Kristine Torres l March 29, 2024 l The Manila Times
IN the era of sustainability and growing concerns over climate change, environmental, social and governance (ESG) considerations have gained more significance in the context of mergers and acquisition (M&As) and dealmaking. Companies, investors and stakeholders are faced with increasing pressure to integrate ESG factors in business and investment decisions including M&As transactions.
Why ESG matters in M&As
From the perspective of acquirers and investors, those who stand out with ESG compliance are perceived to be more attractive as M&A targets that not just create value for investors, but also help enhance reputational impact. Beyond showing profitability and scalability, in modern M&A deals, being environmentally and socially responsible and having good corporate governance as key investment criteria make an organization more desirable since they help acquirers enhance their reputation post-acquisition.
ESG reporting and issuances
The increased interest in ESG considerations can also be seen in the accelerated push for ESG or sustainability reporting and disclosures among publicly listed companies (PLCs). Aside from the growing stakeholder and investor awareness, there have been a number of regulatory developments in the Philippines on ESG reporting, since the earlier Code of Corporate Governance for Publicly Listed Companies, that introduced sustainability reporting and was released back in 2016 by the Securities and Exchange Commission (SEC).
In 2019, the SEC released Memorandum Circular 4, Series of 2019, entitled “Sustainability Reporting Guidelines for Publicly-Listed Companies,” which requires PLCs on a “comply or explain approach” to submit a sustainability report as part of their annual report. In 2023, the SEC stepped it up by announcing that it is revising the said guidelines where PLCs will be required to submit narrative and sustainability reports that elevate the quality of sustainability reporting aligned with the latest developments in global sustainability frameworks.
As ESG continues to gain traction and our Philippine regulators continue to steadily adopt policies and reporting frameworks on sustainability, there will be an increased demand for transparency in ESG disclosures, which should be addressed as well by private companies involved in M&A transactions.
ESG due diligence
This great attention to ESG and the government initiatives to step up the sustainability reporting framework also put more emphasis on the importance of ESG due diligence that continues to reshape M&A transactions. While review of the different facets of ESG such as labor, human rights, environmental compliance and corporate governance has long been part of a customary diligence investigation, it has only been relatively recently that specific focus on ESG considerations ― both as value driver, and brand and reputation enhancer ― is being made and weighed heavily in M&A decision-making processes.
Legal and technical advisors play a crucial role in identifying risks and in helping companies prepare a remediation plan or mitigants.
For example, for the buy-side, ESG due diligence covering the “E” component would focus on the compliance by the target company with national or local environmental regulations, checking environment-related risks, waste disposal, carbon dioxide emissions and climate policy, among others.
For the “S” component, this will cover investigation of the social aspects such as human right law, labor standards, code of conduct, health and safety, data privacy, cybersecurity, diversity and equal opportunities for employees.
Lastly, for the “G” component, this constitutes evaluating the corporate governance framework, risk management systems, internal policies for anti-bribery, anti-corruption and whistleblowing, and the oversight function of the board, among others.
M&A documentation
Closely linked with ESG due diligence, it is not uncommon to see ESG representations and warranties, as well as tailored-fit ESG covenants and indemnities in the definitive agreements, as risk-allocation tools. For impact investor-led deals, standard ESG representations and warranties are typically included.
In some cases, and depending on the parties’ negotiating strength, material adverse effect or material adverse change clauses would also capture scenarios on ESG risks, which, if present, will allow the buyer or investor to walk-away.
Overall, the approach to ESG as it impacts M&A deals would vary depending on the industry of the target company, heavily influenced by the parties involved, their profiles and culture.
One size does not fit all, but the approach should ultimately be risk-appropriate.
***Kristine T. Torres (kttorres@gorricetalaw.com) is a partner and head of project finance and ESG practice groups of Gorriceta Africa Cauton & Saavedra (www.gorricetalaw.com). She is also a member of the firm’s corporate/M&A and TMT Practice groups. She specializes in corporate and M&A, technology, media and telecommunications, banking, finance and securities law, capital markets, project finance and ESG. Photo from Pinterest.