Diane Eshleman, Chief Sustainability Officer at Delta Capita, outlines how mergers pose challenges and opportunities to refresh and realign on ESG.
2023 may have gotten off to a rocky start for capital markets – with geopolitical uncertainty, the collapse of several banks, and stubbornly rising interest rates – but around the globe we are now starting to see signs of optimism and renewed confidence in M&A activity. With the acceleration of merger activity, it will be necessary to address and rationalise ESG policies and business practices across the combining companies.
Clearly, every merger will be characterised by both opportunities and risks for the combined entity. With regards to ESG, there is the potential for leveraging the varied approaches of the two organisations — but there is also a genuine risk of conflicting views and priorities. Indeed, there is a likelihood that there will be diminished focus on ESG, given the other complexities of merger integration.
Different approaches
Although the topics of sustainability, ESG reporting and related regulatory compliance have received increased focus in recent years, companies are still responding differently to the challenge. Some may take a minimal approach with a narrow focus on compliance and risk management. At the other end of the spectrum are companies seeking to make Sustainability integral to their strategy, business priorities and brand.
Across this ESG spectrum, policies between the merging firms may be divergent:
- From an Environmental standpoint, there can be very different views on carbon emission measurement, reporting and goal-setting. Even “green” policies with regards to premises and recycling can be vastly different. There is also a requirement to look across the entire supply chain in order to evaluate third-party environmental credentials.
- In terms of Social policy, firms must rationalise their respective views on topics like pay equity, diversity and CSR. In addition, mergers can often result in some level of staff redundancy, which must be handled with fairness to protect the rights of individual employees and avoid adverse effect of negative press. And there are “softer” topics like mission and values that must be reconciled across the two predecessor organisations to derive a shared culture for the new company.
- Although often not a prominent part of discussions on sustainability, Governance is among the most important and challenging aspects of a merger. Along with the alignment of policies and associated business processes cited earlier, getting the two firms to agree how to manage the combined company can be a complex undertaking. It includes not only the organisational structure and a new operating model, but also the composition of the leadership team, the approach to compensation and rewards, risk management practices, and agreement on the appropriate business metrics to ensure optimal performance for the merged entity.
Investor perspective
From an investor perspective, there will be a diversity of views about the importance of ESG. There continues to be a great deal of noise about the risk that returns could be degraded when companies focus on sustainability. The merged company needs to understand the demographics of its investor base and accept that more conventional investors must be assured about ESG — and that being ethical and socially-responsible is simply good business. With the generational wealth transfer currently underway toward Millennials and Gen Z, a focus on sustainability can be crucial to meeting those investors’ expectations and thus guiding their investment decisions.
For firms whose investments or portfolio companies are harming the planet, engaging in unethical behaviour or ignoring the risks to their long-term survival, the double entendre of ‘sustainability’ is brought to life – ignoring potential adverse impacts can be a warning flag when looking at the company’s longevity over the next 15 years or so. Building a more sustainable brand can be crucial for survival, and harmonising ESG strategy in the integration stage of a merger is key to unlocking value for the investing firm.
Investee perspective
From an investee perspective, a merger or acquisition amongst major investors creates a set of unique challenges and opportunities. The respective client bases of the merging entities may be very different — with perhaps one focused on institutional or traditional retail investors, and another more focused on private equity clients who seek more non-traditional investment options. This may open new opportunities for the acquired firm in the form of access to new markets, but it also exposes the risk of potentially divergent sustainability priorities. These must be reconciled in order to agree on portfolio composition and investment guidelines.
If investment company A has ESG criteria woven into its investment decision-making processes and investment company B is investing heavily in controversial industries such weapons and fossil fuels, the new merged entity will need to evaluate and assess the risks associated with the combined investment portfolio and potentially alter their holdings appropriately to align with their combined strategy. Depending on the priorities of each investor, the combined investment philosophy has the potential to be positive or negative on the investee firm from a sustainability perspective.
With separate firms come separate philosophies towards sustainability, often embedded within corporate culture. In the case of a merger or acquisition, the ideal would be to take best practice from each firm and integrate them to a unified and coherent sustainability culture. For the investee, this has the potential to cause dilution of sustainability best practice if the acquiring firm do not share a positive sustainability ethos, or alternatively to improve their practices if they do. Sharing knowledge and resources, as well as establishing consistent sustainability policies and procedures across the merged entity are key in achieving the best outcome and driving positive impact.
Depending on the jurisdictions that each firm operates in, this can also have an impact on regulatory obligations. If a UK-based asset manager acquires a firm with a European footprint, or even markets products in the EU, they will now need to adhere to SFDR as well as the UK’s SDR for example. The recent introduction of the ISSB standards marks the move towards a standardised global baseline of sustainability disclosures to help alleviate the regulatory burden, but currently for investee firms, M&A can significantly influence regulatory burden.
External perspective
Finally, the combined entity needs to decide how to position itself to the market and how to build out the merged brand. The reputation and image of the new company will influence its value — robust ESG disclosures and reporting have the potential to enhance the company’s profile with those varied stakeholders who truly care about sustainability. It is important to gauge what external validation is appropriate for the combined firm. While legal and regulatory compliance are a given, there are also external “badges” that can be secured – for example, subscription to the UN Global Compact or external assessment by a third-party ESG rating agency.
Transparency is key when articulating the mission and ESG credentials of the merged company and when describing the underlying ESG attributes of operations and investments. Companies should be prepared to describe those efforts they are taking to combat the climate crisis, avoid discrimination and manage risk through robust governance. For example, a consumer-focused company should be focusing on making its products accessible to someone with a disability. There is abundant evidence showing the importance of reputation on valuation — and how a values and purpose-centred company attracts clients, investors and employees alike.
