ESG – maximising opportunity and managing risk Until recently companies have largely considered that building environmental, social and governance (ESG) considerations into their business strategy was optional, utilising any action taken as part of a marketing strategy to support their brand.
Targeted ESG policy and practice was therefore a ‘nice to have’, with limited legal or market risk if a company did not incorporate these aspects into their processes and procedures. This is no longer the case. In a growing number of sectors and business sizes, investors require a clear, sustainable value creation strategy with ESG at its core. Survey data in the Private Funds CFO Insights 2020 found about 70% of limited partners “delve” into the private equity’s ESG initiatives with some frequency. 1 ESG policy acknowledges that a business’ impact on society as a whole should be a significant consideration when forming that valuation creation strategy. This not only provides businesses and investors with an opportunity to have a positive impact while creating sustainable growth, but also creates opportunities for companies to mitigate against potentially damaging risks in the form of reputational factors, public opinion and litigation should they fall short of certain requirements. When it comes to reputational factors in relation to ESG issues, perception amongst boards is that the balance has tipped and that the cost of inaction outweighs the cost of action.
Environmental • Environmental policy • Environmental performance • Climate change • Biodiversity • Sustainability Social • Human rights • Health and safety • Supply chain standards • Diversity • Consumer protection Governance • Corporate governance • Code of ethics • Bribery and corruption • Employee relations • Executive compensation
1 Private Funds CFO Insights 2020 available at www.privatefundscfo.com/insights-2020
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Opportunities vs Risks ESG risk permeates throughout a business’ entire corporate structure and supply chain, from the diversity of the board to the health and safety practices of suppliers. How information is recorded, interpreted and reported within a business is therefore vital in tracking risk and adapting accordingly. There has been a significant increase in the amount of ESG-related litigation including environmental and human rights cases which demonstrates that businesses are being held to account when significant failures are identified. There is mounting pressure for greater corporate transparency from governments with increasing ESG related legal requirements, but also from shareholders, as ESG ratings are easily obtained to get an indication of a company’s exposures to ESG risks. It is reported that the better the ESG rating the more bids received on a target business and from wealthier investors. Some stock exchanges are also demanding transparency by making ESG reporting required as a listing rule. For example, in the European Union (EU), the Sustainable Finance Disclosure Regulation (SFDR) has come into effect in 2021. “The legislation requires funds to understand the ESG status of their portfolio investments and [requires] fund managers to report on the sustainability of their assets,” according to Forbes.2 With businesses expected to increase their diversification post COVID-19 and therefore funding for acquisitions will be required, lenders will also want to see that the business has an ESG strategy and in practice it may be more difficult for companies with poor ESG profiles to access capital. Allocating ESG risk in M&A As the impact of ESG compliance on a target’s attractiveness continues to grow, buyers will increasingly look to thorough, specific ESG diligence alongside their standard anti-bribery and corruption, employment and environmental due diligence exercise. The types of ESG-specific issues that arise more frequently, such as disputes by employees regarding hiring practices or health and safety violations in the supply chain, would generally be picked up by way of disclosures against the typical suite of litigation warranties provided in a share purchase agreement. However, to the extent no litigation has been at least threatened, and in absence of targeted diligence into the company’s ESG practices, this leaves the buyer with potentially significant unidentified risk. Although not yet common practice, we expect to see an increase in the use of more targeted ESG related warranties, albeit those that are quantifiable in nature.
In the event that a buyer is looking to utilise Warranty and Indemnity (W&I) Insurance on the acquisition of a business, the nature of the ESG warranties they are seeking and the scope of diligence they carry out will be of even greater importance in order for the W&I policy to provide the cover sought. If, through diligence or disclosure, a risk is uncovered, for example, threatened litigation, then the M&A insurance market may be able to insure against it with a contingent litigation policy, therefore providing the buyer with financial certainty.
