Consideration of ESG factors in valuations

Recently proposed updates to international valuation standards (IVS) include prescriptive requirements to consider environmental, social, and governance (ESG) factors when conducting valuations on both companies and other subject assets.

The International Valuations Standards Council (IVSC) is an independent organisation which establishes and promotes global valuation standards to serve the public interest. The IVSC is responsible for setting the IVS which guide professionals globally to promote consistency and confidence in valuations.

While historically ESG implications were often considered implicitly in the valuation process, new proposed guidance ensures ESG matters are interpreted and considered consistently and explicitly in all valuations compliant with IVS standards.

Updated guidance provided by the IVSC touches on 4 key components of the valuation process, including:

1. ESG considerations when defining the valuation scope
   An additional item must be included in the defined scope of work of the valuation, namely, consideration of ESG requirements. Therefore, ESG factors must be explicitly considered from the outset of any valuation process.
   
   
2. ESG considerations when performing the valuation
   The IVSC has recommended that ESG is carefully considered under all three principal valuation methodologies including:
   
   
1. Market approach
   The valuer is required to make relevant, necessary adjustments between comparable assets and the subject asset being valued. New IVSC guidance explicitly includes “differences in ESG considerations” as a core adjustment to consider.
   
   
2. Income approach
   The IVS clearly defines factors to be considered when calculating a reasonable, terminal value cashflow. Guidance has been updated to include risks and opportunities associated with ESG of the subject asset.Additional guidance is provided regarding the inclusion and consideration of the impact of ESG factors on an appropriate discount rate.
   
   
3. Cost approach
   Adverse changes in ESG characteristics of the subject asset should be included as an input in the calculation of replacement/reproduction cost. This adjustment normally takes the form of an economic obsolescence calculation which includes the loss of utility as a result of economic or external factors to the subject asset.
   
   
3. ESG considerations when drafting the valuation report
   “Minimum reporting requirements” have been updated to include ESG inputs used and considered.
   
   
4. ESG considerations specific to certain asset types
   The IVSC has identified two specific asset classes where the impact of ESG is especially critical, namely: plant, equipment & infrastructure, and development property. Additional focus on ESG considerations will need to be applied when performing valuations in these asset classes.

As a result of the above, professionals performing valuation services will be explicitly required to consider ESG factors and explain them throughout their valuation engagements. Despite current limitations of available information and other related challenges, there is a clear trend of integrating ESG into valuation and investment decision-making processes moving forward.

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Stuart Noland specialises in corporate finance & management consulting with specific focus on valuations, deal advisory & business performance optimisation. Stuart is a Chartered Accountant and holds a Masters in Finance from the University of Cape Town and an MBA from the University of Oxford.