The rise of ESG in mergers and acquisitions

The rise of ESG in M&A represents a significant shift in the corporate world.

14 Jun 2023 08:24 Minutes Radio interview

At a glance

Corporate & Commercial Law Director, Roxanna Valayathum unpacks the how ESG considerations have evolved in recent years, with Fine Music Radio.

The rise of ESG in mergers and acquisitions

The rise of ESG in mergers and acquisitions


The rise of ESG in mergers and acquisitions


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Michael Avery: Brought to you by Deal Leaders International, leaders in Mergers & Acquisitions.

Now "ESG", which as we know stands for Environmental, Social & Governance, has been gaining traction in recent years as investors and consumers demand greater transparency and accountability from firms.

Our guest today is Roxanna Valayathum, who's a corporate and commercial practice director at law firm Cliffe Dekker Hoffmeyr. And we're going to be talking about how ESG is shaping the landscape of M&A transactions. Roxanna, thanks for joining us today. To kick things off, can you just tell us how ESG considerations have evolved in recent years and why they're becoming increasingly crucial when it comes to getting an M&A deal over the line?

Roxanna Valayathum: Hi, Michael. Thanks for having me on the show. So ESG considerations are not a new concept in South Africa. South Africa is a resource-driven economy and with the unique history that we've had, we've had to grapple with many of the ESG factors in the past years.

But the reason that it's evolving as a concept into a much more tangible subject that can be measured in terms of a company's financials and reputation, et cetera, is really because the world is looking to a much more sustainable way of operating businesses and looking to the long term.

I think matters such as climate change and COP have actually really shined a light on how ESG considerations have to actually be a much more tangible part of business practice.

Michael Avery: I was recently hosting the Annexe Forbes Hot Topics Tour and it was quite interesting the research that was shared there around ESG in particular. And now this is talking to pension fund trustees and they're stewards of their members capital, many of them invest in the largest listed equities that go out and conduct merger and acquisition type transactions. And there was always this sense that, well, you know, you've got to give up some of the financial gains in order to do good.

But the research shows that very often ESG factors can actually benefit financially in more than 50% of the cases of a deal. Can you just elaborate on the potential benefits and how they impact financial performance?

Roxanna Valayathum: Sure. A company which has a strong ESG focus is viewed as a much more sustainable business into the long term. And that as a general principle will improve the valuation of a company. Companies then have specific ESG practices that they undertake. And when speaking to their bankers, these ESG practices open up the door to much more preferential loans and interest rate terms for specific companies.

So it does improve and lower the bottom line and actually assist the financial performance of a company to ensure that ESG factors are taken into account.

Michael Avery: And often it can be just a couple of basis points, not even a percentage point that can make a deal bankable or not. So if you can get preferential access and lower your cost of capital, like South Africa is doing with the JETP, go out and do it.

Obviously, while there are potential benefits, there are also risks and challenges associated with integrating these ESG factors into M&A deals.

I think on the environmental side, probably a little bit easier to quantify things like scope 1, 2, and 3 emissions. But when you come to the "S" and the "G", maybe a little bit more subjective. How do companies navigate these challenges?

Roxanna Valayathum: I agree with you. The "S" and the "G" are slightly more difficult to make tangible into how it needs to be implemented. But I think there is a lot of information out in the public about what it means to be a socially responsible company. The Companies Act requires you to have a social and ethics committee.

And so that's the first guideline as to what it means to be socially responsible. Even if you're not required in terms of the Companies Act to have a social and ethics committee, there are various factors that companies can take into account in order to ensure that they're paying heed to the "S" in ESG.

In relation to governance factors, listed companies have a much more stringent obligation to abide by the King IV code and other aspects, other companies, you know, don't have to comply.

But if you're looking to improve on your "S" and your "G", you'd look to firstly, the Companies Act, what are the requirements for social and ethics committees? And in terms of governance, you'd look at, you know, the King code and what are the obligations for a company to align themselves to a higher standard of adherence?

Michael Avery: And chatting to Dr. Mervyn King, just the other day, it's interesting to get his thoughts on where he sees the direction of travel. He reckons that we'll see an amendment to the Companies Act to enable the Minister to promulgate further regulation around exactly what it is when it comes to the "S" and the "G" that companies should be looking toward, so very interesting that. Obviously ESG due diligence is an important aspect of integrating these ESG factors into a M&A deal. Can you just explain what a really good ESG due diligence entails and the key areas that transacting parties should be considering here?

Roxanna Valayathum: Sure. It will differ from business to business and some businesses have very unique environmental issues that would need to be dealt with. Mining companies then have very specific social issues that need to be dealt with.

But what you would ultimately do is at the outset of a due diligence, you would consider exactly which sector the business operates in and what are the potential factors that may expose the business to risk. And so you would look at your, and every business acquisition requires a due diligence to be done upfront, but you'd look at the ESG factors and tailor your due diligence around exactly what the potential risks could be faced by the business that your client is considering purchasing.

Michael Avery: It is really wholly dependent as well, on the sector in which you operate, but extremely important to be able to get a better view on particularly the "S" and the "G". And it comes back down to having the right metrics to be able to measure the right things as well, so you're not comparing apples with oranges.

Just lastly, how do companies incorporate ESG considerations into their overall business strategy and decision making, just beyond the M&A part of the deal? Surely this needs to become almost core to the business's purpose?

Roxanna Valayathum: Absolutely. And there are advisors such as law firms and other advisors that do assist companies to look at what their ESG status is and how they can improve upon their ESG status.

So in circumstances where there is data, where a company is looking to hopefully improve upon its valuation or its general reputation, there are advisors who are able to assist in relation to each and every factor and how this can be improved upon.

Thank you, Roxanna for sharing those insights on the importance of ESG considerations in M&A transactions. And this week's due diligence here on Classic Business as always brought you by Deal Leaders partnering with you.

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