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The term ESG, an abbreviation of “environment,” “social,” and “governance,” was first introduced as a concept in 2004 in the United Nations report titled “Who Cares Wins” (WCW Report). “Who Cares Wins” originated as an initiative (WCW Initiative) launched in collaboration with the United Nations and the Swiss government, with the support of 23 financial institutions. Under the motto “Who Cares Wins,” it was emphasised that companies that prioritise ESG considerations ultimately benefit in the long run and are in an advantageous position in the eyes of investors compared to those that do not. Between 2004 and 2008, meetings and workshops were organised to ensure that environmental, social, and corporate governance issues, often referred to as ESG factors today, play a more significant role in investment decisions.
The WCW Report, produced as part of the WCW Initiative, underscores the impact of how companies handle ESG factors on their company’s value and the sustainable development of their communities in an increasingly globalised, interconnected, and competitive world.
Three Main Themes of ESG
The three main themes of ESG are environmental, social and governance, from which the name is derived.
Environment:
Under the environmental heading, a company’s policies and practices related to the climate crisis and global warming, the environmental damage it causes, the risks it faces related to the climate crisis, and the sustainability of its operational activities are typically addressed.
Social:
The term “social” encompasses a wide range of issues, including a company’s respect for human rights and freedoms, the safety, health, and working conditions of its employees, the diversity of products, services, and marketing, and ensuring that the workplace is inclusive and accommodating for people with different identities, perspectives, and characteristics.
Corporate Governance:
In general terms, corporate governance aims to ensure equal, fair, accountable and transparent corporate management.
ESG Impacts on Company Value and Transparency
The WCW Report highlights that effective ESG management has a positive impact on company value in terms of:
(i) Early identification of risks, threats, and management failures;
(ii) Uncovering new business opportunities;
(iii) Enhancing customer satisfaction and loyalty;
(iv) Increasing employer attractiveness;
(v) Fostering partnerships with business partners and stakeholders;
(vi) Building a good reputation and a strong brand;
(vii) Reducing regulatory intervention;
(viii) Achieving cost savings;
(ix) Gaining access to capital and reducing the cost of capital;
(x) Improving risk management.
To harness the benefits of sound ESG management, companies need to improve their transparency and disclosure practices. Accordingly, with sustainability and ESG factors gaining prominence among investors and customers, companies have chosen to make their stances, practices, and policies on these issues more visible. It’s accurate to say that robust ESG practices, recognised by shareholders and managers as enhancing corporate value, have become a tool that companies utilise to showcase themselves and enhance their reputation.
As the demand for sustainability and the influence of ESG factors continue to grow, transparency and disclosure are no longer merely a preference but have evolved into a legal obligation. In this context, the Corporate Sustainability Reporting Directive, which took effect on January 5, 2023, stands as an important example of European Union legislation. Additionally, the Capital Markets Board in Turkey introduced an amendment to the Communiqué on Corporate Governance, making it mandatory to disclose reports on compliance with corporate governance principles and sustainability principles.
ESG Analysis and Score
It is crucial to emphasise the need for companies to adopt transparency as a corporate policy and for the establishment of legal regulations to enable financial market participants to incorporate ESG factors into their analyses.
Asset managers, investment banks, and individual investors rely on reports prepared by ESG rating agencies to evaluate a company’s ESG compliance. These rating agencies generate a company’s ESG score by analysing data from a range of sources, including the company’s own disclosures, data and reports, government databases, and media sources. ESG rating agencies employ various criteria to assess ESG compliance. For instance, some organizations evaluate a company’s ESG score, while others assess its ESG risk.
In simple terms, the stronger a company’s ESG management practices, the higher its ESG score. A favourable ESG score, in turn, offers the company access to the advantages mentioned in earlier sections, such as facilitating investments and reducing financing costs.
ESG Impacts on M&As in Turkey
Due Diligence
As sustainability and ESG awareness have grown on a global scale, a similar trend has emerged in Turkey. Due diligence is akin to an X-ray of a company, offering a comprehensive insight into the target company from various perspectives, including tax, finance, corporate, legal, and human resources.
While environmental, social, and governance considerations have historically been part of due diligence, their scope has primarily revolved around compliance with relevant laws. However, we anticipate an expansion in the inclusion of more detailed ESG issues and potential risks in the due diligence process. These encompass the target company’s ESG disclosures and policies, the sustainability reports it releases, its impact on the community, diversity among employees and board members, the responsibilities held by the board and senior management, and, more broadly, whether the target company conducts its operations responsibly.
Negotiation of the Share Purchase Agreements
The findings from due diligence have always played a pivotal role in M&A transactions, serving as the foundation for numerous provisions in share purchase agreements. These provisions include conditions precedent, seller responsibilities, specific indemnities, and more. With an increased focus on ESG matters during due diligence, their direct influence on share purchase agreement negotiations is expected to grow. It won’t be long before the use of the term “ESG” in share purchase agreements becomes commonplace.
Post-Closing Integrations
Additionally, the integration of the target company’s operations, information technologies, and human resources must be considered. Due diligence continues to play a crucial role in the post-closing period, providing the parties involved with a comprehensive understanding of the target company. Now, the integration of ESG policies and management can be added to the list of considerations.
