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/
2
Powered by FlippingBook