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Dealmakers should continue to weigh the impact of ESG issues on M&A deals as ESG standards evolve.

By Richard Butterwick, Pierre-Louis Cléro, Paul A. Davies, Tobias Larisch, Michael D. Green, James Bee, and Catherine Campbell

Environmental, social, and governance (ESG) issues have become increasingly important for corporates in recent years, driven initially by investor and consumer demand, and now by legislative developments across multiple jurisdictions.

As ESG becomes a growing part of the dealmaking conversation and acquirers seek to improve ESG credentials through individual acquisitions, the M&A market is showing a greater demand for enhanced ESG due diligence, particularly in relation to value chains. A wider range of deal provisions are being considered in light of their potential to enhance the ESG outlook of acquisitions. Further, regulatory developments and forthcoming changes mean that reporting obligations, both voluntary and mandatory, should remain front of mind. In this M&A Views article, we consider how corporates and M&A dealmakers are responding to the growing importance of ESG.

By Aaron Franklin

The United States has the deepest, most liquid capital markets in the world, attracting issuers from across the globe. To sell to US investors, these issuers must comply with US securities laws, entailing a more rigorous diligence and disclosure process. Issuers must weigh the benefits of increased demand against the additional costs, but the outcome should not depend on whether the bonds will be green or otherwise have sustainability credentials.

The US securities laws that apply to bond deals include a variety of rules on who can issue and purchase bonds, such as the registration requirements in the Securities Act of 1933, the Trust Indenture Act of 1939, and the Investment Company Act of 1940. But the real concern for bond issuers and underwriters is the threat of investors claiming securities fraud under the Securities Exchange Act of 1934, using “Rule 10b-5.” In general, a plaintiff is entitled to damages under Rule 10b-5 if a bond issuer or underwriter misrepresented or omitted a material fact in connection with the purchase or sale of the bond, with the intent to deceive or with recklessness, and the plaintiff lost money by relying on that misrepresentation or omission. This right to litigate for “material omissions” does not exist in most other jurisdictions, even where contractual fraud claims are possible. To avoid lawsuits under Rule 10b-5, issuers and underwriters (and their legal counsel) typically spend more time and effort (relative to deals not sold to US investors) investigating the affairs of the issuer and ensuring the offering disclosure is sufficiently robust.

By Paul Davies, Bridget Reineking, and Andrew Westgate

Since establishing the People’s Bank of China’s Green Finance Task Force in 2014, China has encouraged green financing mechanisms through a variety of pioneering initiatives. For example, the country has designated five green finance pilot zones, within which financial institutions are incentivised to provide credit and special funds for environmentally friendly industries.

However, investors have yet to take full advantage of these developments. The lack of uptake may in part relate to recommendations set out in the Green Task Force Final Report published in April 2015. In particular, recommendation 13 of the Report proposes imposing environmental lender liability on banks – the practical consequence of which is that banks and other financial institutions become liable for environmental pollution or damage caused by their borrowers. Although green projects are by nature less environmental risk-laden than other projects, they are not risk-free. As a result, investors have been hesitant to utilize the new financing mechanisms, and banks are equally hesitant to offer financing in the face of uncertain associated liabilities.

By Paul Davies, Aaron Franklin, and Andrew Westgate

The China Securities Regulatory Commission (CSRC) released new guidelines (the Guidelines) on the issuance of green bonds on March 2, 2017, marking an important step in the development of what is now the world’s largest green bond market, accounting for 39% of global issuances by principal amount issued during 2016 (after excluding green bonds that the Climate Bond Initiative considered did not qualify as green bonds).  Key policies in the Guidelines include CSRC adopting the categories of projects eligible for funding with green bonds that were promulgated by the People’s Bank of China (PBoC) (which we have previously covered), a requirement to deliver a “commitment letter” to CSRC relating to the green attributes of the issuance, and a prohibition in principle on issuances of green bonds by non-green issuers (e.g., oil companies).  Because this last prohibition is qualified by “in principle” in the text of the guidelines, the CSRC may grant exceptions in certain circumstances.

