CORPORATE/M&A: An Introduction to London (Firms)
Authored by Richard Moulton
We have seen the Mergers and Acquisitions market soften from the outset of 2022 and this softening has accelerated due to the combined effects of the war in Ukraine, inflation and interest rates rising and supply chain issues. The key question to consider is not ‘is this the end of the M&A boom?’ it’s more ‘when will the M&A market recover?’. To answer that question, we need to understand the ongoing issues affecting the wider economy and the likely impact of them.
What we’re seeing at the moment is the UK being slightly more adversely affected by a slowdown in corporate activity than many other jurisdictions, despite the large sums of cash available for deployment, particularly by PE firms. This is all down to confidence and a ‘wait and see’ attitude. What corporates – and investors – are grappling with is an environment where a sequence of interconnected events is causing market participants to be more cautious to undertake M&A.
In recent times, the impact of the COVID-19 pandemic (including the recent lockdowns in China), the Brexit transition period and the conflict in Ukraine have all exposed the fragility of supply chains.
Despite the increased globalisation of their customer base, organisations have adjusted their practices, and are having to look to secure multiple local suppliers to minimise the risk that a localised crisis or issue may cause disruptions to their supply chain. Such uncertainty has translated into a driver of M&A activity.
Moreover, the impact of inflation in the wider economy is leaving businesses in all sectors grappling with increasing costs. This is particularly the case for manufacturing and retail businesses, which incur high energy costs and those with high transportation costs. Deals are not necessarily aborting due to rising inflation; however, deals are taking longer to close as the burden of financial and regulatory diligence increases. Current economic uncertainty is impacting valuations, as buyers and sellers have to adjust valuations to take account of the new economic and geopolitical backdrop.
Earlier in 2022 we commissioned research that found the war in Ukraine is fundamentally impacting appetite for M&A, with 67% of business leaders indicating that the conflict has reduced their organisation’s investment in M&A activity.
As expected, there has been caution among our clients and this has resulted in deal timelines slipping. That said, geopolitical events tend to be digested quickly by the market, as business leaders reassess and reposition. We are therefore cautiously optimistic that markets will adjust and that transactional activity will pick up further into Q3 and beyond.
The regulatory environment for M&A is becoming more complex in many jurisdictions, not least the UK. In recent years, jurisdictions worldwide have introduced new foreign direct investment (FDI) screening regimes or have expanded existing regimes to enable governmental control of inbound investments into certain sectors. In some jurisdictions, this has been driven by an increased desire to protect domestic assets from what has been seen as opportunistic foreign acquisitions. However, security of the supply chain is also a relevant factor. These foreign investment regimes no longer focus solely on the military and defence sectors, impacting the TMT, life sciences and agribusiness sectors, for example.
In the UK, by way of example, the new national security and investment (NSI) screening regime came into force in January 2022. This means that a wide range of transactions will be required to make a mandatory notification and obtain clearance before the deal can close. Similarly, the EU also has introduced a new regime which encourages cooperation between EU countries and the European Commission in relation to foreign investment screening. 24 of the 27 EU countries have, or are in the process of implementing, such regimes. We are also seeing competition regulators across the globe heavily scrutinising deals involving potential competitors.
FDI regimes need to be looked at now across all jurisdictions and a clearance of FDI in one jurisdiction does not necessarily mean clearance in another. Failure to abide by the new rules can lead to significant penalties. As the UK regime can apply to transactions completed since 12 November 2020, we are seeing that historic acquisitions may need to be diligenced. Organisations will therefore need to ensure they factor in additional delay to their transaction timetables in order to comply with both competition and FDI regulations.
In addition, EU Member States will have to bring their national laws in line with the EU Directive on cross-border mergers, conversions and divisions by 31 January 2023. Broadly, the Directive updates the existing conditions and provisions for cross-border mergers within the European Union and, in addition thereto, introduces new conditions and provisions on cross-border conversions and divisions for limited liability companies in the EU, including additional protections for members and creditors.
ESG is likely to become an increasingly important driver of M&A. There are a couple of areas to mention that will impact the deal community. Firstly, the EU Corporate Sustainability Due Diligence Directive will require larger EU companies and certain larger non-EU companies operating in EU Member States to identify and, where necessary, prevent, end or mitigate adverse impacts of their activities on human rights (eg child labour and exploitation of workers) and on the environment. This will increase the importance of the focus on ESG issues in the supply chain from an ESG perspective, ie the detection and prevention of supply chain abuses and maintaining labour standards.
Secondly, an increased focus from governments and regulators on ESG and climate-related disclosures. In the UK, larger companies will have to make mandatory climate-related disclosures as a result of amendments to the provisions of the Companies Act 2006 regarding the strategic report contents that will apply to financial years from 6 April 2022. The EU will introduce enhanced sustainability reporting requirements under the Corporate Sustainability Reporting Directive. These regulatory changes will inevitably increase the focus on ESG considerations in M&A transactions. Buyers may need to consider how prepared companies are to make these disclosures.
For public companies, the UK government is moving ahead post-Brexit with moves to make it easier for UK listed companies to fundraise on the public markets, having accepted the findings of the UK Secondary Capital Raising Review, and also moving ahead with proposals to simplify the UK prospectus regime, which will be implemented by the Financial Services and Markets Bill which has been recently introduced to Parliament. This of course should assist listed companies to be more acquisitive by making fundraising easier.
Despite the challenges, we feel the need to do deals, across all areas of the market, remains ingrained in the psyche of corporates and investors as a way to secure growth and adjust businesses to be fit and relevant in the future economy. With that in mind, whilst we will not see 2021 levels of activity, we expect M&A activity to begin to increase in the second half of 2022 and continue to firm into 2023 as corporates and investors begin to have confidence that the economic cycle will turn more favourably for M&A activity.