Willis Towers Watson recently hosted a roundtable in collaboration with Airmic and MinterEllison exploring climate liability risk. Attendees took part in group discussions on some of the key issues around businesses managing these risks. We summarise the experiences and opinions of participants in discussing climate risk in the context of mergers and acquisitions (M&A).
Climate change brings an additional layer of risk to mergers and acquisitions that needs to be considered alongside each of the traditional risks and concerns.
We considered the example of a business aligned with the Paris Agreement on climate change that was considering acquiring a target that did not have such a mature climate change strategy.
In this case, the buyer will have a much more sophisticated view of climate-related risks and is likely to be much better prepared to think about the operational and transitional risks. For example, if it is already doing Taskforce on Climate-Related Financial Disclosure (TCFD) reporting, it will already be highly engaged in climate change issues, so will be able to bring that level of understanding to its standard due diligence processes. Irrespective of the maturity of the target’s climate change strategy, the buyer must look at the target’s current experience of managing risk.
The buyer would be able to bring this sophistication to its understanding of the risks associated with the target. It would be able to price in those risks and make sure it had the necessary protection in place.
The buyer will also need to consider how the acquisition of the target will impact on the buyer’s stated disclosures going forward, and the costs and risks attached to aligning the target with the buyer’s strategy.
The wider implication for Paris-aligned businesses is what growth through acquisition should look like when targets may not have such mature climate change strategies in place. This means buyers will need to work out how they apply their own standards and values to the target.
Since climate change related risks could be operational, transitional or liability, assessing and understanding the risks requires integration of technical specialists and legal teams so that the buyer can consider both areas in tandem. This requires a forensic review of the target’s operational and strategic risk registers.
In the session, there was some support for framing due diligence questions in a way that assumes there are liabilities to discover. For example, this would require the seller to actively demonstrate that there is no liability.
Buyers should also look very closely at warranties, liabilities and exclusions, and be strict about where these are held by the seller, for example by the seller or buyer.
Some or all of a target business’s past infrastructure projects may have not considered the changing climate in their future use. For example, assets that were constructed years ago may well have been designed and built without taking climate change into account.
This could affect future capital expenditure and operational expenditure related to transition pathways. The assets may require additional capital expenditure to manage the changing requirements imposed by climate change, while the asset life may be shorter than originally planned by the target, leading to some premature asset write-off.
Assets may also be sited in regions where climate change may affect the supply chain. For example, climate change may affect energy or water availability.
In all cases, the buyer may need to consider pushing risks and costs back to the seller in the terms of warranties and liabilities.
Traditionally, due diligence would look at current or historic liabilities. However, climate change requires a different mindset to address the challenges of an uncertain world. Not only do buyers and sellers need to consider future potential liabilities related to the direct impact of climate change related events, but they must also attempt to anticipate developments in law and policy. These could leave them facing very different regulatory framework in the near and long-term future.
Longer term horizons, such as the European Union’s 2050 long-term strategy, can have short-term implications because of the need to be thinking about the route to get to the long-term goal, such as pathways for emissions reduction. By looking at their roadmap ahead, buyers can assess the implications for the near-term in terms of transition risks, liability risks and physical risks.
Buyers need to play out scenarios that look at how the climate-related regulatory framework might change during the lifetime of the assets they are purchasing. This will enable them to assess what the costs will be of ensuring that the assets keep pace with the changes.
Some climate-related liability risks may arise as a result of the M&A process itself.
These include risks to the buyer due to the fact that they are buying the assets, but there could also be liability risks to banks and financial institutions, such as credit risks, or project finance, or extending facilities.
Both the buyer and seller need to consider such risks.
Liabilities that are hiding within the target could flow through to the buyer, particularly in the case of a share sale rather than asset sale.
With share sales, buyers need to consider the representations and warranties in relation to climate change as well as all other considerations. After uncovering any liabilities, the parties need to agree what is passed through during the transaction and what should stay with the party that controlled the fact that gave rise to the liability.
Buyers also need to consider what climate change could mean for traditional risks, such as slips and trips. For example, changes in the weather could mean that current trends are likely to increase or even decrease.
For further insight into climate liability risk, read our climate liability whitepaper.
