In Part 2 of our ESG Public Markets Snapshot, we summarise key ESG points coming down the track for UK corporates and their advisers.
Key ESG points to watch out for:
- Practical ESG issues on M&A deals – ignoring ESG can be costly, but early/efficient review and remediation pays off.
- Pressure to improve diversity & inclusion – ratcheting up from government/regulators and the broader market, and they expect results.
- Government sharpening its claws on audit reform – failure is no longer an option, so history shouldn’t repeat itself.
- Environmental disclosure rules bite – for listed companies, with more on the way.
- Peer pressure – on leading companies to be in the right ESG crowd.
- Practical ESG issues on M&A deals include engaging the right counsel early to:
- ensure optimum DD and negotiation process set-up, including to:
- scope/resolve key ESG issues across a broad range of areas: such as environment, governance (including government/regulatory, anti-bribery and corruption, transparency and tax), health & safety, supply chains, employment and diversity etc.
- co-ordinate with right ESG sub-specialists and laser-focus on the most relevant information sources/senior management – not always obvious in what is a novel and fast-moving area.
- focus DD and contractual protection on ESG liabilities and historic/existing policies, but also how to optimise ESG issues and procedures going forward, and identify upsides to enhance long-term future, finances and reputation. Engage with third parties (e.g. warranty & indemnity insurers, and financing banks) and explain ESG risks in the “right light” for optimum modelling/pricing.
- focus on risk and mitigation tools – as usual routes (e.g. typical warranties and indemnities, and consideration deferral) may not always work for ESG issues where financial impact, triggers and timing are hard to define. It’s important to set up short to medium term ESG management and resolution procedures where appropriate. It’s equally the case that some issues are not easily protected against (for example, reputational/brand damage caused by a failing in ESG matters), so engaging early on other possible risk mitigation strategies will be key.
- drill down on contractual protection – DD is particularly important on public M&A deals, where it is only possible to include meaningful offer conditionality in rare/extreme cases. On private M&A deals – broad warranties may trigger useful ESG disclosure, but meaningful enforcement may be hard without bespoke protections for higher risk areas (including as identified in DD eg. compliance with particular environmental or anti-bribery & corruption laws, reporting regimes, or maintenance of financial risk and other relevant policies) – hence importance of expert focus on breach triggers, loss and remedies.
- Pressure to improve diversity & inclusion is ratcheting up from the FCA, Bank of England and PRA, and indeed the broader market. Listing Rule changes are expected (for financial years starting on or after 1 January 2022) to require comprehensive “comply or explain” diversity disclosures on boards and executive management. Regulators are lining up further requirements in the financial sector and beyond. Major business and regulatory ramifications will hit companies and advisers caught short, so counsel should be engaged now to help ensure implementation and improvement of D&I, equality and related systems/horizon-scanning tools – and that they’re producing the right results.
- UK Government sharpening its claws on audit reform following the high-profile collapse of companies such as BHS, Patisserie Valerie and Carillion. Already well into its public consultation, companies and their advisers should engage counsel to start preparing now for the changes, some high-level points including:
- application of a tough new regime to a broad range of companies (i.e. not just major listed corporates), and requirement to publish an annual business “resilience statement”, and audit/assurance policy.
- laser-focus on the effectiveness of a company’s internal controls and risk management, disclosure and verification of key financials (including P&L, distributable reserves and dividends), and anti-fraud measures.
- rehaul of audit profession and regulatory framework, and tough new regulator (“ARGA” – Audit, Reporting and Governance Authority) with punchy powers to pursue companies, directors (including remuneration clawback) and auditors.
Nor should new criminal offences and unlimited fines under the Pension Schemes Act 2021 be ignored.
- Environmental disclosure rules bite: UK Listing Rules now require premium-listed companies to “comply or explain” in their annual reports (for financial years from 1 January 2021) against recommendations of the Financial Stability Board's Task Force on Climate-related Financial Disclosures (“TCFD”) for the effective disclosure of climate-related financial risks and opportunities. Counsel should be engaged now to help ensure that supporting systems/data collection are in place to enable appropriate disclosure to be made.
The UK Government plans to widen the net of those caught by TCFD reporting and intends to impose similar disclosures on a phased basis by 2025 on a broad range of organisations (including other listed companies, large private companies, asset managers, insurers and pension schemes).
- Peer pressure: discussions among leading FTSE 100 and FTSE 250 companies reveal several common ESG concerns:
- impossible to ignore risks/opportunities of fast-evolving and demanding ESG requirements, particularly diversity & inclusion, governance and environment and increased ESG agitation at AGMs and more broadly (including blocking votes/action).
- enhanced engagement/action being demanded by wide range of stakeholders, particularly investors and government/regulators – all needing increased senior-executive and board attention – and embedding ESG metrics into remuneration.
- need to allocate material resource and engage the right ESG counsel, to show concrete steps being taken, including clear ESG action plans tailored throughout the business, commitments/metrics, and reporting/review processes.