UK Public Markets Snapshot – ESG: See What’s Coming (Part 2) October 2021 | Hogan Lovells
In Part 2 of our ESG Public Markets Snapshot, we summarize the most important ESG points for UK companies and their advisors.
Key ESG points to look out for:
- Practical ESG topics in M&A deals – Ignoring ESG can be costly, but early / efficient review and remediation pays off.
- Pressure to improve diversity and inclusion – Stocking up by governments / regulations and the broader market and they are expecting results.
- Government sharpens its claws on revision reform – Failure is no longer an option, so history shouldn’t repeat itself.
- Bite to the rules of environmental disclosure – for listed companies, others are on the way.
- Peer pressure – To leading companies to be in the right ESG crowd.
- Practical ESG topics in M&A deals This includes engaging the right lawyer early to:
- Ensure optimal DD and negotiation process setup, including:
- Scope / resolution of key ESG issues in a wide range of areas: environment, governance (including government / regulation, anti-corruption and anti-corruption, transparency and taxation), health and safety, supply chains, employment and diversity, etc.
- coordinate with the right ESG sub-specialists and laser focus on the most relevant information sources / executives – not always obvious in a new and fast moving area.
- Focus on DD and contract protection ESG commitments and historical / existing guidelines, but also how Optimizing ESG issues and processes for the future, and identify benefits to improve long-term future, finances, and reputation. Get involved with third parties (e.g. warranty and liability insurers and financing banks) and explain ESG risks in the “right light” for optimal modeling / pricing.
- focus on Risk and Mitigation Tools – For ESG issues where the financial impact, trigger and timing are difficult to define, the usual pathways (e.g. typical warranties and indemnities and deferrals of consideration) may not always work. It is important to have short to medium term ESG management and resolution processes in place where appropriate. It is also the case that some issues are not easy to protect (e.g. reputational / brand damage from a failure in ESG matters). It is therefore important to take other possible risk reduction strategies early on.
- Drill down for contractual protection – DD is particularly important in public M&A deals, where sensible offer conditionality is only possible in rare / extreme cases. In private M&A deals – broad guarantees can trigger useful ESG disclosure, but meaningful enforcement can be without tailored protections for areas of higher risk (including as identified in DD, e.g. maintaining financial risk and other relevant guidelines) – hence it is It is important that the experts focus on the triggers, losses and remedial actions for violations.
- Pressure to improve diversity and inclusion is reinforced by the FCA, the Bank of England and the PRA and indeed the broader market. Changes to the listing rule are expected (for fiscal years beginning on or after January 1, 2022) to require extensive “comply or explain” disclosures on the diversity of board members and senior management. Regulators have additional requirements in the financial sector and beyond. Larger business and regulatory implications will hit businesses and consultants who fall short, so legal counsel should be called in now to help Ensure implementation and improvement of D&I, equality and related systems / horizon scanning tools – and that they deliver the right results.
- The British government is sharpening its claws on revision reform after the high profile collapse of companies like BHS, Patisserie Valerie and Carillion. Companies and their advisors should seek advice as early as the public consultation to start preparing now for the changes, some high-level items including:
- application of a tough new regime to a wide range of companies (ie not only large publicly traded companies) and obligation to publish annual business “Statement on resilience“, and Audit / pledge policy.
- Laser focus on the effectiveness of a internal controls and risk management of the company, Disclosure and review of key financial ratios (including income statement, distributable reserves and dividends) and anti-fraud measures.
- Revision of the auditing profession and legal framework, and tough new regulator (“ARGA”- Audit, Reporting and Governance Authority) with powerful powers to prosecute companies, directors (including refund claims) and auditors.
New crimes and unlimited fines under the Pension Insurance Act 2021 must not be ignored.
- Bite to the rules of environmental disclosure: UK Listing Rules now require premium listed companies to effectively disclose climate-related issues in their annual reports (for fiscal years beginning January 1, 2021) against recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (“TCFD”) financial risks and opportunities. The lawyer should be brought in now to ensure, that supporting systems / data collection are in place to allow adequate disclosure.
The UK government plans to expand the network of people covered by TCFD coverage and intends to gradually require similar disclosures across a wide range of organizations (including other publicly traded companies, large private companies, asset managers, insurers and pension schemes) by 2025. .
- Peer pressure: Discussions between leading FTSE 100 and FTSE 250 companies reveal several common ESG concerns:
- Risks / opportunities not to be ignored the rapidly evolving and demanding ESG requirements, especially diversity & inclusion, governance and the environment as well as increased ESG agitation at general meetings and in a broader sense (including blocking of votes / actions).
- Increased engagement / actions required by a wide range of stakeholders, particularly investors and governments / regulators – all of which require increased attention from senior executives and the board of directors – and embedding ESG metrics into compensation.
- need to allocate material resources and hire the right ESG advisor in order to show concrete stepsincluding clear ESG action plans tailored across the company, commitments / metrics and reporting / review processes.