The overall implications of integrating Environmental, Social, and Governance – ESG factors into due diligence processes for M&A transactions are not yet fully seen in South Africa or globally. However, the inclusion of ESG factors when it comes to companies’ due diligence processes has led to the cancellation of more than half of all M&A deals that had been reported in 2023.
ESG has made prominent progress in finance as well as investment analysis, which presents an exciting opportunity to apply the same level of thinking to M&A and thereby potentially advance ESG practices in this area as well.
The background of ESG-related investing across South Africa
South Africa’s investment environment happens to be backed by a comprehensive legal structure that has in it various aspects such as environmental safeguarding, labor regulations, as well as takeover demands. The country has recently gone on to updated its anti-money laundering, terrorism financing, as well as financial sector regulations in accordance with international best practices. It is well to be noted that South Africa gives priority to governance frameworks within the realm of ESG factors, recognizing their important role in promoting sustainable as well as responsible investment practices. The fact is that the King reports have played a crucial role in shaping South Africa’s approach, to be specific.
The King reports are basically essential in promoting sustainable as well as responsible investment practices. King I, implemented governance standards for listed companies as well as banks that emphasized a total approach. These standards took into account not just the financial factors but also social as well as environmental considerations too. King II introduced the idea of the triple bottom line, thereby incorporating sustainability into corporate governance talks. The trajectory in South Africa was further pushed high by the King III and King IV reports.
South Africa’s sustainable and also responsible investment approach went on to be further strengthened in 2004 with the introduction of the JSE’s Sustainable and Responsible Investment Index. This was indeed a significant milestone, especially considering the growing market context. Based on the principles established by King II, this index was developed to identify companies that have incorporated investment practices that are responsible. It also serves as a comparative benchmark when it comes to investors.
It is well to be noted that the United Nations Principles for Responsible Investment- UN PRI were developed in 2006 so as to help investors analyze ESG factors and attributes more effectively. These principles provide a common language when it comes to responsible investing. The Government Employees Pension Fund, in addition to other signatories, has gone on to make a commitment to incorporate ESG factors into their investment strategies. The Code for Responsible Investing in South Africa- CRISA has been developed as a practical guide so as to analyze investments that promote sustainable development, following the establishment when it comes to UN PRI. It is worth noting that the CRISA was updated in 2022. The five principles of CRISA have major similarities with the UN PRI and go on to promote the integration of sustainability considerations, like ESG factors, into investors’ investment activities.
It is well to be noted that all this information collectively serves as a framework for South Africa’s commitment to responsible as well as environmentally friendly investment practices. The frameworks happen to have a significant impact on the M&A space, especially in terms of funding accessibility as well as litigation risk.
Investment assessment and impact on M&A
The framework described above goes on to represent South Africa’s absolute strategy for sustainable and also responsible funding. Apart from influencing responsible investment practices, these factors are becoming more significant when it comes to M&A transactions. When M&A deals are supported by funders who show a commitment to the UN PRI, CRISA, or other ESG-related codes, it is important for the due diligence procedures to thoroughly assess as well as take into account ESG factors. The increasing significance of ESG factors has gone on to result in investment decisions that are in line with the ESG mandates of funders, which means that capital is being directed away from projects that happen to have low ESG ratings.
The analysis of ESG factors in finance as well as investment is constantly evolving. As a result, there are now more strict reporting frameworks that happen to be in place so as to regulate sustainable and responsible investments. Apart from reporting, funders may also go on to face a growing number of climate litigation cases. In the South African context, directors can also face litigation for breaching their fiduciary responsibilities, in addition to other possible claims. Funders should take into consideration the potential risks when it comes to asset devaluation and the growth of stranded assets that may not be in sync with the shift towards more sustainable economies.
It is worth noting that M&A’s present companies with the chance to grow their ESG practices and appeal to investors who look to prioritize these factors. This can be achieved by specifically looking out for acquisitions that possess favorable ESG ratings. Boards can potentially gain much simpler and easier access to funding by growing a company’s ESG practices and scoring. The increased emphasis on ESG can also go on to promote more openness as well as responsibility, which in turn builds trust among stakeholders and has the capacity to drive long-term sustainable growth.
A company, for example, that happens to have lower ESG performance might consider acquiring a company that has a strong ESG rating. This would go on to help enhance its own ESG performance and also elevate its overall ESG profile. In another instance, a company may choose to divest from assets that happen to have negative ESG impacts. This decision can help elevate the company’s overall ESG performance. Aligning strategically with ESG principles not just improves a company’s reputation but at the same time positions it favorably in a changing market where responsible and sustainable practices happen to be highly valued by investors as well as stakeholders.
M&A transactions need assessing target companies’ practices as well as potential risks. To assimilate ESG factors into the due diligence line, responsible investing principles happen to offer a helpful framework. Investors can analyze and gauge a target’s long-term sustainability, social impact, as well as alignment with the values of the company by taking into account ESG factors. This entire approach goes on to promote responsible choices in the M&A space.