By Merlin Piscitelli, Chief Revenue Officer, EMEA, Datasite
Earlier this month, representatives from over 200 countries gathered in Glasgow for COP26. As predicted, the summit focused on big policy pledges aimed at addressing climate change and pr.omoting sustainability.
There were some positive steps. For the first time countries agreed to act on fossil fuels and there was consensus across several issues including approving to a set of rules on reducing emissions and bolstering the climate finance package to support developing countries to reach their climate goals. While there have been encouraging developments, achieving these targets will take some doing not to mention strong political will. Some critics have argued that COP26 mounted to nothing more than greenwashing however in short, it has brought us closer to being on track for a 1.5C world and galvanized a global impetus for transformative change on a scale never seen before. It is key that we work to closing the gap between ambitions and actions.
The UK Government made some very clear announcements about the finance industry and how it can ensure best practices are implemented in the transition to net-zero, a stance welcomed by the M&A sector. For example, our recent survey interviewing 200 dealmakers found that 42% of UK dealmakers wanted to see unified commitment from COP26 and 40% expect climate-change concerns to be the biggest dealbreaker in the next 12 months.
This sentiment is robust, and dealmakers are clearly planning with the environment at the forefront of their minds. In fact, climate change related financial risks and ESG issues are increasingly dictating how investors assess M&A targets and deploy capital. Combined with political and regulatory pressures, dealmakers are beginning to grasp the urgent need to approach investment in a more sustainable way.
COP26 pledges and ESG dealmaking
At COP26, Chancellor of the Exchequer Rishi Sunak pledged to turn the UK into ‘the world’s first net-zero aligned financial center’. A week earlier, the Chancellor announced that large businesses will be required to report climate-risk related information in line with the recommendations of the Task Force on Climate-related Financial Disclosures from April 2022. Therefore, dealmakers will need to assess a deal’s susceptibility to climate change, analyse its longer-term financial impact and mitigate against any negative impacts to protect returns.
Former Bank of England governor Mark Carney also declared a ‘watershed’ moment in financing the world’s move to net zero. As part of this commitment, he noted that $130trn of private capital is now waiting to be deployed to achieve this target. From an M&A perspective, this is likely to trigger an acceleration of deals with an environmental agenda.
The focus on the ‘E’ in environmental, social and governance (ESG) within business comes as no surprise as shifting consumer and investor sentiments is likely to lead to a disinvestment in companies with poor ESG outcomes. In fact, just under two-thirds (65%) of 400 US and UK dealmakers that we interviewed expect to see more deals fall apart because of climate-change related due diligence risks over the next two years.
The state of M&A and due diligence following COP26
Global M&A activity accelerated to new heights in the first half of 2021, reaching $2.6trn, largely in part to the imbalance between the amount of capital looking to be invested and suitable opportunities. Amid this backdrop, market players are also placing greater importance on due diligence as part of the dealmaking process. In fact, from January to September 2021, new content on Datasite’s platform was up 52% year over year. This not only reflects the increase in deal activity, but also the increased rigor during diligence and expanding content areas like ESG.
With 70% of dealmakers stating that ESG is now a priority category for them, any future due diligence will need to consider ESG outcomes. By incorporating these factors into the formal review process, professionals in the M&A industry will be in a better position to understand how the companies in question are actively promoting sustainable activities and if they are environmentally conscious. Doing so ensures those involved in future deals understand their risks, opportunities, and exposure in accordance with new regulation concerning the environment.
Prior to COP26, 76% of UK dealmakers said the UK and FCA needed to be more ambitious when integrating ESG factors into the financial markets. Governing bodies will ultimately need to put regulatory measures in place that satisfy ESG outcomes, while giving M&A professionals the freedom to originate and conclude deals.
Overall, dealmakers are aware of the increased focus on ESG considerations and the global shift towards more sustainable practices. The impact this will have on future deals will vary as risks are quantified and returns are calculated on a longer-term basis.
Looking to the future, we can expect to see an increase in the number of green deals, with private funds targeting sustainable companies focused on green tech or solutions that address environmental concerns.
With the large amounts of capital currently floating around, along with limited assets to invest in, activity within the M&A market is likely to remain high in the short-term. There is no doubt that climate change presents significant risks that all businesses must navigate. With climate-related considerations becoming increasingly incorporated into investment decisions in the M&A context, businesses can use their M&A activity to jump on opportunities and make transformational improvements that mitigate climate change risk.
With the dust settling on COP26, the bigger question now is understanding what action will be taken by the government to realise climate goals and how this will evolve over time.
Changes to international cooperation, stakeholder and investor expectations, public pressure, the development of carbon markets and success of renewable technologies will all play a part and impact M&A activity.