Businesses that embrace environmental, social and governance (ESG) considerations and understand the value and risks inherent in their business may not only be able to avoid ESG risks but could also be in a position to use ESG disclosures to demonstrate their sustainability credentials, thereby attracting investors and consumers and availing of more favourable debt terms. This is the view of Robert O’Shea, partner and head of the Corporate Department at Matheson, Ireland’s largest law firm.
According to O’Shea, ESG issues have soared up the corporate agenda recently and Europe has been at the forefront of policy making and legislative developments in this area. “First presented in December 2019, the European Green Deal is a set of policy initiatives with the aim of making the European Union climate neutral by 2050,” he points out. “The Sustainable Finance Disclosure Regulation (SFRD), a central pillar of the European Green Deal, imposes certain disclosure obligations on operators in the private capital market requiring private equity firms, pension funds, hedge funds and other asset managers to consider and disclose how ESG factors are adopted in their decision-making processes.”
That means companies which avail of private capital will need to understand the nature and extent of the data they will be required to report to their investors or lenders. “The ESG Data Convergence Project, an international association of investors and private equity funds, have agreed to initially track and report on a core set of ESG metrics for underlying portfolio companies which include emissions, board diversity, renewable energy and employee engagement,” O’Shea adds.
The impact on the lending market is already apparent. “Lenders are increasingly considering long-term sustainability strategies when deciding whether to make capital available and at what cost,” he says.
“The introduction of sustainability-linked pricing models will see high carbon emitters having higher costs of capital compared to businesses with low emissions. Irish pillar banks have also demonstrated their commitment to driving change through the issuance of green and social bonds, with the specific purpose of facilitating lending to projects with environmental and social benefits.”
Private equity sector
It is also being felt in the increasingly important private equity sector. “Private equity’s influence on the Irish economy continues to expand in line with the increasing number of Irish companies receiving investment from domestic and international private equity funds,” O’Shea explains. “In the M&A space, more than one in every four deals reported in the Irish market in 2021 involved a private equity fund. Similarly, there has been a notable increase in the number of Irish businesses availing of alternative sources of capital, whether from debt and capital markets or alternative lenders.”
And there are now several dedicated ESG funds as well as a number of companies and investors looking to use M&A to help achieve their ESG targets, he continues.
“ESG factors have therefore become increasingly important value-drivers for dealmakers. For private equity firms in particular, ESG factors are a core focus as their investors are required to disclose how their capital has been deployed,” says O’Shea.
“With the current demand for ESG targets now influencing M&A activity in Ireland, well-managed Irish companies with good ESG credentials are attracting higher valuations. It is expected that ESG considerations will become an increasingly important factor, and the presence or absence of a strong ESG strategy will become a key factor in determining the attractiveness and, ultimately, the value of an Irish business. Failure to address ESG risk may narrow the pool of prospective buyers for any sellers of a business.”
Businesses can respond to this by focusing on building a strong ESG strategy with robust data reporting to demonstrate compliance with the strategy, he points out. According to O’Shea, an effective ESG strategy should include a continuous review of corporate governance structures, pro-active and meaningful engagement with its workforce and regular review and interrogation of supply chains and environmental impacts. “Businesses should also understand their current exposure to ESG risks under their existing commercial contracts.”
Matheson is adapting to advise clients in this space, he concludes. “We have enhanced and differentiated our ESG offering by bringing our depth and range of expertise into one combined cross-departmental advisory grou. We believe that this will enable us to provide an even stronger service proposition in supporting the challenges and opportunities which our clients face across all three pillars – environmental, social and governance – as they respond to assist businesses as they react to the accelerated pace of change in domestic and international legislation, industry standards and practices, and the expectations of both investors and regulators in relation to ESG.”
The above article was originally published in the Innovation section of The Irish Times on Thursday, 5 May, 2022.