INSIGHT

What is ESG diligence and why is it relevant?

Environment, Social, Governance Mergers & Acquisitions

A company's ESG credentials can have a material impact on its long-term performance and valuation

ESG diligence is particularly important for companies in the context of M&A transactions. So, too, if you are doing business with a new third party, or if you are thinking about expanding into a new country, product or sector.

In this video, our cross-sector experts provide:

  • the real and potential ESG due diligence traps for organisations;
  • best practices for ESG diligence on investments and acquisitions; and
  • some thoughts on steps to be taking once the deal is done.  

Transcript

Dora Banyasz When it comes to ESG diligence, there are really two key focus areas for companies to be thinking about:

Michelle Bennett First, in the context of M&A transactions; and second, if you are looking to do business with a new third party, or in a new country, sector or product range.

Emily Turnbull In this video, we'll highlight the real and potential due diligence traps for organisations, outline best practice for ESG diligence on investments and acquisitions, and offer some thoughts on steps to be taking once the deal is done.

What is ESG diligence? 

Dora Banyasz In the case of an acquisition, best practice involves three key steps:

  1. A comprehensive assessment of the target's material ESG risks.
  2. Benchmarking of their ESG practices against peer and sector best practice.
  3. An assessment of the target's compliance with regulations, soft law and voluntary commitments they have made, to understand whether they are compliant and whether their position is consistent with your own ESG position, or whether any uplift is required post transaction.

When it comes to direct investments and engagement with third parties, again you want make sure all key material ESG risks that may arise are on your radar. This means conducting appropriately scoped risk assessments and due diligence, and ensuring that the perspectives of all key stakeholders are understood.

Practical due diligence tools, such as checklists, can help you to monitor and assess ESG issues, and to monitor and assess whether the company or third party in question is complying with the commitments they have made.

Why is it relevant? 

Emily Turnbull We are increasingly involved in M&A transactions where ESG issues such as free prior and informed consent, and net zero transition risk, have become front and centre. Neither of these are hard law compliance issues that would have formed part of a traditional due diligence exercise.

We are also being asked to undertake deeper dives into more established issues, such as investigating more fully the risks of modern slavery in a target's operations and supply chains.

There's no doubt that stakeholder expectations are high and growing in these areas – and this makes effective due diligence a must.

What are the risks and opportunities?

Michelle Bennett A company's ESG credentials are becoming more and more relevant. They can have a material impact on things like your:

  • growth opportunities;
  • ability to attract finance;
  • winning of project bids; or even
  • share price.

ESG performance is also impacting employee retention and morale, as well as alignment and engagement with the community more generally, such as your customers.

We are seeing an uptick in ESG disputes, such as shareholder activism and litigation. So, getting ESG matters right is really important.

What should you be doing now to mitigate risk?

Dora Banyasz So, to recap, what should you be doing now to prepare for ESG diligence?

Firstly, make sure ESG issues are on your radar and on the radar of any relevant parts of your business in any of these contexts.

Have the right tools and experts to hand, to make sure you can conduct ESG due diligence efficiently and in a targeted way.  

And, finally, think about the key ESG issues that may arise in different contexts, as they can vary.

Emily Turnbull Also, be looking ahead to once the deal is done, or the country or sector entry complete. Consider what controls shift or uplift is required to help you mitigate risk and maximise compliance from day one post completion, and to maximise the opportunities that can come from having a strong ESG position.

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