M&A Report 2022: M&A dealmakers should expect enhanced regulatory focus

The recovery of the M&A market since the early days of the pandemic has been impressive. Even allowing for varying treatment of Covid-19 winners and losers, deal processes for resilient assets (and even for less obviously attractive assets) are often extremely competitive, and valuation multiples have continued to rise. Such high deal values and volumes have been accompanied by heightened regulatory interest in deal making, and challenges for deal planning and execution.

The extent to which the war in Ukraine, the imposition of sanctions and export controls on Russia, and related geopolitical, financial and commodity volatility will impact the global M&A outlook is hard to predict – some geographies, sectors and businesses have experienced immediate effects, while for others implications will become clear in time. However, it seems certain that as regulators and governments push to introduce or enhance a wide range of rules impacting investments in multiple sectors, dealmakers should expect that the hand of government will be felt in M&A deals, even for businesses not traditionally viewed as ‘regulated’. In our view, such enhanced regulatory focus is here to stay and dealmakers must now address how best to tackle the implications and minimise the impact of regulatory interventions in deals.

Successfully executing an acquisition in 2022 will require skilful navigation of a complex and evolving legal and regulatory landscape – and deal teams must remain agile to clear hurdles and achieve their commercial objectives.

Amid the tumult of recent years, the risk of short-term corporate decisions having long-term financial and reputational consequences is heightened. Large and well-publicised fines, including for bribery, cyber and data breaches, gun jumping, cartel behaviours, and breaches of regulatory orders, mean that dealmakers must remain alert to the risk of inheriting liabilities for historical regulatory noncompliance.

Rising regulation of tech innovation is also noteworthy. While fast-growing sectors such as fintech thrive, such growth has begun to attract greater regulatory scrutiny, as has the tech industry more broadly. In the UK, for example, the Financial Conduct Authority is pursuing a formal transformation program and intends to be more assertive, and as such stakeholders should expect a stricter regulator prepared to “test [its] powers to the limit”. Stakeholders are already witnessing this in practice.

While the level of supervisory oversight is set to increase, posing challenges for industry participants and impacting players operating on the unregulated perimeter, a more robust regulatory environment could also play into the hands of some buyers and create opportunities for those able to navigate change.

The UK’s National Security and Investment Act (NSIA) is now officially in force, granting powers to the Secretary of State for Business, Energy and Industrial Strategy (BEIS) to screen a broad range of transactions on national security grounds, allowing BEIS to block, impose conditions, or potentially unwind already completed deals that give rise to national security concerns.

The NSIA arrives at a time of heightened scrutiny of foreign direct investments (FDIs) across Europe and beyond. According to the 2021 edition of Latham & Watkins’ Private M&A Market Study – which examined more than 320 European deals – the prevalence of FDI approval conditions in deals continues to grow. This reflects the increased number of jurisdictions with FDI approval regimes and the high value, high profile, and strategically significant nature of the deals surveyed. With the advent of the NSIA, we anticipate that this trend will continue (and accelerate), bringing new considerations and challenges to deals.

Merger control scrutiny is tightening. Agencies are scrutinising the suitability of buyers and merger dynamics more closely and imposing greater evidentiary burdens on merging parties. Amid the changes to UK laws and regulations brought about by Brexit, the end of the transition period means that acquirers face potential parallel EU and UK competition investigations – with the effect that the UK’s Competition and Markets Authority (CMA) now plays a more prominent role in reviewing global M&A deals.

Dealmakers must remain alert to the CMA’s increasingly interventionist approach, including in transactions with a limited nexus to the UK – and all in the context of a voluntary merger regime. This trend is likely to increase the regulatory burden on acquirers, who must navigate potentially divergent EU and UK processes for deals that would previously have been reviewed by only one of those two regulators.

Big tech and digital mergers remain key areas of focus, with regulators keen to step up traditional enforcement and also seek new ways to intervene, as demonstrated by the 2021 publication of Article 22 Guidance by the European Commission (EC). While the EC has historically discouraged referrals of transactions from EU national competition authorities that fall below the national merger control thresholds, the EC changed practice because of a perceived enforcement gap regarding potentially anticompetitive mergers falling below all EU merger thresholds. Digital and pharma/biotech mergers are in the eye of the storm, but the EC’s renewed practice is not limited to those specific sectors.

In the US, the Biden Administration has focused on merger enforcement – particularly in technology, healthcare, and banking – along with specific practices that affect workers’ mobility and wages, such as non-competes in employment agreements. US regulators have announced enquiries anticipated to expand antitrust scrutiny going forward, consistent with changes practitioners are already seeing.