Regulation of green bonds in China is divided primarily on the basis of the type of issuer, with the PBoC regulating green bonds issued by financial entities and the National Development and Reform Commission (NDRC) regulating bonds issued by other corporates that do not have listed equity.  Both of these agencies have previously issued their own green bond guidelines (PBoC in 2015 and NDRC in 2016).  In addition, both the Shanghai and Shenzhen stock exchanges have issued pilot guidelines applying to bonds issued on their exchanges.  Until now, “green” private placements and other non-listed securities were only required to be notified to the National Association of Financial Market Institutional Investors.  Now, CSRC’s new Guidelines will apply to all green bonds other than those covered by the PBoC and NDRC guidelines, including those issued by non-financial corporate issuers with listed equity.

By Paul Davies and Michael Green

The Vice-President of the European Investment Bank, Jonathan Taylor called for “a renewed effort from the world’s financial institutions to make the Paris Agreement a reality” at the COP 22 Conference, held last month in Marrakesh.

Green finance will have an instrumental role to play in the transition of countries to a low carbon economy. Indeed, sovereign green bonds have been described by financial analysts as “the perfect financial vehicle” and “missing link” to enable signatories to finance their sustainable infrastructure.

There have been a number of notable developments in green finance in recent months, sustaining its momentum.

By Paul Davies and Andrew Westgate

Now in its eleventh year, The G20 Summit heads to the city of Hangzhou, China – the first time a G20 summit has been held for heads of state in China. As this years’ destination, China is maximising its role as the host nation to not only highlight its position as an economic superpower, but also to push for continued commitment to climate change and showcase its market-leading role in green finance.

In preparation for the summit, China has not only spruced-up its host city, but has cleaned up its skies. Chinese authorities implemented strict controls on factories operating in the provinces of Zhejiang (where Hangzhou is located), Jiangsu and the city of Shanghai, as part of its short-term air quality plan to ensure blue skies during the G20. As significant industrial centres, the restrictions introduced impact global supply chains across various industries, yet such impact has not deterred the priority of air quality.

By Paul Davies and Aaron Franklin

China has become the world’s largest green bond market, with green bonds issued in the first half of 2016 reaching 75 billion yuan (US$11 billion), 33% of the world total. This figure is approximately two percent of the total assets of China’s commercial banks, and demand for green bonds is expected to rise to 20 times that much.

Green bonds provide access to an ever-growing and important market to corporate issuers and international investors. Bloomberg Business estimates that China’s green bond market may be worth US$230 billion in the next five years – an opportunity too big for the international business community to ignore.

By Aaron Franklin

Green Bonds have led a tremendous growth in environmental finance over the past five years, but that growth has been heavily-weighted towards investment grade credits with their accompanying risk/return.  The predominance of investment-grade credits partially results from the all-or-nothing approach of Green Bonds – the bond is either 100% green or 0% green.  The 100% green requirement shuts out many issuers seeking to finance environmentally-sustainable projects because a company needs to be sufficiently large and well-capitalized to…

By Paul Davies and Andrew Westgate

Green bonds, which tie the proceeds of the issuance to investments that have positive environmental and/or climate benefits, are a rapidly growing asset class. Recent figures have corroborated the narrative of growth predicted by industry experts.

In the first quarter of 2016, green bonds totalling US$17 billion were issued globally – three times the total amount issued in the same period in 2015, almost half of which are attributed to Chinese issuers. Banks continue to dominate issuances, but a recent corporate issuance shows the burgeoning development of the asset class.

Zhejiang Geely – perhaps best known in the UK as the owner of the London Taxi Company, manufacturer of London’s iconic black taxi cabs – recently issued US$400 million of green bonds. The funds will be used in part to develop green taxis in Europe, but also to fund electric vehicle design in Asia.

By Paul Davies and Andrew Westgate

China has launched a green bond pilot initiative via the Shanghai Stock Exchange, encouraging further foreign investment in a rapidly growing asset class and paving the way for issuances by non-financial institutions.

This initiative closely follows the publication of green bond guidelines in December 2015 by the National Association of Financial Market Institutional Investors (NAFMII). The Shanghai green bond stock exchange initiative and the guidelines go hand-in-hand with China’s efforts to transition towards a green and low carbon economy.