• James Holley, Partner |
  • Amanda Ong, Director |
5 min read

ESG – often a priority for businesses’ stakeholders – is increasingly being seen as a measure of an organisation’s performance. Having become the defining megatrend affecting today’s companies, it’s shaping not just how firms operate and engage their stakeholders; but also the world of deal making.

Increasingly transactions are being influenced by environmental, social and governance (ESG) factors. Investment targets with strong ESG track records – and the data to back it up – are attracting higher valuations.

Given this potential to create and protect value, buyers are routinely conducting ESG due diligence (ESG DD), and not as a last-minute tick box exercise, much earlier on in the process.

The view from dealmakers

To find out more about the rise of ESG DD, we spoke to 150-plus dealmakers across the EMA region. We asked them about the importance of ESG DD in today’s market, and the challenges it poses.

You can explore the findings in detail in our 2022 EMA ESG Due Diligence Study. But broadly speaking, two telling trends emerged from our research:

1. Due diligence is on the rise as ESG enhances value

Four fifths of dealmakers said that ESG considerations are now firmly on their M&A agenda. And more than two thirds would pay a premium for targets with high levels of maturity on the issues that make up their own ESG priorities.

What’s more, two thirds agreed that material ESG concerns could be a dealbreaker.

2. ESG DD presents a range of challenges

The study also highlighted three common difficulties, which around half dealmakers encounter when carrying out ESG DD:

  • 54% struggle to set a meaningful, yet manageable, scope for the exercise.

  • 49% lack access to robust data or written policies on targets’ operating processes and practices.

  • 45% have trouble quantifying the findings from their analysis.

Addressing common challenges

Let’s take a look at how bidders can tackle these three problems, and improve the outputs of their ESG DD investigations.

1. Scope

Established frameworks and ratings providers can indicate the material ESG topics common to most organisations. Frameworks include the Sustainability Accounting Standards Board (SASB) and Global Reporting Initiative (GRI); while Refinitiv and S&P Global are among the best-known ratings providers.

54% struggle to decide on a meaningful, yet manageable, scope for ESG due diligence.

But ESG DD must also account for company-specific factors. These can be determined from a range of sources: the Information Memorandum; discussions with management; other due diligence workstreams; and the bidder’s own research.

Understanding the ESG perspectives of the target’s stakeholders is also important. The actions and expectations of regulators, customers, employees and financers can have an immediate and significant impact on the value of a business. Their views should therefore be integrated into a holistic scoping exercise.

2. Data and policies

Where robust ESG data and written policies are lacking, identifying the most material gaps should part be of the due diligence exercise. That will highlight any areas of increased risk, or potential for post-acquisition value creation.

In particular, companies without mature ESG data and policies risk failing to comply with regulations that demand them. These include the Task Force on Climate-related Financial Disclosures (TCFD), gender pay-gap reporting, and the proposed EU Corporate Sustainability Due Diligence Directive (CS3D).

49% lack access to robust data or written policies on targets’ operating processes and practices.

Data and policy gaps should be placed in their wider industry context, and benchmarked against best practice. That will allow bidders to assess the target’s overall ESG maturity.

It can also help them understand the impact of any gaps. For example, enquiring about the resources allocated to staff training, or seeking records of non-compliance incidents, will offer insight into a target’s ESG risks and opportunities.

3. Quantification

Quantifying the financial impact of due diligence findings is a perennial problem – and not just in the ESG arena. But where ESG DD is concerned, there are a number of helpful starting points.

49% have difficulty quantifying the findings of their ESG DD analysis.

  • The financial impact of a target’s carbon footprint can be calculated using prices from emissions trading schemes.
  • Risks and opportunities can provide a lens through which to estimate financial impact. For example, a B2C firm may miss revenue opportunities by not adapting to customers’ preferences for sustainable products. Or compliance risks can be quantified in terms of any associated penalties.
  • Bidders should also consider the costs of any remediation and improvement efforts. So if a target’s board lacks diversity, for instance, the cost of hiring new talent should be factored in.
  • The positive implications of a target’s ESG activity should also be considered. These might include revenue growth due to positive customer sentiment; or access to green financing at favourable rates.

Ask the experts

A final word of advice: drawing on external expertise can help you design and implement a practical and efficient ESG DD framework. Utilising specialist ESG practitioners to share their knowledge and insights, will support you focus on what materially matters and navigate the myriad of themes, standards and frameworks that can influence value drivers.

KPMG’s dedicated ESG due diligence teams help you protect and create value during a deal. We have established a global practice with deep technical and commercial expertise, which can be fully integrated into our financial due diligence offering to provide a one-stop-shop.

We’re working with many of the world’s leading corporate and financial investors, to develop ESG-related deal strategies that meet their unique needs and objectives.

Please get in touch to find out how we can support you integrate ESG into your investment strategy and processes.