Introduction

In recent years, environmental, social, and governance (“ESG”) factors have become an increasingly important consideration in M&A transactions in Malaysia. As businesses worldwide shift towards more sustainable and responsible practices, investors and acquirers are recognising the significance of ESG performance in determining the long-term value and stability of a company. This article explores the growing influence of ESG in M&A deals and how it is reshaping the due diligence process, representations and warranties in share sale and purchase agreements (“SPA”) and the valuation of companies.

Integration of ESG into the Due Diligence Process​

Traditionally, the due diligence process in M&A transactions is primarily focused on financial and legal matters. However, the rise of ESG considerations has expanded the scope of due diligence to assess a company’s environmental impact, social practices, and governance framework.

ESG-related due diligence involves a thorough review of a company’s policies, procedures, and performance related to environmental sustainability, employee welfare, supply chain ethics, and corporate governance practices. It also involves analysing a company’s compliance with relevant laws, regulations, and industry standards pertaining to ESG matters.

By integrating ESG considerations into the due diligence process, investors are able to make more informed decisions as they gain valuable insights into a target company’s sustainability practices, risk management capabilities, and alignment with industry best practices.

Representation and Warranties in SPAs

In M&A transactions, representations and warranties play a critical role in allocating risks between the buyer and the seller. Alongside standard representations and warranties broadly covering customary matters, including legal, regulatory and environmental compliance, may offer significant protection, the Buyer may also consider more specific ESG-focused representations and warranties.

Typical ESG-related representations and warranties may cover areas such as environmental compliance, employee relations, supply chain sustainability, and adherence to relevant corporate governance standards. For instance, a seller may represent that their company complies with all applicable environmental laws, has not incurred significant environmental violations, or faced fines for such violations.

Including ESG-related representations and warranties allows buyers to seek redress in case of any material discrepancies between the disclosed information and the actual ESG performance post-acquisition. This provides an added layer of protection for acquirers, reinforcing the importance of ESG considerations in M&A deals.

How Does ESG Performance Affect the Valuation of a Company?

Companies with robust ESG practices are often viewed as more attractive investment as strong ESG performance is seen as an indicator of effective risk management and potential cost savings. For instance, a company with efficient waste management practices may face lower regulatory risks and expenses related to waste disposal.

In contrast, companies that exhibit poor ESG performance could encounter heightened risks associated with regulatory violations, reputational harm, and potential legal consequences. For example, in September 2015, Volkswagen faced significant backlash due to the “Dieselgate Scandal” wherein they publicly admitted to installing faulty devices on 11 million vehicles to deceive emissions tests. Investors, troubled by the company’s non-compliance with environmental standards and lack of transparency, divested from Volkswagen, leading to a sharp decline in its stock price. The Dieselgate Scandal serves as a compelling example of how poor ESG performance can severely impact a company’s valuation, financial well-being and standing in the market.

Conclusion

The integration of ESG considerations into M&A transactions marks a significant shift in how companies are evaluated and valued in the Malaysian corporate landscape. ESG factors are increasingly seen as critical indicators of a company’s sustainability, resilience, and long-term prospects.

As investors and acquirers embrace responsible and sustainable practices, ESG performance is expected to play an even more prominent role in shaping M&A strategies and decision-making in the future. By prioritising ESG considerations throughout the M&A process, businesses can drive positive social and environmental impacts while also enhancing their overall financial performance and reputation in the market.

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