Despite the doom-mongering, Brexit appears to have had little impact on the UK’s position as a leader in mergers and acquisitions. But, writes Joanna Goodman, there are clouds on the horizon
The low down
When the UK voted to leave the EU in 2016, there were concerns that we would lose our position as Europe’s financial hub and a leader in mergers and acquisitions (M&A), and that London would no longer be a key destination for M&A infrastructure and expertise. City lawyers have profited as these concerns appear to have been unfounded – so far. Notwithstanding a more complex regulatory landscape, 2021 was a bumper year for M&A, globally, in Europe and in the UK. As the economy starts to founder, however, there may be trouble ahead.
When the UK officially left the EU on 31 January 2020, it entered a transition period until 31 December 2020. This was designed to allow for the completion and ratification of negotiations on the UK’s long-term relationship with Europe.
In January 2021, legal services were included in the EU-UK Trade and Cooperation Agreement (TCA). This established the new trading relationship between the EU and the UK, giving lawyers the ability to offer ‘designated services’ in the EU. However, post-Brexit, UK solicitors and law firms face a more complex European business environment. There are now 27 different regulatory regimes, one for each EU member state. And a lawyer’s ability to practise in Europe also varies by jurisdiction and specialism.
Moreover, the TCA does not seek convergence or continuity in key legal areas for M&A, such as financial services and investment. And the powers it gives ministers to amend, disapply or modify retained EU law under the European Union (Withdrawal) Act 2018, suggest that divergence will increase. So far, however, despite some supply chain disruption, this has not stifled UK business.
Record year for M&A
Investment and M&A activity indicate that, so far, Brexit had less impact than expected on UK M&A transactions and demand for associated professional services. Thomson Reuters’ State of the UK Legal Market 2022 report cited M&A as the practice area with the highest growth in demand, which increased 21.5% over 2020. Demand across all practice areas rose 8.7% on 2020.
Thomson Reuters found that, by practice area, UK buyers of legal services plan to increase spending on regulatory, corporate and M&A, noting: ‘For UK law firms, it becomes clear that because of or regardless of Brexit, UK clients continue to have increasing international legal needs in Europe and across the world. That means UK law firms should maintain and even strengthen their global networks and partnerships to best serve these clients.’
On the inbound side, demand has also remained steady: ‘70% of global multinationals report that they have legal needs in the UK, which is up compared to 68% in last year’s survey. More importantly, more than half (52%) of these global multinationals say they expect to spend more in the UK legal market over the next 12 months, compared to 29% that say they plan to spend less.’
It is often difficult to distinguish between the effects of Brexit on M&A activity and fallout from the pandemic. But EY’s UK Attractiveness Survey for financial services, published last month, shows that while financial services foreign direct investment (FDI) fell 2.8% across Europe in 2021, the UK bucked the trend, attracting 63 projects (including 54 new ones). While France narrowed the gap with the UK, and for the first time attracted the highest number of investment projects from the US (the largest source of financial investment into Europe), EY ranked the UK as Europe’s most attractive location for financial services FDI. Germany and France were next.
'Where Brexit has presented challenges to the UK is in its attractiveness as a listing venue. There is increased competition with Amsterdam and Paris'
Patrick Sarch, Hogan Lovells
‘The UK remains an attractive destination for M&A,’ says Patrick Sarch, co-head of UK M&A at Hogan Lovells. ‘Sterling is down, FTSE multiples are lower, and you can buy attractive assets at a good price. The drivers of these deals include the consolidation of supply chains, companies scaling up across borders, and diversification across markets.
‘Where Brexit has presented challenges to the UK is in its attractiveness as a listing venue. There is increased competition with Amsterdam and Paris. This has been the subject of many ongoing discussions on how to best position the UK as a market following Brexit.’
Tony Williams, principal at legal consultancy Jomati, is less optimistic. ‘Since the Brexit referendum in 2016, the FTSE 100 has massively underperformed global markets and many fund managers have been underweight in their portfolios. This has been compounded by the relative absence of major tech players in the FTSE 100. But there is an odd contrarian element to that too. With sterling relatively weak compared with previous years and the stock market relatively poor, the UK is a place for bargains for international buyers. In terms of M&A, international buyers have looked to the UK, where targets are undervalued, particularly compared with the US.
