The role of ESG in M&A continues to grow — not only affecting what companies are targets but raising the risk profile of some locations.
It’s a sign that countries with poor environmental regulations, a problematic approach to corruption, or issues with human rights abuses could suffer a long-term penalty as foreign investors turn their back on risky markets.
Baker Tilly’s annual Cross-border M&A Outlook report, produced in conjunction with Mergermarket, records a step-change in dealmakers’ approach to ESG, which continues to be a key factor in the choice of targets and whether a deal will proceed.
More than 80% of respondents surveyed say their approach to ESG in dealmaking is driven by new thinking about the importance of this topic, which has become a darling of activist investors, boards and large private equity groups.
Only 7% believe the focus on ESG risks now to be no different than traditional actions around environment or social responsibilities.
The findings back previous research by Baker Tilly and Mergermarket that found 65% of dealmakers now nominate ESG as an important consideration when making investments.
More than half the dealmakers in that research said their ESG investment strategy had a positive impact on overall investment returns in their recent deals.
“What our Cross-border M&A Outlook shows us is that ESG in dealmaking is not a fad, but a trend that is now embedded in the M&A discussions taking place in boardrooms, among advisors and in the target businesses,” says Julie Haeflinger, Corporate Finance lead at Baker Tilly France.
“The range of regulations relating to disclosures is only going to grow, and social pressure on corporates will continue to motivate companies to avoid being left holding assets that might be costly or damaging to their reputation.”
Ms Haeflinger says ESG concerns were raised earlier in dealmaking discussions – with boards, investors and financiers far more cognisant of ESG risk.
“Previously, a deal might have been marginal when judged on environmental, social or governance but financially sound enough for dealmakers to get it over the line,” she says.
“Now, with risk at the forefront of dealmaker minds, poor ESG performance can easily derail a deal.”
The combination of ESG risks and other concerns about jurisdictional recovery from the pandemic appears to have led dealmakers to downgrade some regions — at least for the time being.
Dealmakers cited both geopolitical change and investor preference as reasons to adjust investment strategies.
While 56% of dealmakers reported a stronger appetite for cross-border M&A, interest in some markets has all but vanished.
North America was tipped by 39% of respondents as an area where deals would increase significantly, while only one per cent were as ambitious for Latin America.
Overall, two-thirds of respondents expected at least some increase in North America, followed by Western Europe (62%) and Asia Pacific (59%).
Nearly 60% tipped a moderate or significant fall in dealmaking for the Middle East and Africa, and 53% for Latin America.
“In the next 12 months, Middle East and Africa markets will see lesser activity,” according to one of the dealmakers surveyed.
“The ESG norms and the ESG-specific investment intent is something that would restrict companies from seeking targets in this region.”
Another dealmaker makes a similar point: “South America is the most challenging market to invest. Companies have to improve on their ESG scope and the problems of bribery and corruption still exist in many regions.”
For those looking ahead, the issue of shareholder activism and stakeholder sentiment were anticipated to increase as the focus shifted from the pandemic.
“The demands from investors have changed and they are placing more importance on ESG scrutiny and reporting,” one dealmaker said.
“This has changed our outlook as well, and we are investing more time in ESG standards.”
Within regions, Eastern Europe and North Asia were seen as the most challenging markets, offering the most risk.
Even Australasia, traditionally one of the best performing markets for reduced risk and higher opportunities, has fallen down the list of places dealmakers look for investment opportunities, perceived to be riskier than the US, UK or Western Europe, and offering fewer opportunities than almost any other market bar Africa.
For many dealmakers, ESG now ranks alongside the geopolitical challenges stemming from the US-China trade war as a key area of concern, and even the perception of poor governance or environmental standards presents a threat that can derail an acquisition.
Baker Tilly Corporate Finance Lead Michael Sonego says each element of ESG carries significant weight, and social and governance expectations have grown to be substantial considerations for business.
“Environmental concerns are not only limited to direct emissions but emissions all along the supply chain, from how manufacturing power is generated and where materials are sourced, to how the products are used,” says Mr Sonego.
“Corporate social responsibility and social licence to operate have expanded to include employment policies, gender inclusion and diversity at a board level, as well as the interface between the business and its community.
“For governance, there’s a host of new requirements as jurisdictions introduce tougher reporting standards, from tax to modern slavery.
“The cyber security landscape has changed, and dealmakers are paying close attention to how data privacy is being protected.
“ESG has become a proxy for a growing number of risks dealmakers must weigh up.”
The Cross-border M&A Outlook report found slightly more than half of dealmakers believed ESG requirements were applied too liberally, but there was widespread recognition that ESG would remain a motivating factor for investors and a mobilising one for shareholders into the future.
Baker Tilly France’s Julie Haeflinger says corporates face heightened expectations of responsible and sustainable behaviour from staff, customers, and now financiers and investors.
“Organisations cannot pay lip service without allocating adequate time and resources to ESG because the demands for transparency have also increased,” she says.
“Sellers need to factor ESG considerations into any proposed sale, well in advance of heading to market.”
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