Why businesses should be thinking about Environmental, Social and Governance (ESG)
What is Environmental, Social and Governance (ESG) and how can it support future corporate transactions and general good practice for companies
Environmental, Social and Governance (ESG) is a term that has its origins predominantly being used in the financial sector and encompasses a broad range of environmental, social and governance factors. Originally this was a tool used to assess an entity’s behaviours when considering investing. Increasingly, it is a best practice standard adopted by listed companies and more substantial private companies, especially where there are private equity and venture capital investors. Increasingly, this is the benchmark approach to:
- Environmental: measures a company’s impact on the natural environment.
- Social: measures how a company treats people such as employees, customers and the communities in which it operates.
- Governance: measures how a company operates in terms of audits, board diversity, internal controls and shareholder rights.
It is being increasingly used in place of Corporate Social Responsibility and is used to determine whether investee companies are adhering to standards of behaviour that comply with ESG goals which are promoted and accepted as best practice and standards to be achieved where reporting requirements require compliance.
ESG and Investing
Institutional investors are being required to place a greater focus on ESG (including climate change) following the FRC’s publication of the UK stewardship Code 2020 which sets out good practice for institutional investors on engagement with investee companies.
The definition of stewardship now includes creating “long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society”.
ESG can form an express, dedicated work stream in a private equity transactions and feature throughout the investment process. In particular, through due diligence exercises where investors are considering ESG risks that may affect the sustainability and longer-term profitability (and even viability) of the investment.
Poor ESG performance can mean an increased risk of legal liability or a direct loss in the value of a business, with enhanced attention from regulatory bodies such as The Pensions Regulator. Accordingly, the use of ESG provisions in share purchase and investment agreements is set to increase and careful consideration will be needed to understand the potential liabilities established.
Environmental Social Governance (ESG) developments
Aside from the legal and regulatory requirements, studies have shown that ESG is becoming a key reputational concern, with more investors interested in sustainable investing and adopting its principles as part of their strategy, with Millennials leading the charge on this .
Considering ESG issues may also support organisations in realising opportunities e.g. identifying inefficiencies or improving safety performance. The coronavirus pandemic, has intensified discussions about sustainability and business resilience, and investors are increasingly seeking assurance that positive relationships with workforce, customers and wider stakeholders are being maintained. This will also include consideration of supply chains. The UK government committed to the EU in their trade and co-operation agreement that they will encourage responsible supply chain management and CSR, so it is likely that this areas will continue to develop and the principles around outsourcing and operational resilience already being applied to financial institutions will expand further.
With this in mind, organisations need to be considering whether they have an ESG strategy in place and policies that set out ESG goals and how they are being met. This will not only facilitate the achievement of objectives but also support future corporate transactions and make companies more attractive to investors.
We are increasingly involved in working with clients and their other professional advisors to develop and deliver programmes to establish ESG compliance as part of the business culture. Banks and Investors have established their own compliance targets for ESG in the businesses they support and invest in and we are already seeing ESG compliant businesses becoming easier to finance and obtain finance for. On the other side, businesses that have no ESG culture are finding Banks and Investors less open to be involved.
If you would like to discuss any of the points mentioned above in more detail or would like advice in connection with business affairs, please contact Tim Sadka partner in our Corporate and Commercial department via email at firstname.lastname@example.org