The Growing Importance of ESG in the Italian M&A Market
In this Chambers Expert Focus article, Lucia Occhiuto, Raffaella Ceglia and Giulia Martino, of Cappelli RCCD, explore the implications for mergers and acquisitions in Italy of the increasing centrality of ESG concerns.
The growth of the ESG framework
Environmental, social and governance (ESG) factors are increasingly high on the to-do lists of both public and private entities, in Italy and worldwide. The growing interest in such matters in recent years has been driven by the enactment of specific legislative provisions in several jurisdictions and by the continuing needs of companies (mainly professional investors). Indeed, sustainability has turned into a key word for corporate and financial stakeholders. This emphasis is due to factors including reputational considerations, public incentives and compliance with best practices.
The importance of ESG concerns has become apparent in the M&A and private equity fields, as market players appear to be particularly focused on integrating sustainability and ESG standards in their operating models. In the Italian market, the attraction of sustainable investments has grown significantly; a rise prompted by a legislature that is keenly observant of the EU legal and regulatory framework, and also by the Italian institutions, in terms of both mandatory and voluntary ESG-related provisions.
"Comprehensive analysis of potential problems from an ESG standpoint is essential."
Regarding mandatory provisions, despite there not being a dedicated set of ESG-related laws, Italy has a historical tradition of legislation inspired by sustainability goals, starting with the 1948 Italian Constitution and the Italian Civil Code embracing many UN Sustainable Development Goals, and continuing through several additional legal measures.
On the voluntary side, AIFI has implemented its Charter of Sustainable and Responsible Investment of Italian Finance, promoted by FeBAF, and issued ESG Guidelines. Furthermore, a few months ago, Borsa Italiana launched the first blue-chip index for Italy dedicated to ESG best practices and has recently adopted the new Corporate Governance Code for public entities, which provides that the board of directors leads the company by pursuing its sustainable success.
In such a scenario, the COVID-19 pandemic has focused attention on sustainability, and we can expect that decisions on ESG aspects will play an even greater role in the investments sector due to recent EU initiatives which, besides having the objective of facing the negative economic and social consequences of the pandemic, also aim at the achievement of goals in the field of sustainability, including green and digital transitions.
ESG implications in M&A deals
From a legal standpoint, the rising importance of ESG standards in the M&A landscape has implications for different aspects of the transaction, from the evaluation of the target to the drafting of the transaction documents and, in general, the life of the investment.
ESG due diligence
A comprehensive analysis of potential problems from an ESG standpoint is essential for investors to make an accurate evaluation of their investment as well as to negotiate the appropriate terms and conditions of the transaction.
In this respect, clients often require the due diligence to focus on items such as composition of the corporate bodies, workers' rights, human rights, pollution, climate change, the exploitation of resources, and data privacy and protection.
"ESG compliance is shifting from being a nice to have to a must."
Particular attention is paid to corporate governance, and matters falling within the scope of legal due diligence (eg, health and safety, emissions, compliance) are scrutinised from a range of sustainability perspectives.
Transaction documents in the ESG market
The consequences of the ESG due diligence impact not only on the economics of the deal, but also on the negotiation of the transaction documents. The way the deal agreements are drafted can be a useful tool to mitigate risks to the client.
Here are some practical examples of how ESG topics may affect the deal documents:
- composition of corporate bodies regulated in such a way as to ensure compliance with inclusivity and diversity principles;
- establishment of internal committees focused on sustainability to deal with ESG-related risks;
- periodic reporting duties to investors to monitor the ESG performance of the target, both during the interim period and following completion of the transaction;
- contractual protections specifically aimed at mitigating possible risks evidenced by the ESG diligence;
- post-closing action plans to address any deficiencies arising from the ESG diligence; and
- economic benefits linked to ESG-related performance targets (such as ratchets and earn-outs).
Why ESG is a necessity not a luxury
The trend towards sustainability is leading to dealmakers broadening their perspectives to include ESG topics in the analysis of their deals. The M&A sector is particularly affected by this trend and ESG compliance is shifting from being a nice to have to a must.
Not only may inadequate ESG compliance result in legal, reputational and economic risks for the parties involved in M&A transactions, but the implementation of high ESG standards actively contributes to the reduction of such risks.