‘2021 was almost a perfect storm for M&A practices globally,’ adds Williams. ‘Private equity funds had more money than ever, and they could leverage up very effectively. The trade buyers had strong balance sheets that enabled them to make strategic acquisitions. Consequently, Brexit may have slightly benefited deal activity in the UK because values were suppressed. But by the end of 2021 things had started to change. Now they have changed quite dramatically, with bankers reversing quantitative easing and hiking up interest rates.’
Williams does not see increased regulation as a dealbreaker – yet. ‘During Covid, both the EU and the UK tightened up competition requirements,’ he says. ‘It is not as if the UK became an outlier in regulatory terms – regulations are increasing everywhere – but in the UK, although the promise of Brexit being a bonfire of regulation was not delivered, regulators have tried not to spook international markets and investors.’
As well as losing the advantages of EU directives that facilitate cross-border M&A transactions within the EU, UK businesses and their advisers have to work with new government measures that increase the regulatory hurdles for parties to corporate transactions. This increases the risk of deals being delayed or derailed.
In an article earlier this year, Stephen Kon, senior consultant in Macfarlanes’ competition practice, outlined the regulatory complexity that post-Brexit measures have brought to M&A transactions involving UK businesses. ‘Mergers with both an EU and UK dimension no longer benefit from the “one-stop shop” anti-trust clearance regime established by the EU Merger Regulation. As a result, many transactions will now require clearance from both the European Commission (EC) and the UK’s Competition and Markets Authority (CMA),’ he wrote. Kon added that parties and advisers now need to factor in the possibility that mergers may be cleared by the EC, but be blocked, delayed, or subjected to conditions by the CMA. All this is increasing the CMA’s workload, as well as the risks associated with international mergers. However, in 2021, the CMA conducted only 12 merger reviews parallel to EU reviews, just two of which went to a second phase review.
The National Security and Investment Act 2021 (NSIA) introduced a mandatory reporting regime for notifiable acquisitions and investments across 17 sensitive economic sectors that could potentially present a risk to national security. Qualifying transactions include those taking place outside the UK and involving overseas entities. According to a report published on 16 June by the Department for Business, Energy & Industrial Strategy (BEIS), the Investment Security Unit received 222 notifications in the first quarter of 2022, 17 of which were called in for further assessment, which can take up to 30 days. Three were cleared and 14 are still under investigation. NSIA gives the secretary of state the power to place conditions on a deal or even block it, but so far this has not happened. BEIS published a memorandum of understanding with the CMA around aligning national security and merger control procedures, and avoiding inconsistency or conflict between the two regimes.
Deal volume increases while average values fall
Mergermarket’s 2021 law firm league tables show that, with a few exceptions, European deals increased for the top 20 law firms by both value and deal count. The rankings in terms of deal count are relatively stable, with the same top-10 firms in a slightly different order, and only slight fluctuations across the top-20 firms. There is more variety in the rankings by value, and the fluctuations in value year on year, but again they involve mostly the same players.
UK league tables also show higher deal volume pretty much across the board, but only 25% of the top-20 firms experienced a significant increase in deal value, while most are seeing no change or a reduction in value.
‘The UK has been remarkably robust as an M&A market over the last two years since Brexit was finalised,’ says Sarch. ‘Private capital has continued to be invested in growth companies (the UK has more tech unicorns than any other market), the flow of public takeovers has continued in respect of companies big and small, and private M&A, in particular the cross-border work we handle, has been resilient.’
‘The Mergermarket data indicating a slight drop on deal values is interesting,’ says Chris Dobson, corporate partner at Reading firm Boyes Turner. ‘I’ve witnessed a few transactions stall or even fall over on the basis that target businesses had experienced a “Covid Bubble”, with sellers pushing for higher multiples and buyers understandably taking a more cautious approach. This stand-off has resulted in deals taking longer than normal to get across the line while financial due diligence has been really scrutinised and/or earn-out structures deployed with quite aggressive revenue or margin targets ultimately not being hit.’
Williams considers deal value as a potentially misleading indicator, as ‘value is skewed by one or two big deals. For example one £50bn deal will skew the whole table’.
