Mitigate ESG risks. Addressing ESG in PMI reduces risks by equipping the combined entity to anticipate and meet compliance requirements, reduce controversy and reputational concerns, secure scarce resources, and respond to demand shifts. Ultimately, ESG risk mitigation eases overall business risk.

Heightened regulatory standards pose a significant challenge. Regulators, particularly in Europe, are becoming more assertive. For instance, the EU’s Fit for 55 package sets new ESG performance standards that aim to cut greenhouse gas emissions by at least 55% by 2030, compared with 1990 levels. And the forthcoming EU Corporate Sustainability Reporting Directive (CSRD) and the European Sustainability Reporting Standards (ESRS) present new disclosure requirements. Global and regional regulatory landscapes will continue to evolve, making it imperative that risk mitigation in PMI includes consideration of the regulatory baseline as well as potential future developments.

Integrate ESG practices and ensure continuity. A key task during PMI is to converge and harmonize the organizations’ approaches to ESG disclosure and data collection, as there is often a lack of uniformity and consistency. For example, the acquiree’s ESG reporting system may need to be adjusted to accommodate the acquirer’s reporting needs. This requires creating a unified approach that combines the strengths and addresses the weaknesses of each company’s existing ESG practices, while still ensuring continuity.

Strong ESG practices, including effective reporting, are crucial for maintaining favorable ESG ratings and valuations. Rating agencies and investors are scrutinizing ESG disclosures more closely as their valuation models now incorporate this topic.

Capture ESG opportunities. The PMI process lays the foundation for delivering ESG synergies, which yield both quantifiable and non-quantifiable benefits. Quantifiable benefits primarily influence the bottom line in terms of recurring cost savings through process enhancements and efficiency gains. Applying an ESG lens when redefining the combined entity’s operating model encourages the new organization to adopt best-in-class corporate governance, new decision processes, and data-driven monitoring systems. Companies can capture additional revenue, too, with methods such as distributing their green products through their broader combined networks. Robust ESG performance can also help reduce the cost of capital and improve access to financing, thereby bolstering the company’s balance sheet and overall financial well-being.

Non-quantifiable benefits stem from the positive influence of ESG synergies on the equity story and total shareholder return (TSR), as investors appreciate the potential for long-term value creation. Moreover, articulating a compelling ESG narrative during PMI can enhance workforce productivity, customer loyalty, and community relations. It also aids in attracting and retaining talent by strengthening the corporate culture and satisfying the expectations of ESG-conscious workers.

Embed ESG Strategy and Enablers in PMI

To best take advantage of these success factors during PMI, companies need to define their ESG strategy and establish enablers.

Defining the ESG strategy before PMI rests on two pillars:

Materiality and Prioritization. Identify and prioritize ESG topics that may have a material financial or operational impact on the merged organization. These topics may be identified during the due diligence process or through a materiality assessment. A triple materiality assessment—encompassing the acquirer, acquiree, and the combined entity—is valuable for pinpointing the most impactful ESG criteria and harmonizing the priority topics. Materiality can be scored in terms of relevance to business success and importance for stakeholders. Third-party resources, such as the SASB’s analysis of materiality across industries, can provide a taxonomy of topics and support the assessment. (See Exhibit 3.)

To assist in setting priorities, establish a baseline for the combined organization’s most relevant ESG KPIs and benchmark performance against that of peers and best-in-class players. This will facilitate the creation of targets and a roadmap and aid in identifying ESG synergies.

Targets, Roadmap, and Synergies. Set and validate ESG targets, and devise an implementation roadmap for significant ESG topics, including alignment on objectives for net zero emissions. Establish a plan for addressing ESG risks and synergies. Also consider how to integrate the organizations’ renewed or new commitments and public pledges into communications. Doing this is especially critical if the acquirer and acquiree have previously announced different ambitions. In many cases, the PMI process will transform the combined entity’s ESG ambitions and how they should be communicated.

Setting climate goals is a specific ESG commitment that needs to be addressed during a PMI to manage stakeholders’ expectations and ensure clarity in communications. Revising climate commitments and communication strategies will require updating and revalidating the acquirer’s climate targets. Companies that seek revalidation of targets by the Science Based Targets initiative should anticipate that the process will take 6 to 12 months and plan accordingly.

Establishing ESG enablers before PMI also rests on two pillars:

Metrics, Reporting, and Rating. Address four key aspects to support decision making, and align the organization with sustainability goals and stakeholder expectations:

• Combine or build data capabilities and management. Design and set up an ESG data collection organization and processes across the value chain, and establish proper controls. This includes harmonizing the organizations’ ESG metrics (such as greenhouse gas footprint measurement, carbon pricing, and KPIs), data (including databases, systems, maintenance, and sourcing), and disclosure methodologies (from data collection to reporting).
• Adhere to external requirements. Prepare the combined entity to cater to the standards of customers, investors, regulators, and data raters, among others.
• Foster positive relationships with stakeholders. Take control of the narrative of how sustainability impacts your business, and actively engage investors, customers, and others on the key topics.
• Engage with the ecosystem. Establish a voice within the ESG community by interacting with data raters, industry coalitions, and sustainability consortiums.

By focusing on these aspects, even companies in hard-to-abate industries can elevate their ESG performance and ratings. For example, the Xella Group—a manufacturer and supplier of building and insulation materials—achieved a one percentage-point increase in its EBITDA margin, a top-tier ESG ranking within its sub-industry, and a 5% valuation boost.

Organization and Governance. A PMI is the right time to set up a best-in-class ESG organization. This should entail reconsidering the combined entity’s organizational structure and governance from an ESG perspective, focusing on committees and teams that are responsible for the steering, management, and execution of sustainability strategy. The integration process can lead to changes in the structure, content, and frequency of reporting on sustainability initiatives and performance. To inform this effort, work to gain a baseline understanding of both existing organizations’ ESG functions, capabilities, and responsibilities and how ESG is integrated into their cultures, practices, and communications.

Integrate ESG into Core PMI Processes

Addressing ESG topics alongside strategy and enablers requires adapting core PMI processes. (See Exhibit 4.) Two areas exemplify the impact this can have:

Integration Management Organization. This team manages the integration process, focusing on risk mitigation, business continuity, and value capture. Each of these dimensions is directly affected by ESG topics.

There are several ways to organize ESG initiatives in a PMI. They can be handled in the context of functional workstreams if they aren’t the focus of the integration or are well managed by the functions. However, a separate ESG workstream is advisable if a corporate function dedicated to ESG exists or is planned. Alternatively, if ESG is a key topic for the integration, with potential opportunities to capture value and mitigate risks, the best option is to establish an ESG-focused platform team within the integration management office.

Day-One Planning. The combined organization must be prepared to maintain ESG compliance from the first day of joint operations. In the short term, ESG topics could create risks and negatively impact staff engagement if not managed properly. To ensure a smooth transition on day one, companies must establish ESG priorities and a roadmap, communicate a renewed ESG narrative, and ensure functional integration.
 

As a catalyst for transformative change, PMI presents a valuable opportunity to promote the ESG agenda and elevate related ambitions. It provides an avenue for businesses to pursue a more ambitious ESG strategy by setting new targets, employing best practices, and communicating goals. The societal and financial rewards are well worth the effort. Now is the time to use PMI to capture the promising value of ESG.

The authors would like to thank Luis Arjona, Guillaume Cornet, Dominik Degen, and Maximilian Krebs for their contributions to this article.