ESG as a key factor in M&A transactions.
Sustainability (Environment), Social Responsibility (Social) and Good Governance (Governance) are becoming important factors in the M&A world. Several countries have already adopted specific rules on working conditions in supply chains and diversity.
Attorney Christofer Mellert, M&A expert at Deloitte, explains what innovations the German Diligence Act (Sorgfaltspflichtengesetz, mostly referred to as Supply Chain Act) brings and what impact ESG aspects have on M&A activities. Interview by Viola C. Didier, RES JURA.
Mr. Mellert, ESG is currently heard mainly in relation to the planned German Supply Chain Act. Please give us a brief overview of the purpose of the proposed legislation and who it will affect.
The government draft of a Supply Chain Act provides for an obligation on businesses in Germany to fulfill their responsibility in the supply chain with regard to human rights and environmental standards. This responsibility is to extend to the entire supply chain, which means it also applies to direct suppliers. Risks at indirect suppliers are relevant if there are any indications for violations of the relevant standards.
The law is to be passed by the Bundestag before the summer break, so that it will become operational from 2023. The law will then apply to German companies with 3,000 or more employees and, from 2024, to all German companies with at least 1,000 employees - almost 3,000 in total.
In addition to new obligations for companies, this probably also means the threat of sanctions in the event of violations...
Exactly. The current government draft provides for fines and penalties of up to two percent of global group revenues in the event of violations. That can really hurt. Depending on the type and severity of the violation, companies fined 175,000 euros or more can even be excluded from public procurement.
Should companies already be preparing for the Supply Chain Act to come into force?
It is quite possible that there will be some changes to the content of the Act before it comes into force. However, the option of simply waiting to see what the law will look like in the end is not really a good idea. Companies should already be thinking about the structures that need to be set up with regard to supply chains. Incidentally, this also applies to companies that are not directly affected initially or permanently because they do not have the relevant number of employees, but are integrated into the supply chain - the obligations will be passed on.
In addition, we have been experiencing the general trend towards ESG for some time now, so that we will certainly have to face further obligations with regard to sustainability aspects. There are already corresponding efforts at the EU level. In this respect, it is worthwhile to hold initial discussions with advisors now in order to get a better overview of which tools are already available and how the necessary structures can then be set up efficiently.
Despite all the obligations, ESG can also be an opportunity, since sustainability and social standards are becoming increasingly important for stakeholders and investors. So is ESG becoming a key factor in M&A transactions?
ESG is already a key factor in M&A transactions today because financial investors in particular no longer buy a target without having dealt with this issue. There is specific ESG due diligence, which is now carried out by almost every investor as standard. This automatically makes ESG a value driver - those who are not yet well positioned in this area are happy to buy a target with better sustainability standards and thereby improve their own group's ESG balance. And of course, ESG issues are also always reputation issues, which are directly reflected in the image - the value driver par excellence.
How can ESG value drivers and ESG risks be identified?
With a customized due diligence. This is also available as a standard off-the-shelf product, but if you want to identify real value drivers or uncover hidden risks, you have to look much more closely - and in the future even more explicitly at supply chains, by the way, as soon as the Supply Chain Act comes into force.
So let's say you identify ESG risks in a target, but you still want to acquire it. Is it possible to cover such risks?
First of all, if I see an intrinsic risk, the first thought should be to discount the purchase price. Otherwise, there is of course the possibility of warranties or indemnities and, on top of that, the insurance of relevant risks through W&I insurance. However, since these insurances only take effect if a sufficiently extensive due diligence has been carried out, this is precisely what should not be skimped on in the run-up to the transaction.
How can the target company be integrated into the ESG compliance structures of the buyer or, conversely, how can the ESG compliance structures of the target company be integrated into the organization of the buyer?
It is important to plan the respective integration as early as the initiation of the transaction so that the strategy can be implemented immediately after closing. Whether this can be achieved with internal resources - depending on the size of the compliance department and other interdisciplinary employees - or whether external support can be called upon right away, must also be clarified early on in the run-up to the transaction.
Prominent investors such as BlackRock are already committing to sustainability as part of their investment decision. Should all companies follow this example?
Absolutely: Yes! After all, we're talking about a social trend - think Fridays for Future, Green Energy and your own carbon footprint - if not social pressure. Business has always followed trends, so the vast majority of companies will follow it now and establish appropriate structures.
Throughout every stage of a transaction - from its negotiation and structuring to its execution.
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