ESG to the fore in M&A deals

With a rebound in mergers and acquisitions (M&A) activity predicted in 2024, ESG Risk Review talked to Luise O’Gorman, Aon’s global head of ESG Transaction Advisory Services, about the role of ESG in M&A transactions, the drivers of growing scrutiny, and ratings to inform ESG due diligence.

Are ESG factors playing a growing role in M&A transactions? Is there greater ESG scrutiny in M&A deals? What is driving this?

Luise O’Gorman: I think it is fair to say that ESG, even just a few years ago, was perhaps more of an afterthought and it has evolved in the last decade to become a vital consideration as part of M&A and other transactions, and in some cases, it is almost non-negotiable to look at the ESG credentials of targets.

There is more scrutiny of ESG factors in M&A (and other) transactions than even just a few years ago. There’s a plethora of drivers that have contributed to that, including the ever-evolving regulatory landscape which is demanding much more transparency about how sustainability factors have been considered.

Lenders and investors are demanding more information, and of much greater granularity, than before. That same trend is visible in an M&A context where there is much more scrutiny of ESG factors in a deals context.

Is there also a fear of litigation? Is that also a driver?

Luise O’Gorman: Absolutely. I think that plays on professionals’ minds and people obviously want to meet the disclosure requirements, but on the other hand they are also careful as to what they put out in the public domain, to not over promise and under deliver, which could open them up to possible cases of litigation.

What areas are the most important factors?

Luise O’Gorman: It varies, and what is material, and a material risk, for a given target very much depends on the sector in which the company operates, and to a certain extent the geography as well, as to whether the emphasis is more on the environmental, social or governance side.

It’s probably fair to say that historically the emphasis has been more on the environmental side and understanding climate risk, both physical and transition risk and broader environmental risk in the context of transactions. But in more recent years, social factors are being analysed in much greater detail and there is much more focus around, for example, labour standards in the supply chain, working conditions, responsible sourcing across the supply chain, and so on, and these are all being analysed in greater depth than previously.

Does it make a difference whether the deal is public or private?

Luise O’Gorman: I would argue that although historically, perhaps, there was more scrutiny if it was a public transaction, those same requirements ‘trickle down’ into the private sector so the same expectations need to be met. Also, there are a number of disclosure requirements that are now impacting private companies. So the approach to ESG due diligence won’t be that different whether it is a private or public company.

How can a company ensure its ESG due diligence and disclosure is appropriate?

Luise O’Gorman: From a due diligence perspective, there is no ‘cookie cutter’ approach to ESG due diligence. It needs to look at the areas that may pose a material financial risk and that will depend, in part, on the sector of the target, as to whether the focus is on the environmental, social or governance side.

Also, a much debated topic with respect to ESG due diligence is the quantification of risks and opportunities – where possible. To not just assess it from a qualitative perspective but try to quantify those risks (and opportunities for value creation) in a way that is meaningful to deal teams. Whether that is trying to assess the impact of physical climate risk on the target, or transition risk, or categories of risk that are now only recently being able to be quantified such as reputational risk, for example. The quantification of those risks currently is key – as is the understanding from a forward-looking perspective of how those risks might evolve in years to come.

And finally, we come back to the appreciation and understanding of the ever-evolving regulatory landscape and the mandatory and voluntary frameworks as they will help inform the exam questions that ESG due diligence needs to pose.

Are ESG ratings of value in an M&A context?

Luise O’Gorman: Yes, they can be used to inform ESG due diligence. I’m aware of the regulatory changes that are being considered in this context, particularly around the amalgamation of the E, the S, and the G into one score. I think there’s a desire to unpick that and to make the underlying factors stand out more. Also, there is a desire to have more transparency around the methodology that was applied to derive those scores, all of which is helpful.

Even if certain scores differ, there are still insights that can be gained from those, and understanding why they may differ and what potentially is being picked up by one versus another, is actually very helpful to uncover certain ESG concerns, for example.

They can provide insight and understanding about how an external company such as a rating agency is viewing and assessing what has been put out in the public domain. Looking at your disclosures from a third-party lens in this context is helpful to understand what more you could do, what other data you may wish to publish, in order to give third parties the assurance that you are tackling all of the ESG objectives that have been set out.

Does all of this require collaboration?

Luise O’Gorman: Typically, deal teams will assess a whole host of risks associated with a deal and ESG is just one of the dimensions that they look at. The deal team or the corporate development team will work hand in hand with the risk function to ascertain whether a particular target has any ESG-related red flags, or orange flags, that the company should be aware of. And also look very closely at whether the acquisition would help the company’s own sustainability objectives or indeed hinder the company in reaching its own sustainability or net-zero objectives, for example. More broadly perhaps, ESG should not just be a standalone workstream but should be integrated and embedded into all aspects of the investment lifecycle and hence, collaboration across business functions is vital.