly when there are fundamental changes in the regulatory or technological environment – companies are looking for new growth opportunities or hedge risks amid the winds of change. That is very clearly the case with ESG, as countries and companies struggle to adjust to a rapidly revolving environment, in terms of regulatory framework, operational costs, considerations for licence to operate and consumer appetite. As a strategic tool, M&A allows rapid entry into emerging markets, leave fading businesses or close gaps in your competitiveness.

Challenges and best practices in conducting ESG due diligence

ESG due diligence practitioners still face major challenges. Based on KPMG’s survey, there seems to be no consensus in the market today as to the meaning and scope of ESG due diligence. There are also concerns about the availability of data and documentation – this, in turn, makes it difficult to quantify the findings of a pre-transaction analysis in monetary terms when assessing ESG risks or business opportunities. However, this concern should be alleviated by the introduction of a sustainability reporting obligation for large companies in the European Union from 2025 the CSRD Directive, which should help to shape effective comparisons.

As it stands European investors are in advance of the US in terms of integrating ESG into the M&A agenda, at 82% of investors against the US figure of 74%. At the same time 48% of respondents in the EMA region are expecting to do ESG due diligence on over 80% of their deals against a US figure of 27%. According to KPMG, “All the EMA respondents with a top-notch approach have a strong link between their ESG due diligence and strategy”, while in the US only the top 60% are fully aligned.

Dealmakers believe ESG is here to stay

While the political debate about asset managers use of the ESG lens for investment decisions continues, 82% of M&A market players in the US reported that ESG is important to them and sustainability issues are also a determining factor in their investment decisions.

The market is still at an early stage, with the ways in which ESG impacts transactions still unclear for many investors, and there is a wide variance in maturity and experience amongst investors. The point however is that whatever politicians have to say, deal makers are seeing higher value in companies with strong ESG strategies.

It’s also worth noting that while the Republican backlash on ESG is becoming something of a political ‘cause celebre’, the 2022 Morningstar Sustainalytics Corporate ESG Survey Report showed that over 90% of businesses either have, or intend to implement, an ESG strategy. It’s simply common sense for companies, and investors, to know more about the potential risks they facing in a changing environment.

As Alyssa Stankiewicz, associate director of sustainability research at Morningstar, said: “It is increasingly apparent that material environmental and social factors play a role in a company’s performance and shareholder returns. For example, if a company’s supply chain is prone to increasingly frequent severe weather events, which is the case in countless regions across the world these days, it’s prudent to shore up protections and infrastructure to ensure the business can continue operating.” In the same vein she said: “If a company is proactive about treating its workforce well, it won’t suffer as much as competitors from turnover, and it will save on costs like hiring and training new employees.”

Strong ESG performance is driving price

Another observation from the survey concerns one of the most pressing issues in the world of sustainability: whether ESG-related efforts also increase the value of the company? The answer appears to be ‘yes’ – with two thirds of the respondents saying they would be willing to pay a higher price if the target company stands out with a high level of ESG maturity with respect to issues that are important to the investor. Half of the respondents are willing to pay 1-5% more and one in five investors even 5-10% more.

Based on KPMG’s survey, it can be concluded that companies who plan to make transactions with their businesses and want to be in a strong negotiating position must also have a strong and transparent sustainability (ESG) strategy.

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