Industry experts expect the M&A boom to continue as a result of the need for companies to transition to net zero.
Initiatives launched during COP26 have heaped pressure on the private sector to improve its green credentials and set out plans to transition to net zero carbon emissions.
“Businesses need to get to net zero and have to change what they’re doing,” said Fraser Greenshields, senior corporate finance partner at EY. “They need fundamental change, so they buy a business that they can then integrate and use that to effect change faster.”
This year has brought the highest level of M&A activity since the 2007-8 financial crisis, in the aftermath of the lockdown drought.
See also: COP26: gaps in emissions reporting could dampen effects of Sunak’s net zero target
None of the announcements at COP26 have made it mandatory for financial institutions to transition to net zero, and most of the requirements have been left on a voluntary basis. However, Greenshields expects investor pressure to push companies to make more sustainable business plans.
“The majority of the money invested around the world is very concerned about this,” he said. “The vast majority of these businesses need to take it seriously to raise and maintain the capital they require to operate – even if they themselves don’t care as much.”
If companies did not set out sustainability plans, Greenshields continued, they would make it very difficult for a large proportion of potential backers to invest. “Potential backers have to report back to their own investors on the green credentials of the assets they’re buying,” he added.
No time to die
Due to the increased use of M&A as a route to net zero, experts do not expect the boom to die down any time soon.
“It's part and parcel,” said Silke Goldberg, global head of ESG at Herbert Smith Freehills. “This is something that’s here to stay as companies realign and position themselves on the energy transition spectrum.”
She added: “It’s not a one-time event with everybody buying and selling little bits of the markets, which then dies down. M&A is a natural tool for a company to achieve its objectives, and on that basis, the current level of activity is here to stay.”
Two-way strategy
For many companies, M&A will be a key part of their net zero plans, in two ways.
“A company might want to buy assets that have technologies or other solutions that would accelerate its ability to decarbonise,” said James Stacey, global director for climate change and low carbon economy transition at ERM, a sustainability consultancy.
“Other times, an organisation might want to divest an asset because it’s presenting a challenge to its decarbonisation journey and might not be compatible with it,” he added.
See also: COP26: IFRS’ new international sustainability disclosure standards broadly welcomed
Passing the buck
This strategy has generated some criticism, as it means high-polluting assets continue to operate and are only changing hands.
“We have to be careful that those high-polluting assets don’t end up in the hands of people who just want to make as much money as they can and do not care at all about environmental impact,” said James Alexander, chief executive at the UK Sustainable Investment and Finance Association (UKSIF). “High-polluting assets do not have a future in a net zero world. Those business units need to either clean up their act, or shut down.”
See also: Asset management firms want clearer sustainable investing definitions
For Alexander, the only solution to this problem is government regulation.
“For example, there will be a point when governments will say they don’t allow coal-generated electricity to join the grid,” he said. “So if you are in the business of buying these high-polluting assets and thinking you can make a quick buck, the government will have to come down on that and regulate those industries.”
ESG concern boom
Even outside transactions directly related to the net zero transition, ESG is having a large impact on M&A.
According to research from insurance group Aon, ESG has become as much of a concern in M&A deals as the parties’ financial figures.
The report, based on interviews with 21 M&A experts, highlights that traditional approaches to due diligence are no longer enough. Leaving out ESG considerations in a model can have a substantial adverse impact on financial returns, according to Aon.
“Today, sellers and buyers must assess businesses’ ESG practices, digital capabilities, technology and intellectual property just as closely as they scrutinise financials,” said Alistair Lester, global co-CEO of M&A and transaction solutions at Aon. “Expert insight alongside public and client-specific data is necessary to help quantify and value assets, identify and mitigate risks and ensure proper disclosure.”
As the pressure mounts for companies to demonstrate sustainability credentials, one can expect the impact of ESG concerns on the financial sector to keep growing.