How should dealmakers respond? Assess the opportunity

The M&A market is likely to place a greater emphasis on deal planning and critical assessment of regulatory risks, including developing a strategic regulatory clearance plan focused on managing the impact of filings, clearances, and other hurdles. Nascent regimes and amended approaches mean that work is required to mitigate unexpected delays or remedies. If a transaction falls within scope of a particular regime, screening processes may well involve extensive disclosure requirements that can impact deal timetables, creating barriers to closing. For example, clients have undertaken a merger control-style analysis of FDI approval issues, including analysing their own shareholder base and that of any other investors involved in the deal. Deal teams should consider opening an early dialogue with regulators to allay potential concerns.

Deal teams should also prepare for the imposition of undertakings in order to close sensitive deals, and consider how this would impact deal value and transaction rationale. Recent deals with a UK nexus have seen BEIS require undertakings designed to protect UK national security, including safeguarding the confidential information of the target, limiting the extent to which information can flow up to the ultimate investor, and imposing UK nationality requirements for board appointees.

The UK government has also shown a desire for investors to give ‘voluntary’ economic commitments (e.g. relating to UK jobs), even though this falls outside the scope of existing legislation, including the NSIA. Dealmakers should note that undertakings and commitments typically relate to the target rather than the buyer, and may therefore impede the attractiveness of the target on exit.

Differences in process between BEIS, the CMA, and other antitrust or FDI regulators are likely to create challenges in ensuring that remedy offers can successfully straddle relevant regimes effectively. For example, the Committee on Foreign Investment in the United States (CFIUS) may accept undertakings as a condition of clearance, including prohibiting or limiting the transfer of certain intellectual property, trade secrets, or knowhow. There is also an emerging practice of FDI regulators in one jurisdiction raising national security concerns about the likely impact of remedies offered by the investor to a regulator in another jurisdiction. Balancing the requirements of different regulators in different jurisdictions requires agility.

Deal documents will need to respond to the regulatory framework to which the transaction and the target company are subject. However, transferring risk into deal term protections in the current highly competitive M&A market is challenging, requiring dealmakers to triage and prioritise what can be back-ended to the gap period, and what is essential for signing.

Latham’s 2021 Private M&A Market Study found that the prevalence of FDI approval conditions (included in 15% of deals analysed) remains significantly lower than that of merger control conditions (included in 52% of deals analysed). This appears likely to change, given the expansive scope of the NSIA and similar regimes applicable in other jurisdictions. Dealmakers should consider the terms and scope of such conditions and the efforts that parties are compelled to take to satisfy them, in addition to the implications on deal timetable and, in some cases, deal certainty.

Further, compressed deal timetables and a sellers’ market in recent years have contributed to a downward trend for liability caps on warranty claims – 63% of sellers in Latham’s 2021 Private M&A Market Study limited their commercial warranty liability to less than 20% of equity value, compared to 41% in the 2014 edition.

While buyers may have sought additional warranties, indemnities, and post-closing price adjustments to mitigate the uncertainties of recent years (including fines and other regulatory risks), the competitive M&A market has frequently forced acquirers to accept less-than-perfect deal protections. This development emphasises the importance of a detailed diligence exercise and the potential need, in some cases, for a risk-based post-closing audit and remedial processes.

Gap covenants governing the conduct of the target business between signing and closing came under heightened scrutiny in 2020 (as dealmakers debated what type of business conduct counted as ‘ordinary course’ in extraordinary times) and further scrutiny in 2021 (as dealmakers considered the implications of EC fines for gun jumping infringements).

In an increasingly regulated M&A environment, deal teams should expect a greater focus on gap covenants, particularly given lengthening timelines between signing and closing. Buyers need sufficient confidence in the operation of the business by the seller up until deal closing, but without having control through equity ownership, or board voting rights where it may be able to exercise control over the target or determine its strategic commercial behaviour (until relevant merger clearances are received) – always being cognisant of gun jumping rules.

Special purpose acquisition companies (SPACs) emerged as the hottest market trend in 2020 and 2021, allowing SPAC sponsors to launch shell companies with the goal of taking private companies public via merger. The launch of European-style SPACs, the growing number of triple-track deal processes (i.e. with an auction sale, an IPO, and a SPAC sale as possible outcomes), and increasing instances of stressed or distressed M&A present novel, complex deal structures and new challenges – all of which require agile legal advisers who are able to navigate regulatory interventions and give dealmakers the competitive edge.

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