Deal flow, however, is more responsive to economic and market factors. ‘From our perspective, deal flow last year remained consistent, if not slightly up on pre-pandemic levels,’ says Dobson. ‘It certainly seemed to be business as usual for our stable of buy-side clients. We’ve seen plenty of UK deal activity for overseas parented companies (especially from the US). It doesn’t appear to be the case that the post-Brexit landscape has deterred inward foreign investment. Albeit I’m conscious that, given our proximity to London and focus on technology, we’ve perhaps been sheltered from the impact new regulatory barriers will have had on businesses operating within different sectors across the UK.’
Most firms leading the Mergermarket league tables have European offices, enabling them to manage European anti-trust and competition matters directly with Brussels. But Brexit means that UK-based firms and UK-qualified lawyers face additional barriers when working in Europe, so are more likely to make referrals to European counterparts than try to handle everything remotely from here.
This resonates with Dobson: ‘Looking across to Europe, we’ve probably been more active in making referrals to overseas partner firms than we have in receiving them.’
Economic and geopolitical fallout
CMS ranked second in Mergermarket’s league tables for deal count. Introducing the firm’s annual European M&A study, its global head of corporate/M&A, Louise Wallace, referenced its ‘expansive database of more than 5,000 deals, a record number of which, 498, took place in 2021’. This was a 22% increase on 2020. While the outlook was optimistic, it did identify concerns. These are associated with geopolitical risk, notably the economic impact of Russia’s invasion of Ukraine and continued fallout from the pandemic.
Concerns closer to home include the possibility of investment banks and clearing moving to the EU. Equivalence, which was not part of the original Brexit negotiations, is a significant sticking point. This is flagged up by the Lords European Affairs Committee report The UK-EU relationship in financial services, published on 23 June. It highlights the lack of EU equivalence decisions and discusses whether the EU’s withholding of equivalence decisions is based on political rather than technical considerations.
There were also arguments in the report, including by Peter Bevan, global head of Linklaters’ financial regulation group, that ‘it was always understood that [firms] needed to prepare on the assumption that… equivalence would not be forthcoming’ and therefore the value of future equivalence decisions had diminished. The London Market Group agreed, stating: ‘Given the ongoing uncertainty over equivalence… much of the London market is moving on from that debate and looking towards the potential that domestic reform could bring.’
'The UK is still an attractive place for business, and London is still the European capital for professional services'
Tony Williams, Jomati
The Association of British Insurers’ director of regulation, Charlotte Clark, had told the committee that for insurers, an equivalence agreement with the EU would be a ‘nice to have’ rather than a ‘need to have… because UK consumers tend to buy insurance from UK-based insurers’, and ‘foreign companies tend to have UK subsidiaries’ but that it was a ‘big issue’ for reinsurance.
This is corroborated by the fact that the warnings that financial institutions and law firms would shift their headquarters from London to the EU turned out to be another unfounded Brexit concern.
Williams sees the slowdown in economic growth as a looming threat. The Organization for Economic Co-operation and Development’s latest UK economic report (published on 8 June) forecasts that the UK economy will grow by 3.6% this year but experience 0% growth next year. ‘If we underperform as predicted, we will become a less attractive destination and acquisitions in the UK might be diverted,’ he says. ‘Previously, foreign investors have seen the UK as an open and welcoming market. Clearly the proposition is different now: if you are selling into the EU, it makes sense to base your operations in the EU rather than the UK. It would be sensible for the government to go back to the EU and mend fences and remove some of the frictions that currently exist. This would be to the benefit of trade and investment.’
Moving on from Brexit
Williams also highlights the importance of moving on from Brexit – especially for the government: ‘The UK is still an attractive place for business, and London is still the European capital for professional services. Much of the friction between the EU and the UK is political. It is a classic divorce and both sides are still very sore, as is clear from the equivalence regime, which has no legal basis. But there is an opportunity for negotiating a reset. This is important because Brexit has taken away a few of the advantages that made London an attractive business destination and added red tape and associated costs to UK M&A. The danger is that the incremental effects of these changes may threaten the UK’s position in the medium-term.’