Lessons learned
I speak here from experience. For the past eighteen months, I have been working with colleagues to integrate sustainability across two combined financial consultancy firms. Merging two companies with different ESG approaches has been a challenging undertaking, yet it has also allowed for a significant refresh and realignment of effort toward what are now common goals at the firm. The effort and outcome are truly worthwhile.
Diane Eshleman, Chief Sustainability Officer at Delta Capita, outlines how mergers pose challenges and opportunities to refresh and realign on ESG.
2023 may have gotten off to a rocky start for capital markets – with geopolitical uncertainty, the collapse of several banks, and stubbornly rising interest rates – but around the globe we are now starting to see signs of optimism and renewed confidence in M&A activity. With the acceleration of merger activity, it will be necessary to address and rationalise ESG policies and business practices across the combining companies.
Clearly, every merger will be characterised by both opportunities and risks for the combined entity. With regards to ESG, there is the potential for leveraging the varied approaches of the two organisations — but there is also a genuine risk of conflicting views and priorities. Indeed, there is a likelihood that there will be diminished focus on ESG, given the other complexities of merger integration.
Different approaches
Although the topics of sustainability, ESG reporting and related regulatory compliance have received increased focus in recent years, companies are still responding differently to the challenge. Some may take a minimal approach with a narrow focus on compliance and risk management. At the other end of the spectrum are companies seeking to make Sustainability integral to their strategy, business priorities and brand.
Across this ESG spectrum, policies between the merging firms may be divergent:
Investor perspective
From an investor perspective, there will be a diversity of views about the importance of ESG. There continues to be a great deal of noise about the risk that returns could be degraded when companies focus on sustainability. The merged company needs to understand the demographics of its investor base and accept that more conventional investors must be assured about ESG — and that being ethical and socially-responsible is simply good business. With the generational wealth transfer currently underway toward Millennials and Gen Z, a focus on sustainability can be crucial to meeting those investors’ expectations and thus guiding their investment decisions.
For firms whose investments or portfolio companies are harming the planet, engaging in unethical behaviour or ignoring the risks to their long-term survival, the double entendre of ‘sustainability’ is brought to life – ignoring potential adverse impacts can be a warning flag when looking at the company’s longevity over the next 15 years or so. Building a more sustainable brand can be crucial for survival, and harmonising ESG strategy in the integration stage of a merger is key to unlocking value for the investing firm.
Investee perspective
From an investee perspective, a merger or acquisition amongst major investors creates a set of unique challenges and opportunities. The respective client bases of the merging entities may be very different — with perhaps one focused on institutional or traditional retail investors, and another more focused on private equity clients who seek more non-traditional investment options. This may open new opportunities for the acquired firm in the form of access to new markets, but it also exposes the risk of potentially divergent sustainability priorities. These must be reconciled in order to agree on portfolio composition and investment guidelines.
If investment company A has ESG criteria woven into its investment decision-making processes and investment company B is investing heavily in controversial industries such weapons and fossil fuels, the new merged entity will need to evaluate and assess the risks associated with the combined investment portfolio and potentially alter their holdings appropriately to align with their combined strategy. Depending on the priorities of each investor, the combined investment philosophy has the potential to be positive or negative on the investee firm from a sustainability perspective.
With separate firms come separate philosophies towards sustainability, often embedded within corporate culture. In the case of a merger or acquisition, the ideal would be to take best practice from each firm and integrate them to a unified and coherent sustainability culture. For the investee, this has the potential to cause dilution of sustainability best practice if the acquiring firm do not share a positive sustainability ethos, or alternatively to improve their practices if they do. Sharing knowledge and resources, as well as establishing consistent sustainability policies and procedures across the merged entity are key in achieving the best outcome and driving positive impact.
Depending on the jurisdictions that each firm operates in, this can also have an impact on regulatory obligations. If a UK-based asset manager acquires a firm with a European footprint, or even markets products in the EU, they will now need to adhere to SFDR as well as the UK’s SDR for example. The recent introduction of the ISSB standards marks the move towards a standardised global baseline of sustainability disclosures to help alleviate the regulatory burden, but currently for investee firms, M&A can significantly influence regulatory burden.
External perspective
Finally, the combined entity needs to decide how to position itself to the market and how to build out the merged brand. The reputation and image of the new company will influence its value — robust ESG disclosures and reporting have the potential to enhance the company’s profile with those varied stakeholders who truly care about sustainability. It is important to gauge what external validation is appropriate for the combined firm. While legal and regulatory compliance are a given, there are also external “badges” that can be secured – for example, subscription to the UN Global Compact or external assessment by a third-party ESG rating agency.
Transparency is key when articulating the mission and ESG credentials of the merged company and when describing the underlying ESG attributes of operations and investments. Companies should be prepared to describe those efforts they are taking to combat the climate crisis, avoid discrimination and manage risk through robust governance. For example, a consumer-focused company should be focusing on making its products accessible to someone with a disability. There is abundant evidence showing the importance of reputation on valuation — and how a values and purpose-centred company attracts clients, investors and employees alike.
Lessons learned
I speak here from experience. For the past eighteen months, I have been working with colleagues to integrate sustainability across two combined financial consultancy firms. Merging two companies with different ESG approaches has been a challenging undertaking, yet it has also allowed for a significant refresh and realignment of effort toward what are now common goals at the firm. The effort and outcome are truly worthwhile.
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