Examples of ESG issues: • Human rights • Employment standards • Board composition • Data privacy • Tax avoidance • Workplace diversity • Water management
• Product safety • Business ethics • Consumer protection • Climate change / greenhouse gas emissions Conclusion The requirement to have a clear ESG strategy continues to pervade through markets driven by a new, all-encompassing stakeholder category which includes employees, customers, investors, regulators and governments. The growth in awareness of ESG compliance provides all businesses with an opportunity to have a positive impact on society, with increasingly severe repercussions where they fail to meet the required standards, whether they be regulatory or set by the public. The impact of this on the M&A market has not crystallised in a material way, something that is likely to change as sellers and buyers determine how to allocate this risk.
2 How ESG Is Sweeping Private Equity Alongside Hedge Funds, Forbes, 2020. Available at: https://www.forbes.com/sites/jacobwolinsky/2020/11/26/how-esg-is-sweeping-private-equity-alongside-hedge-funds/
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About the BMS Private Equity, M&A and Tax Division Every transaction is different and we pride ourselves on being able to structure tailored M&A insurance solutions with the broadest coverage in a clear and concise manner. We have access to insurance capacity across the world and have developed strong relationships with M&A and Tax insurance markets in London, Europe, North America and Asia. Our team is a group of multi-disciplined professionals with backgrounds in M&A, Insurance, Law, Tax, Finance & Accounting, and Litigation. With our global reach and experience, we have extensive expertise of cross-border and domestic M&A transactions. We partner with our clients and their advisers to help them navigate efficiently through the course of a transaction. This entails an in depth understanding of the transaction dynamic, our client’s commercial goals and identifying potential obstacles as early as possible. This process allows us to provide innovative insurance solutions which facilitate transactions regardless of the complexity, size and sector, all within your transaction timetable. About BMS BMS is an independent, specialist Lloyd’s broker built around teams of experts in the fields of reinsurance, wholesale and direct insurance. We have been established since 1980. We are the largest employee-owned insurance business in the London market. Headquartered in London, we have more than 520 employees and a global presence, with offices located across the US, Canada, Latin America, Australia, Asia and Europe. In recent times, the company has diversified into other specialty Insurance lines, attracting market-leading talent, particularly in the areas of marine, property, cyber, construction, casualty, financial lines, energy and now M&A.
55 countries where we have supported transactions $50 bn + of transaction value advised on
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BMS Group Ltd is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 309686, One America Square, London EC3N 2LS. Registered in England 1479949. BMS Mediacion Iberia, Correduria De Seguros Y Reaseguros S.L.U. UK Branch is deemed authorised and regulated by the Financial Conduct Authority. Details of the Temporary Permissions Regime, which allows EEA-based firms to operate in the UK for a limited period while seeking full authorisation, are available on the Financial Conduct Authority’s website. (No. 826268).Registered in England at One America Square, London, EC3N 2LS (No. FC035750). BMS PEMA Ltd is an appointed representative of BMS Group Ltd which is authorised and regulated by the Financial Conduct Authority. This is a marketing communication. Formal terms of engagement must be agreed to secure the services of BMS Group.
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Contacts
Please contact the team at m&a@bmsgroup.com or alternatively speak to one of the teammembers directly:
UK Tan Pawar Global Head of PE and M&A T: +44 (0)20-7480-0264 M: +44 (0)7341-133-007 tan.pawar@bmsgroup.com
UK Dean Andrews Head of Tax Liability Insurance T: +44 (0)20-7480-0308 M:+44 (0)7876-815-643 dean.andrews@bmsgroup.com UK Harry Leitch Director, Head of Deal Origination T: +44 (0)20-7480-0346 M:+44 (0)7770-990-368 harry.leitch@bmsgroup.com
UK Sophie Wallace Divisional Director
T: +44 (0)20-7480-0378 M:+44 (0)7824-605-613 sophie.wallace@bmsgroup.com
UK Jessica Bradley Associate Director
Asia Sandra Lee CEO, Asia
T: +852 3579-5485 M: +852 9255-7088 sandra.lee@bmsgroup.com
T: +44 (0)20-7374-5109 M:+44 (0)7880-443-186 jessica.bradley@bmsgroup.com Canada Jason Stone Managing Director, Canada T: +1 416-845-4572 jason.stone@bmsgroup.com
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