Climate Financing in Mergers and Acquisitions: An Evolving Trend

Corporates are becoming more cautious regarding the sustainability and environmental footprint of their business. Consequently, they have shifted their attention to climate financing, which is playing a pivotal role in various business operations, including mergers and acquisitions (M&A). Climate financing entails funding projects – sustainable agriculture, energy efficiency, renewable energy and other environment-focused projects – that improve the climate or deal with mishaps from climate change. Companies can no longer undermine the role of climate financing in M&A. This article will elaborate on the role of climate financing in M&A deals, below are some of the factors that impact the deals in this space.

Growing trend of climate financing

Datasite, a software solution company for M&As, surveyed around 400 dealmakers of which more than half said ESG risks were more likely to hurt a deal. Industries have started focusing on the environmental aspects of deals as well. For example, oil and gas companies are emphasizing the positive environmental impact of a deal and adopting greener production techniques.

Climate financing impact on M&A

Climate financing plays a crucial role in shaping M&A strategies and outcomes. Some ways in which it impacts M&A are described below.

1. Deal structuring and valuation: Companies with access to climate financing can enhance the sustainability of their operations, making them more attractive targets for acquisition. For instance, a company that has secured financing for a large-scale renewable energy project may be viewed more favorably by potential acquirors given its reduced carbon footprint and long-term cost savings.
2. Valuation adjustments: Companies that have successfully integrated climate financing into their operations may command higher valuation, owing to their enhanced sustainability profile and reduced exposure to climate-related risks. Conversely, companies that lack access to climate financing or have not prioritized sustainability may see their valuation adjusted downwards because of potential future liabilities and costs associated with climate change.
3. Due diligence: Traditionally, due diligence has stressed on the financial, legal and operational facets of a target. However, with the growing emphasis on sustainability, acquirers are incorporating climate financing assessments into their evaluation process. This involves scrutinizing a target’s access to climate financing, end use of these funds and potential financial implications. As a result, companies with robust climate financing practices are often considered more attractive, potentially leading to higher valuation and more profitable deal terms.

Impact of regulations on M&A

Regulations, such as the European Union’s Sustainable Finance Disclosure Regulation (SFDR), require financial market participants to disclose how they embed sustainability risks in their investment decisions. Compliance with these regulations is essential for companies looking to engage in M&A, as failure to secure climate financing can result in legal and financial repercussions. Countries have committed to the Paris Agreement, promising to engage in activities that would curb global temperature rise. This also motivates entities in engaging in responsible M&A and assess their impact on climate change.

Challenges 

Post-merger integration: The integration of both the companies following a merger is cumbersome, especially from a sustainability perspective. Hence, companies should be transparent about their sustainability policies and initiatives from the beginning. A thorough background check of the ESG activities, along with documentation, is necessary. Furthermore, acquirers should ensure that the target had not engaged in greenwashing.

Lack of standardization: One of the main challenges is the lack of standardized metrics and methodologies for assessing climate financing. This can make it difficult for acquirers to accurately evaluate a target’s access to climate financing and its utilization. Additionally, resistance may brew within companies against prioritizing climate financing, particularly if it is perceived as a costly or time-consuming affair.

Regulatory and compliance risks: ESG-related regulations are evolving rapidly. Companies must navigate these dynamics to ensure compliance, which can add to the complexity and cost of M&A. Hence, it is imperative for companies to assess the rules and regulations prior to finalizing M&A.

Quantification of ESG impact: Measuring the financial impact of ESG factors is a work in progress. This makes it difficult to assess the benefits and risks tied to ESG initiatives in M&A.

Conclusion

Climate financing is reshaping the M&A landscape, influencing deal structuring and valuation adjustments, among others. By understanding and addressing the implications of climate financing, companies can mitigate potential liabilities and unlock opportunities for growth and value creation. As sustainability continues to gain momentum, climate financing will likely remain a critical factor in the success of M&A.