How to navigate ESG standards in dealmaking
ESG factors are more important than ever. But how can dealmakers define their ESG standards and build a bespoke approach that creates meaningful change, delivers value and reduces risk? Tomas Sys, principal at Ramboll, explains
The increasing focus on ESG among institutional investors, management teams and consumers has been one of the primary drivers behind the rising prominence of ESG in M&A processes, with the number of signatories to the UN Principles for Responsible Investment (UNPRI) expanding from just 63 with $6.5trn of assets under management in 2006 to 3,038 managing $103.4trn in 2020.
Corporate M&A teams and private equity houses are also recognising that ESG best practice, on the one hand, and good financial performance, on the other, are mutually reinforcing. In its 2021 Global Private Equity Divestment Study, EY found that close to three-quarters (72%) of the private equity firms polled expected to capture an ESG premium when exiting companies displayed specific ESG qualities.
Well defined
Even though ESG has moved firmly into the M&A mainstream, building a meaningful framework for its implementation remains a challenge.
There is still a fractured understanding of what ESG is. Some companies and private equity firms equate it with traditional environmental health and safety (EHS) compliance. Right from the outset, ESG has gone beyond compliance, although some regulations are retrospectively dropping into this space. For example, the Modern Slavery Act and the Task Force on Climate-related Financial Disclosures have aligned basic EHS compliance and good ESG more closely, but ESG still extends well beyond basic compliance.
Other organisations, meanwhile, are engaged in good ESG practice, but just don’t refer to it as ESG. At Ramboll, we recently worked with a holiday resorts operator that was tracking its energy consumption per guest-night and monitoring coastal erosion and wastewater output as part of its day-to-day operations, but this wasn’t under the umbrella of its ESG.
The myriad ESG benchmarks and standards that have emerged in recent years have made it difficult for many investors and companies to know what they should be doing. The UNPRI, ratings agencies such as MSCI, the International Integrated Reporting Council and the Sustainability Accounting Standards Board (SASB) are just some of the many organisations that have developed ESG guidelines and reporting frameworks. This work is valuable and has played an important role in codifying what good ESG looks like. However, it has also made ESG complex and tricky to navigate.
A recent survey by fund services group Intertrust, for example, found that although 88% of private equity general partners expected to increase their focus on ESG during the next 24 months, almost half (46%) were anxious about using their own ESG scoring methodologies in case it left them vulnerable to criticism of ESG window dressing and greenwashing.
Bespoke approach
The standardisation of ESG reporting and practice is an important next step for facilitating rigour and comparisons between businesses and investors, but ESG has to be tailored for each organisation if it is to truly deliver value.
Having worked in environmental consultancy for more than 25 years, I have learned that a one-size-fits-all approach to ESG can be counterproductive.
Any ESG assignment or due diligence exercise should consider the sector, geography and ESG maturity of the business. There is little value in compiling a vast ESG questionnaire with hundreds of questions in an attempt to cover all the bases for all industries. This approach reduces ESG to a box-ticking exercise and ultimately undermines the positives.
Take the application of a sector filter, for example. Interrogating the carbon emissions of an industrial company is a valuable exercise. But it is irrelevant to ask a children’s nursery portfolio about its carbon emissions when the real focus should instead be on its employment practices and staff retention.
Equally, it doesn’t make sense to expect a business operating in central Europe, where consumer and investor attitudes to ESG are still nascent, to deliver the same ESG outcomes that apply to more mature markets in the US and western Europe.
The same holds true for the ESG maturity of a company. The approach to a company that is putting key performance indicators (KPIs) in place for the first time should be different to that of a company that is further along its ESG journey and has developed a more sophisticated framework. Setting ESG KPIs that are too taxing puts the engagement of a business and its staff with ESG at risk; it is much more effective to take an incremental approach that grows with the business and gives staff and management the time to join the dots and evolve.
At Ramboll, we tailor our work to each situation and base our research on the SASB’s Materiality Map, which accounts for sector, geography and ESG maturity.
The focus is on identifying the ESG aspects that are most relevant for making financially related decisions.
We don’t want to assess a company’s performance in every possible area of ESG. But we do want to link it to value and flag the issues that are material to the long-term financial and operational sustainability of an organisation.
About the author
Tomas Sys, principal, UK M&A and ESG advisory lead, Ramboll Group – a member organisation of the Corporate Finance Faculty.
