How will sustainability and climate change impact the future of M&A?

Linda Le, Market Analyst

Last month, Metronome’s digital clock in Manhattan was reprogrammed to tell how much time we have left until climate change becomes irreversible. The evidence is in: climate change is here and we are rapidly hurtling towards an irreversible climate catastrophe if urgent, collective action is not taken. The threat posed by climate change is no longer an abstract “future problem”. After all, it was only a few months ago, that our skies turned red as Australians endured one of the worst bushfire seasons we’ve ever seen. There is no ignoring the reality that the climate apocalypse is upon us and if we do not act soon, there will be no coming back from this. Climate change will continue to be a topical issue going forward and the onus is on companies to manage how they respond to this threat; companies involved in M&A need to be cognisant of this.

What is the impact of climate change on business?

A key consideration in M&A is assets and operations sustainability, and this is often regarded as important in assessing the long-term potential of a business. Sustainability considerations may affect the value of the target business: where a business is sustainable and well-developed, this may lead to cost and resource efficiencies. The turnaround is that an unsustainable business might lead to high costs and risks, making the target appear less palatable in an M&A transaction. Further to this, the target business and its assets can be seriously compromised by climate change and its impacts, including rising sea levels and weather extremities. Earlier this summer, a number of businesses were significantly impacted by the Australian bushfires, especially in the tourism and agriculture sectors. The fires also crippled consumer confidence. Climate change impacts may also disrupt supply chains. This disruption may happen in the short-term as a direct result of extreme weather events like flooding and bushfires. It can also happen in the long-term as a result of climate change-related migration. This may then affect the business’ bottom line; the United Nations Development Programme estimates that by 2030, productivity-losses related to climate-change-related workplace disruption in the United States could rise to above $2 trillion.

There are a number of frameworks available to facilitate a sustainability assessment for the purposes of M&A, including The Sustainability Accounting Standards Board, the Task Force on Climate-Related Financial Disclosures, the Global Reporting Initiative Standards and the Guide on Climate Change for Private Equity Investors. In conducting this assessment, it is important to implement due diligence to assess material climate change risks and opportunities faced by the business and how they are presently being addressed. It is also important to build a business case for sustainability, and consider the key internal stakeholders to build buy-in for sustainability.

How can climate change action affect M&A?

In the court of public opinion, major contributors to climate change will often find themselves exposed to criticism and scorn. A 2019 survey of 1,200 financial executives found that companies are feeling the heat from various stakeholders to appropriately respond to climate change and this pressure is coming from a number of stakeholders including: employees, regulators, civil societies and investors. Public criticism of companies is not, however, limited to companies that fail to act, companies that damage the environment or companies that seek to create disinformation around climate change. Indeed, even proactive companies marketing themselves as climate change pioneers might find themselves in trouble where they fail to live up to these claims. Failure to live up to these claims may lead to negative publicity and the possibility of legal liability.

In this respect, companies are feeling the heat as they face increasing pressure to do more to act on climate change. This heat is not limited to the companies themselves, however, but it also extends to potential buyers of these companies and M&A valuations.

How can legislative change affect M&A?

Governments are also becoming increasingly active in legislating around climate change. This may affect M&A and how attractive a target company is to a potential buyer. A number of international treaties have been created including the 1992 United Nations Framework Convention on Climate Change, the 1997 Kyoto Protocol, the 2015 Paris Agreement, the Cancun Agreements, and the 1987 Montreal Protocol, to name a few. Since then, many jurisdictions have passed laws and regulations aimed to combat climate change; this regulatory framework may directly or indirectly affect the target company, its supply chains, its access to raw materials and otherwise impact its operating costs.

There is also increasing risk of companies being exposed to litigious activity as a result of their responses to climate change. Globally, 2019 was the year of climate-related litigation; as at 1 January 2020, the total number of climate change cases filed was approximately 1,444 and the vast majority of these came from the United States, followed closely by Australia, the United Kingdom, Europe, New Zealand and Canada.

Climate change is no longer a future problem; it is well and truly here and the time for action is now. In responding to climate change, companies sit at the forefront of all of this and there is a strong expectation in the market that these demands for sustainable businesses will be met. Deal makers are increasingly emphasising climate change and assessing the sustainability of target businesses and it seems that this trend is only set to continue going forward.

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