ESG Due Diligence – From a Trend Topic to Economic Reality

The Rise of the ESG Trend

Only a few years ago, ESG (Environment, Social, Governance) was considered the business topic of the future. Sustainability reports and climate targets shaped discussions in the leadership bodies of German companies. The growing importance of ESG was driven in particular by regulatory developments; with the European Green Deal in 2019 and subsequent European regulations, what had previously been a largely voluntary sustainability topic increasingly became a matter of regulatory compliance through the juridification of sustainability issues. At the same time, expectations from investors, financial institutions and the public also rose. Companies set up ESG departments, advisers specialised, and many market participants expected that ESG would in future also become the pivotal factor in corporate transactions.

Shift in Significance by 2026: From a Sustainability Symbol to Economic Risk Analysis

However, the initially expected dominance of ESG in transaction business has not materialised to date. In particular, the notion that standalone ESG due diligence reviews would become the standard has not taken hold in practice. Instead, ESG-related aspects have largely been and continue to be integrated into existing review checklists for legal, financial, tax and technical due diligence.

In fact, today’s shift in sentiment has several causes. Geopolitical crises, inflation, rising interest rates and energy prices, as well as higher financing costs, have shifted the priorities of many companies. Due to economic hardship and the resulting social uncertainty, ESG is increasingly viewed through the lens of cost and efficiency. The trend is moving away from a social and ecological understanding of sustainability towards purely sustainable business practices. The European legislator has also responded to these signs of the times and, as part of the Omnibus initiative, raised threshold values for numerous ESG-related regulatory frameworks, meaning that a significant proportion of companies will in future no longer fall directly under certain reporting obligations (including the CSRD). This, too, can be interpreted as a signal of a regulatory “retreat” from ESG.

Does This Supposed “Weak Phase” Now Mean the Failure of ESG?

No, ESG topics will still be a necessary part of due diligence processes in 2026, albeit far more focused and economically oriented than a few years ago.

From the perspective of “financial materiality”, the central question today is less “What impact does the company have on people and the environment?” and much more “Which ESG risks specifically affect enterprise value, financing, regulatory risks and operational stability, and is there, from these perspectives, a reasonable strategy that includes ESG topics?”

ESG in Due Diligence Today

The Business Judgement Rule as the Starting Point

Ultimately, the relevance of ESG topics in corporate transactions is rooted not in political targets or societal expectations, but in the principles of proper business conduct. The starting point here is the Business Judgement Rule, which is set out in Section 93(1) sentence 2 of the German Stock Corporation Act (AktG) but applies to all legal forms. Under this rule, management does not act in breach of duty if, when making a business decision, it could reasonably assume that it was acting for the benefit of the company on the basis of adequate information.

However, this does not give rise to a general obligation for management to review ESG aspects separately in every transaction. What matters is whether the relevant ESG factors (environment, social, governance) are material to the specific investment decision and the risk assessment of the target company. For a business decision, the management board must identify and assess those circumstances that may influence enterprise value, earnings capacity, liability risks and the company’s future development, and it is not required to adhere to a “rigid” checklist.

In transaction practice, the question therefore does not start with the mere existence of an ESG strategy or ESG reporting, but rather with whether the acquisition of the target serves the company’s interests and benefit. For a sound assessment, the management board requires a robust information base, which is regularly created through external due diligence in the form of an expert opinion. This is a process preceding the company acquisition to identify opportunities and risks that are economically material to the specific transaction, in order to develop an appropriate purchase price and a corresponding contractual liability regime or, if necessary, to refrain from the transaction. Depending on the business model, sector, size and geographic location of the target company, this includes in particular ESG-related factors as part of a tailored review framework.

Methodological Approach: Materiality Assessment

The starting point of any due diligence is typically the conduct of a materiality assessment, including one relating to ESG factors. The target is to identify those ESG factors that are genuinely relevant to the target company’s economic, operational and financial development and, where applicable, to post-merger integration, in order to avoid reviewing ESG for its own sake.

Building on the identification of potential risk areas, the topics identified as material are examined in greater depth. The real added value lies in classifying the identified ESG aspects in economic terms, without giving them a special thematic status. The general aim of due diligence is to quantify identified risks as specifically as possible and “translate” them into financial impacts. Potential remediation costs, investment needs, fines or transformation costs feed directly into purchase price considerations and other contractual terms. Financial quantification also forms a material component of the information base on which the management board can make a duly compliant business decision.

Core Areas of ESG Review

Based on the previously determined, tailored review framework, there are various points of reference for reviewing ESG-related criteria. While these depend heavily on the sector and the target’s specific targets, a certain frequency can nevertheless be observed in individual topic areas.

In the “Environment” area, the focus is on environmental risks. This applies in particular to emissions- and resource-intensive sectors. Typical review items include, for example:

• the company’s CO₂ intensity and the associated transformation and adaptation costs, and improving energy efficiency through renewable energy,
• environmental permits and compliance with them.
• dependence on primary raw materials

The “Social” area covers compliance and social issues and becomes particularly relevant in the German M&A context when the target company has subsidiaries operating in emerging markets. Of particular importance here is, among other things, compliance with labour-law and occupational health and safety requirements.

In the “Governance” area, the analysis of business conduct and compliance structures is ultimately central. Particular attention should be paid here to highly regulated sectors (e.g., healthcare or financial services). Typical review focuses include, for example:

• the design and effectiveness of the compliance management system, and
• actions to prevent corruption and money laundering

The economic relevance in these review areas can be considerable. Violations in ESG areas can often lead to fines, remediation and transformation costs, as well as operational restrictions and reputational damage and, from the buyer’s perspective, ultimately act as a dealbreaker for the transaction.

Conclusion

In summary, it can be stated: ESG is not dead—at most, the hype that has accompanied the topic for years is. Regardless of this, certain ESG topics today even have greater economic relevance than before their rise to a fashion trend. Anyone who must make a business decision on the basis of the Business Judgement Rule therefore cannot disregard ESG factors. Particularly in the context of a transaction decision and the due diligence to be carried out in connection with it, ESG factors form part of the material review checklist and must be taken into account in decision-making as part of an adequate information base.