ESG, climate and financing risks in distressed M&A

This article was first published in Unternehmeredition. You can view the original version here.

Why focused ESG due diligence is critical for restructuring viability, financing and value

The growing relevance of distressed M&A reflects a structurally changing market environment rather than a temporary cycle. Macroeconomic volatility, rising interest rates, persistent cost pressures and increasing regulatory requirements are placing sustained strain on business models across many industries. For companies with already tight margins, high capital intensity and limited financial flexibility, these developments translate into liquidity constraints, refinancing challenges and increased restructuring pressure.

As a result, distressed M&A is becoming a central instrument for repositioning and stabilising companies. Transactions in this context are characterised by severe time constraints, limited data availability and a high degree of uncertainty. Decisions are often required before full transparency can be achieved. Despite this, ESG risks cannot be treated as secondary considerations. They directly affect value, liquidity and financing viability and frequently determine whether a restructuring case is credible.

Climate-related risks illustrate this dynamic particularly clearly. Extreme weather events, which cause more than USD 320 billion in annual damages globally, can disrupt production, damage infrastructure and impair logistics networks. In distressed situations, such disruptions often trigger cascading effects across the value chain. Production downtime, delayed deliveries and supply chain interruptions translate directly into revenue losses and additional liquidity pressure, reducing the reliability of short-term planning assumptions.

These cascading effects are particularly critical because they tend to materialise simultaneously across multiple parts of the business model. A local disruption can quickly evolve into a broader operational issue, affecting procurement, production and customer fulfilment at the same time. In financially constrained situations, this amplification effect can accelerate liquidity stress much faster than traditional operational inefficiencies and may significantly increase default risk within a short period.

More broadly, ESG factors directly influence core value drivers in distressed M&A:

• Physical risks affect operational continuity, logistics and insurability
• Transition risks influence regulatory compliance, cost structures and market access
• Environmental liabilities can trigger unplanned capex or legal exposure
• Governance weaknesses may undermine restructuring feasibility and investor confidence

In distressed M&A, risks are not “eliminated” but are often merely shifted in price or timing. ESG risks therefore frequently materialize post-closing—then, however, with full economic impact.

Physical climate risks: More than heat and extreme weather

A further, often underestimated component is water availability. For many industrial and process-driven business models, water is a critical input. Scarcity, regulatory abstraction limits or rising treatment costs can materially disrupt operations. In financially constrained situations, companies frequently lack the capacity to invest in mitigation measures such as alternative sourcing, recycling or infrastructure upgrades. This can quickly translate into reduced output, delivery delays and contractual risks, with immediate financial implications.

In addition to physical constraints, regulatory and customer-driven ESG expectations are evolving rapidly. Requirements related to emissions transparency, supply chain due diligence and sustainability reporting are increasingly shaping competitive positioning. Companies that are unable to meet these expectations may face exclusion from tenders or contractual relationships, even where operational performance remains otherwise intact.

At the same time, ESG data capability is becoming a prerequisite for both market and financing access. Customers, investors and lenders increasingly expect structured ESG, climate and emissions data. Companies that are unable to provide reliable information face growing risks of exclusion from supply chains or financing processes. In a distressed context, this gap can be particularly critical: even operationally viable businesses may lose customers or funding due to insufficient data transparency rather than underlying performance.

Financing is a key transmission channel through which ESG risks become economically decisive. Banks, debt funds and other lenders increasingly integrate ESG considerations into credit assessments, influencing availability, pricing and covenant structures. Where ESG risks are not adequately identified or reflected in the financial model, lender confidence may be reduced. This can affect access to liquidity, delay restructuring processes or increase financing costs at a time when financial headroom is already limited.

Beyond financing considerations, ESG factors also increasingly influence stakeholder alignment and transaction execution risk. In distressed situations, alignment between investors, lenders and management is often fragile and highly sensitive to perceived downside risks. Uncertainty around environmental liabilities, regulatory exposure or future compliance requirements can lead to diverging risk assessments and delay decision-making. This is particularly relevant where additional capital injections, covenant waivers or restructuring agreements depend on a shared understanding of risk.

Moreover, ESG-related uncertainties can affect valuation dynamics and negotiation outcomes. Where risks are insufficiently understood or quantified, buyers and lenders tend to apply conservative assumptions, resulting in pricing discounts, stricter terms or additional protections. Conversely, a clear and well-substantiated assessment of ESG risks can reduce uncertainty, support valuation and facilitate more efficient transaction processes. In this sense, ESG transparency is not only a risk management tool but also a mechanism to stabilise execution in inherently unstable situations.

Focused ESG due diligence under severe time pressure

Against this backdrop, ESG due diligence has become a core component of transaction execution. In distressed M&A, the central challenge is not whether ESG should be assessed, but how to prioritise analysis effectively under severe time pressure. A focused and commercially oriented approach is required, concentrating on those aspects that have an immediate and material impact on value and financing.

In practice, this involves identifying potential deal-breaking risks such as material environmental liabilities, assessing climate and water risks with direct cash flow implications and evaluating ESG data capability in the context of customer and lender requirements. In addition, financing-relevant parameters, including emissions profiles, regulatory exposure and necessary investment pathways, need to be understood sufficiently to support a credible financial narrative and enable informed credit and investment decisions.