Environmental, social, and governance (ESG) due diligence is emerging as a critical element in investment processes, offering a complementary layer to traditional financial and operational assessments.
Renée Law, senior managing director at FTI Consulting, highlighted the importance of ESG factors in identifying risks and opportunities that influence investment outcomes and long-term value creation.
According to Law, investors increasingly evaluate ESG risks and opportunities in mergers and acquisitions as intangible assets, including stakeholder relations, workforce management, and social licence to operate, gain prominence in valuation models. This trend reflects the growing recognition of ESG's impact on transaction pricing and overall company valuation.
For investors, ESG assessments provide a framework to identify gaps, liabilities, and potential risks that may not surface during traditional due diligence. Law noted that areas such as compliance with ESG regulations, human rights concerns in supply chains, and corruption risks can significantly affect deal progression and financial outcomes.
She also highlighted how ESG due diligence can uncover positive practices, such as environmental innovations or sustainable practices, that may offer future revenue opportunities.
The assessment process is particularly vital for international transactions, where differences in regulations and expectations may expose unaddressed risks. For instance, a supply chain review might reveal human rights issues, which could pose reputational and legal challenges if not resolved prior to the transaction.
Strong ESG performance can enhance a company’s attractiveness to investors by demonstrating mature risk management and adaptability to changing operational landscapes. Law said that companies with robust ESG practices can signal stability and readiness for future regulatory and market challenges, complementing financial performance.
Conversely, companies with poor ESG records face reputational, regulatory, and financial risks, which could lower their appeal to potential buyers or partners.
Upcoming regulatory developments, such as Australia's mandatory climate reporting regime set to begin in January 2025, underscore the increasing importance of ESG considerations in transactions. These regulations heighten the need for comprehensive and targeted ESG reviews.
Law pointed out that ESG due diligence presents unique challenges due to its relatively new integration into transaction processes. Best practices for evaluating ESG matters vary significantly across industries and geographic regions.
The success of ESG due diligence often depends on speed and expertise, as assessment timelines are typically tight, requiring in-depth engagement with target companies.
Experts in ESG assessments play a pivotal role in defining scope, identifying critical areas of focus, and ensuring alignment with international and regional sustainability standards. For technical areas, such as climate transition planning, specialised expertise is essential to evaluate performance effectively.
While ESG due diligence can appear complex, Law suggested that streamlined processes can mitigate inefficiencies. Setting clear assessment parameters at the outset and integrating ESG considerations with financial and operational reviews can deliver meaningful insights.
A holistic approach that evaluates data, engages with the target company, and considers post-transaction ESG alignment avoids the pitfalls of superficial or “box-ticking” assessments.
According to Law, comprehensive ESG due diligence not only mitigates risks but also identifies opportunities for business transformation, helping companies and investors align ESG initiatives with strategic goals post-transaction.
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