Environmental, social and governance (ESG) issues are increasingly having an impact on deal discussions and documentation, with some parties willing to walk away from transactions if expectations do not align.
Action has been taken at policy level, such as the transformational EU taxonomy for sustainable activities, but these things take time. Meanwhile, initiatives like The Chancery Lane Project (TCLP), which launched in July 2019 and has already released several iterations of its climate contract playbook, are helping to accelerate progress on the transaction front – be it equity, debt, or M&A.
“Climate change-related discussions on capital markets deals used to be either non-existent or all about risk factors and little else, but now we see people talking about the meaningful, positive change their company is, or is hoping to, bring about,” said Simon Turnbull, director in legal EMEA equity capital markets at Bank of America. “It also means the discussions are more inclusive of every type of company – we’re not just talking about oil and gas anymore, but sustainable policies that impact all companies and their supply chains. It helps if everyone is looking at this.”
This is evidenced by telecoms firm Inmarsat, where the legal team is working to integrate ESG criteria into procurement contracts. “That’s where a company like ours can start to have real impact, because a lot of our carbon footprint happens in the supply chain,” said James Plummer, vice president, legal affairs at Inmarsat.
According to Turnbull, while the current TCLP playbook does not go into detail on capital markets-specific language, the next one – due for publication in the coming weeks – will.
“An exciting part is working with TCLP and Latham & Watkins to gather case studies from deals – providing examples of disclosure and drawing on those examples to create a disclosure drafting blueprint,” added Turnbull. “That would really help those drafting the deals.”
Other industry associations are making progress too. The International Capital Market Association’s (Icma) work on green and sustainable bonds is well known, while in July the Association for Financial Markets in Europe (Afme) published its first ever ESG-specific guidelines for European high yield.
Documentation is changing outside of capital markets too. This year – in response to client requests – law firm Dechert launched an ESG-specific due diligence report for corporate M&A transactions, addressing environmental policies and governance issues including anti-bribery, data protection and trade sanctions, among other areas.
“The report itself will differ between portfolio companies in different sectors, and anything the acquirer isn’t 100% happy with regarding ESG will be added to the post-closing checklist,” said Dechert partner Ross Allardice, who worked with PE funds to draft the report. “Most, if not all, big limited partners and pension funds have a whole team of ESG specialists these days, and the majority of the investor sales pitch is heavily focused on it.”
Calling all companies
Inmarsat is a relative newcomer to TLCP. As Plummer explained, his team’s first step is to review the language and criteria present in existing contracts.
“We also need to make sure that our own activities are optimised before we ask for similar from our suppliers,” said Plummer. “We’ve started by evaluating which contracts and business relationships are the best place to begin incorporating green clauses. We’re also thinking about how to bring the business and operations teams along with us early on in the process too.”
In his view, it’s best to establish climate-related obligations in a formal contractual setting at first. “Those clauses might be struck out or heavily marked-up by a counterparty’s lawyer the first few times they come across it – but in the end, it’s likely that compliance with meaningful climate obligations will become as ubiquitous as the anti-bribery or modern day slavery clauses,” he added.
Matthew Gingell, general counsel at PE firm Oxygen House and TCLP director, recommends tweaking contractual climate provisions to opt-outs rather than opt-ins. The subtle psychological trick made famous by its success on organ donor registries “makes a conversation happen even if the drafting ultimately gets negotiated out…it all counts,” he said.
But is it a dealbreaker?
While most lawyers say they have not yet seen a party walk away from a deal on ESG matters alone, Stockholm-based PE house Summa Equity has.
According to investment director Hannah Jacobsen, in one instance, the management team came back a year later and said that they wanted the company to be acquired and to learn how to be better. “That’s a big change considering two years before they didn’t care and told us that the way they do things works for them,” she said. “Then customers started to complain, regulators took an interest, and they realised they can’t continue like that. That has really changed more recently.”
Summa Equity makes public all of its ESG reporting on the companies it invests in, which it assesses against the relevant UN sustainable development goal. And while its strategy can make it ruthless towards companies that don’t pull their weight on ESG, Jacobsen explained that it doesn’t see itself as an impact fund – it competes directly with other PE houses.
“The private equity model is very well suited to impact investing because five to 10 years is a long time compared to how long investors typically hold stocks,” she said. “By focusing on exit value – and because we sell to owners with 10-year perspectives themselves – we can really make a difference.”
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