In a political environment increasingly hostile towards even the most elemental social values, it may be easy to imagine ESG issues as a mere supplement to the bare economics of mergers and acquisitions.
Think again, according to panelists Thursday morning at the 19th annual Mergers and Acquisitions Institute in Dallas hosted by the University of Texas School of Law. In a wide-ranging discussion (cleverly titled: “WTF Does ESG Really Mean for M&A?”) panelists from five firms concluded that ESG (Environmental, Social and Governance) issues, both financial and legal, are moving toward greater focus in M&A transactions; perhaps at different paces depending on industry or geography, but evolving nonetheless in ways that need the attention of lawyers, regardless of the side they represent.
According to the panel moderator Chauncey Lane, a Dallas partner at Holland & Knight, 53 percent of investors report that they have cancelled a deal because of “material findings” discovered during ESG due diligence. Moreover, some 62 percent of U.S. investors say they are willing to pay a premium for companies that display a high regard for ESG policies in line with their own priorities, and 41 percent of business leaders say that effective ESG strategies add major financial value to financial transactions.
“People believe that focusing on these issues will lead to long-term value,” said Robert Little, a transactional partner in Dallas at Gibson, Dunn & Crutcher. That concern can either be about the core societal values represented by ESG, or by fear of reputational damage when issues arise from accusations about human rights issues in their supply chain or social issues that impede their ability to attract employees.
“These are so important that a board has to be actively asking these questions,” Little said. “Boards can become the subject of scrutiny for not being aware of the impact of these values.”
“We’re in a climate where institutional investors really care about ESG issues,” said David Katz, a partner at Wachtell, Lipton, Rosen & Katz in New York. Pointing to BlackRock’s success with ESG-sensitive funds for investors, Katz noted that companies that display effective ESG values are attracting capital. Although there has been political pushback, he allowed, ESG concerns remain important to M&A transactions for a variety of stakeholders inside and outside M&A transactions.
“Bottom line: It matters to them (investors). It matters to the market. And it matters to the state and local governments that will be looking at them,” Katz said.
Even if specific concerns are evolving in the U.S., companies that transact their business elsewhere are having to confront very specific ESG regulatory frameworks in the European Union, said Johnjerica Hodge, a Katten Muchin Rosenman partner in Washington, D.C.
Although the Federal Trade Commission has been considering new reporting regulations that would extend beyond companies into their supply chains — an issue that has received more than 15,000 public comments in the process — the German Supply Chain Act (as well as a “watered down version developed in India”) has already revealed what that might look like.
Such regulations require due diligence reporting on ESG issues in direct company operations, but require companies to investigate and report on the ESG efficacies involving the vendors within their supply chains. On the one hand, the regulatory mechanism might seem onerous to some companies; but on the other, they might actually need to be aware of issues that could, in some immediate future, offer reputational risk.
“No one wants their company accused of human rights violations, even indirectly,” said Hodge. “But it’s a bit of a debate: “How far do we report out on?”
Diego Gomez-Cornejo, a partner in the Dallas offices of McDermott Will & Emery, said due diligence on ESG issues needs to be a part of any transaction, both for buyers and sellers. That diligence may require boots-on-the-ground interviews or third-party expertise; but it needs to be focused and complete. Detecting issues of human trafficking or money laundering is part of a normal due diligence package, but ESG issues can include unexpected impacts on valuations, even for sellers in a deal.
“ESG is not just one thing. It covers a lot of areas. There is no one thing,” said Gomez. “Understanding the buyer is critical.”
Little agreed, saying some issues may present obvious challenges, even in operations that are familiar to sellers. Issues that seem subtle in general can have a specific, material impact on the valuation of a deal.
“Say you are manufacturing in an area that hasn’t required air conditioning. But because of recent changes in the climate, that is now needed. That’s something that a buyer would have to consider in the valuation: What changes would I need to make?”