Why ESG will become a vital part of deals

The subjects that my clients bring up in conversations are an excellent indication of what’s on their mind – and it’s not always what I expect. Recently, many have raised environmental, societal and corporate governance (ESG); in fact, I can’t recall a time when our clients have talked so much about ESG. The question is, why?

The clue might lie in the results of our recent panel survey of CEOs worldwide, which examined the way in which business leaders have responded to the COVID-19 pandemic. It found that underlying many of the decisions made by CEOs during this time has been an eagerness to protect their company’s reputation. During the pandemic, this meant highlighting the company’s role in society and responsibility to a wide group of stakeholders.

42% of CEOs globally and 49% in the UK, for example, said that their organisation had contributed resources (whether financial, employee resources or in essential goods) to COVID-19 response efforts. 93% of UK CEOs said that focusing on employee safety and wellbeing was driving long-term changes to their business model, with 29% saying that it was also having the biggest positive impact on their organisation’s long-term reputation. Environmental issues also featured in the survey: almost half of CEOs worldwide believe that the pandemic has accelerated the shift towards reducing emissions of greenhouse gases.

Within the deals world, ESG has ebbed and waned as a priority in recent years. During the global financial crisis, many investors deprioritised ESG to focus on solvency. But as I pointed out in my previous blog, this is very different.

Our latest Global M&A Trends report argued that ESG factors are very much on the minds of investors, business leaders and governments, and that investors are increasingly allocating capital based on a company’s ESG performance. A recent article co-authored by Celine Herweijer, our global innovation and sustainability leader, pointed out that share prices for companies with the highest ESG ratings were outperforming others, and that on average, these companies fell less far and recovered more quickly than the market during the onset of the pandemic. This suggests, said Celine, that the trend towards stakeholder capitalism which began before the pandemic is accelerating.

I agree, and believe it’s inevitable that this view will seep into the deals world. From now on, ESG and purpose will have a significant impact on asset values. A company’s resilience to the impact of ESG related issues will be important; private equity will look to acquire ‘clean’ assets (and this in itself will encourage change), and investors are increasingly expecting a solid ESG performance. When this issue was raised in a recent FT Live event, one of the participants (on the sell side) commented that while there was a lot of talk around the importance of ESG, it wasn’t yet driving deals or featuring heavily during a deal. But I think that will change. It seems that it’s already an important issue for buyers, but sellers may take longer to realise its importance. This will risk leaving value on the table.

The pandemic has impacted our economy in many different ways, but this could be a positive shift. COVID-19 has been seen by some as an opportunity for governments and businesses to make a stronger commitment to ESG. If this proves to be the case, we will all benefit.