How to perform ESG due diligence
Discover a step-by-step process for performing ESG due diligence plus common challenges to overcome.
Basic ESG due diligence framework
If your organisation is thinking about merging with or acquiring another, due diligence has long been fundamental to the process. Historically however, this would have been based on financial data and information about company assets. Today, environmental, social and governance (ESG) factors are increasingly included in the due diligence process.
A basic ESG due diligence framework is as follows:
Technology industry
Environmental factors
Climate change considerations
-
What is the target company's carbon footprint?
-
Does the company have a plan to reduce emissions?
-
How does the company manage climate-related risks, such as extreme weather events?
-
Does the company use renewable energy sources?
-
Does the company have policies in place to prevent environmental pollution?​
Resource management
-
Does the company track its consumption of water and other natural resources?
-
How efficient is the company's use of resources?
-
Does the company have policies in place to conserve resources?
-
Does the company recycle and reuse materials?​
Pollution and waste management
-
Does the company comply with all pollution control regulations?
-
Does the company have a system for managing hazardous waste?
-
Does the company have a plan to reduce its waste output?
Social factors
Labour practices
-
Does the company comply with all labour laws?
-
Are employees treated fairly and with respect?
-
Does the company have a diverse and inclusive workforce?
-
Does the company offer competitive wages and benefits?
-
Are there any labour-related risks, such as strikes or labour unrest?
​
Human rights
-
Does the company have a human rights policy?
-
Does the company comply with international human rights standards?
-
Does the company conduct human rights due diligence on its suppliers?
-
Does the company have any operations in countries with poor human rights records?​
Community relations
-
Does the company have a positive relationship with the communities where it operates?
-
Does the company contribute to local social and economic development?
-
Does the company engage in any philanthropic activities?
Corporate governance
-
Does the company have a strong board of directors with independent oversight?
-
Does the company have clear and transparent corporate governance policies?
-
Does the company comply with all applicable corporate governance laws and regulations?
-
Are executive compensation practices aligned with shareholder interests?
-
Does the company have a strong anti-corruption and bribery policy?
​
Risk management
-
Does the company have a robust risk management framework?
-
How does the company identify and manage ESG risks?
-
Does the company have a plan to address ESG risks in the future?​
Compliance​
-
Does the company comply with all applicable laws and regulations?
-
Has the company been involved in any legal or regulatory actions?
-
Does the company have a code of conduct for its employees?​
Reporting and disclosure
-
Does the company publish an annual ESG report?
-
Does the company disclose material ESG information to its investors?
-
Does the company have a good track record of transparency and disclosure?​
This is not an exhaustive list, and the specific questions and issues that should be considered will vary depending on the target company's industry, business model, and operating context. However, these questions provide a good starting point for conducting a thorough ESG due diligence assessment.
How to perform ESG due diligence step by step
Step 1: Define the scope of ESG due diligence
​The first step is to define the scope of the ESG due diligence. This involves identifying the relevant ESG factors for the target company's industry and business model. This can be done by reviewing industry-specific ESG guidelines and frameworks, such as the CSRD, TCFD recommendations, or IFRS standards.
Step 2: Collect ESG information
Once the scope of the ESG due diligence has been defined, the next step is to collect ESG information about the target company. This information can be collected from a variety of sources, including:
-
The target company's ESG reports
-
Publicly available information, such as news articles and regulatory filings
-
Third-party data sources, such as ESG ratings and data providers
Step 4: Identify ESG risks and opportunities
Once the target company's ESG performance has been assessed, the next step is to identify any ESG risks and opportunities. ESG risks are potential negative impacts that ESG factors could have on the target company's financial performance or reputation. ESG opportunities are potential positive impacts that ESG factors could have on the target company's financial performance or reputation.
Step 5: Develop ESG recommendations
The final step is to develop ESG recommendations. These recommendations should be based on the identified ESG risks and opportunities. The recommendations may include:
​
-
Actions to mitigate ESG risks
-
Actions to capitalise on ESG opportunities
-
Recommendations for improving ESG reporting and disclosure​
Step 3: Assess ESG performance
The next step is to evaluate the company's performance on the relevant ESG factors identified in Step 1. This can be done by:
-
Reviewing the collected ESG information
-
Conducting interviews with key stakeholders
-
Conducting site visits, if necessary
Challenges in ESG due diligence
Deal advisors and senior executives should be aware of the following challenges in ESG due diligence:
1. Lack of standardised ESG metrics
and reporting
There is a lack of standardised ESG metrics and reporting frameworks, which makes it difficult to compare and benchmark the ESG performance of different companies. This can make it challenging to assess the target company's ESG performance relative to its peers.
There is a limited availability of reliable and comprehensive ESG data. This can make it difficult to collect the information needed to conduct a thorough ESG due diligence assessment.
2. Limited access to reliable and comprehensive ESG data
3. Difficulty in quantifying the
financial impact of ESG factors
It can be difficult to quantify the financial impact of ESG factors. This can make it challenging to integrate ESG considerations into valuation and deal structuring.
It can be problematic integrating ESG considerations into the overall M&A process because ESG factors may not be well understood by all deal team members. This makes education on ESG matters, as well as tools and an ESG checklist to follow, super-valuable.