Environmental, social and governance (ESG) themes have risen in prominence over the past five years. From the growing efforts worldwide to tackle climate change to high-profile concerns such as the Black Lives Matters campaign, societies are increasingly determined to confront a broad range of issues. Businesses are expected to show their colours in these fights.
In this research, we set out to determine how the rise of ESG is having an impact on the investment and M&A decisions made by both corporates and private equity investors. To what extent are they taking these factors into account when considering potential deals? What drives their ESG policies? How are they adapting due diligence and valuation processes to take account of ESG? And in which markets and sectors are these debates most advanced?
Dealmakers are more focused on ESG than ever before. In large numbers, they confirm that these issues are critical both to their own organisations and also to the way they approach potential transactions. Most say they have walked away from at least one deal on these grounds; many say their view on valuation has been materially affected by ESG considerations that have emerged during due diligence
Many analysts, however, believe the pandemic has turbocharged the focus on ESG, forcing people the world over to think about the way they live and to confront the interconnectedness of society.
In this landscape, the ESG credentials of a business can now be a make-or-break factor in deals. Indeed, 60% of dealmakers have opted to walk away from a potential investment after uncovering problems related to an ESG issue. Corporates and PE firms in equal numbers report having made this decision.
The United Nations’ Principles for Responsible Investment documents more than 730 regulatory revisions in the world’s 50 largest economies that require or encourage investors to consider long-term value considerations such as ESG factors1. At an individual level, businesses potentially targeted by investors face a raft of new regulatory requirements, particularly on reporting and disclosure.
It is also important to recognise that the drivers for ESG come from a broad range of issues that now matter to regulators, policymakers, consumers and other key stakeholders. While 77% of respondents say they regard climate change as a key issue, the issues of human rights (73%) and business ethics (73%) are cited as key concerns by almost as many.
As ESG becomes a global phenomenon, key issues undoubtedly have greater prominence – and are subject to more scrutiny – in certain markets. Respondents point to the developed economies of the West as being more ESG-conscious than their developing market counterparts.
"The trend towards ESG investing reflects the strength of purpose-driven business, as well as customer preference for companies that are good corporate citizens. And while it is true that not every company with a good corporate social reputation is rewarded by customers, it’s clear that those who are perceived as negative, who shun good governance or have a track record of poor social outcomes, are going to get punished by consumers, partners and investors alike"
Reflecting sentiments among the wide body of investors, the head of M&A at an Australian corporation says, “We do not want to find ourselves in a situation where we have not looked at ESG performance measures.”
However, ESG due diligence is not always straightforward. More than a third of respondents (36%) say they sometimes find it challenging to secure permission to access relevant information – it may be that target companies are reluctant to release data beyond the core financial metrics that due diligence processes typically require. More than a quarter of respondents (28%) say it can be difficult to find relevant information at the target – smaller businesses, in particular, may not yet have ESG monitoring and reporting protocols that ensure such data is readily available to investors and buyers.
Such advice may also be increasingly useful for valuation purposes, with ESG factors now widely regarded as part of the assessment – for better or worse. More than half of respondents say ESG factors have had an impact on their valuations of a potential investment: 33% have increased their valuation following a positive ESG assessment, while 18% have downgraded their view on ESG grounds.