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ESG due diligence is an essential addition to traditional financial and operational due diligence and an important tool for risk management and value creation in investment decisions.
Environmental, social and governance ('ESG') risks and opportunities are increasingly factored into mergers and acquisitions as investors recognise the need to assess the value of intangible assets, such as stakeholder relations, workforce management and social licence to operate.
For Investors
Effective ESG due diligence adds an important dimension to investment decision-making and portfolio management, as sustainability factors can influence the pricing of transactions and valuations of companies. A robust review process allows investors to identify shortcomings, long-term liabilities and any emerging risks or opportunities associated with a company in environmental, social and governance areas that aren't traditionally reviewed as part of typical financial and operational due diligence processes.
Investors might uncover a lack of preparedness and alignment with incoming ESG regulations that might be costly to address in the future. For international transactions, corruption-related risks that have not been addressed might stop a deal from progressing. For example, a review of a company's extensive supply chain might uncover human rights-related issues which pose a reputational, legal and compliance risk. On the other hand, due diligence can uncover good environmental practices that have not been disclosed publicly or future ESG-related innovations that can lead to further revenue generation.
For Companies
Strong ESG performance can make a company a desirable target and send positive signals to investors and other stakeholders that they possess mature and comprehensive risk management controls. It also complements strong financial performance and demonstrates a company's awareness and responsiveness to its changing operating landscape. Poor ESG performance can lead to reputational, regulatory and financial risks.
Good ESG Performance Can Enhance Company Value
Where Companies and Investors Encounter Challenges
The need to assess ESG elements in transaction diligence is increasing, particularly as Australia prepares for a mandatory climate reporting regime starting in January 2025. ESG due diligence is a new area of diligence. Carrying out an impactful, decision-useful assessment can be tricky. There are plenty of potential ESG matters to assess and best practice often varies depending on a company's industry and geographical location.
Successful due diligence relies on two things:
- Speed
Assessment timelines tend to be short and require extensive engagement with the target company. Bringing in experts with the right knowledge makes the process easier. - Expertise
Experts skilled in ESG due diligence lend their extensive knowledge to quickly and efficiently define a scope of work that targets the right areas. They are well-versed in international and Australian sustainability standards and regulations, and they know what a good ESG program looks like, what type of data should be obtained and the best way to assess it. For some areas, such as climate transition planning, technical expertise might be required to determine a company's performance.
Making the ESG Process Efficient yet Impactful
Despite these complexities, the ESG due diligence process does not need to be complex or time-consuming. Setting the assessment parameters up front based on best-in-class program design and development and having experts perform the assessment with consideration of financial and operational due diligence will deliver the best outcomes. It is important to avoid ESG due diligence as a box-checking exercise that simply targets evidence of ESG policy and a quick provides a snapshot of metrics. The diligence process must be holistic, encompassing a review of relevant data, qualitative commentary and information and engagement with the target company. Holistic ESG due diligence addresses material ESG-related risks or opportunities, identifies potential greenwashing and finds opportunities for post-transaction alignment of ESG initiatives and business transformation.
At FTI Consulting, we combine a desktop review with an on-the-ground assessment for ESG due diligence.
- Desktop, data room and key personnel engagement: We collect publicly available information and data and request the target company share information and data as well. We evaluate discovery in comparison to best practice, market, regulatory and peer standards. We engage with the company to assess the information provided effectively.
- On-the-ground: In addition to a desktop review, we leverage our global network of FTI Consulting offices and affiliates to conduct interviews and assessments on-the-ground in various jurisdictions and languages. This step allows us to identify any discrepancies between reported information and actual practices, providing critical insights into a company's ESG performance.
- ESG risk assessment report: We then provide our clients with an outcome showing ESG opportunities and risks associated with a company to consider when evaluating an investment opportunity. For more information on FTI Consulting's ESG due diligence capabilities, please contact the ESG team.
Click here for more information on FTI Consulting's ESG & Sustainability and other non-financial due diligence solutions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
