A commercial year in review (Part I) - Tarun Rao and Shastikk Kumaran

Commercial law firms in London and across the world saw high profits and record deal activity in 2021. The economic recovery from the COVID-19 pandemic, and increases in demand for legal services contributed to an increase in profitability even as City law firms competed to offer more enticing compensation packages for newly qualified lawyers. Behind this successful year for commercial law however were several key trends across commercial law in finance and capital markets, with some of these trends likely to see significant shifts and changes in 2022. Record year for Transactional Legal Work The ongoing efforts by City law firms to offer more enticing compensation packages for newly qualified lawyers has occurred in the backdrop of record demand for legal services. With client demand for hours increasing by 15-25% globally, law firms in key financial centres have sought to attract and retain talent both through record bonuses for associates and partners and through the introduction of more flexible working arrangements. City law firms saw record deal activity across various practice areas, including Mergers and Acquisition (M&A), Capital Markets, and Private Equity. Low interest rates, large cash reserves, and strong balance sheets propelled the total value of M&A deals in 2021 beyond US$ 5 trillion, beyond the previous record of US$4.55 trillion set in 2007. At the same time, the distribution of global M&A activity has been skewed towards certain industries, with the technology, media, and telecommunications (TMT) and healthcare sectors both accounting for a disproportionate share of M&A activity. An example of such a restructuring was seen in the rebranding by Royal Dutch Shell into Shell as it undertook a restructuring to shift its tax base and share listing to the United Kingdom from its current dual listing across both the UK and the Netherlands. With increasing concern regarding environmental, social and corporate governance, Shell’s oil and gas business, from where it derives the majority of its revenue, has fallen out of favour among institutional investors, as part of a larger emerging trend of Environmental and Social Governance (ESG) indicators among investors. Shell is the second such Anglo-Dutch conglomerate to ditch the dual listing structure in recent years. Unilever, another Anglo-Dutch multinational, shifted its head office and share listing to London following pressure to simplify its complex organisational structure. Private Equity saw a year of rapid growth as well, with low costs of borrowing propelling a record year of acquisitions. The year of growth was influenced by copious amounts of ‘dry powder’, capital committed to private equity funds which has not been invested. By mid-2021, the value of this dry powder had reached US$3.3 trillion, giving private equity funds unparalleled ammunition for deals and acquisitions. Assets Under Management (AUM) at the largest private equity funds hit record levels with record fundraising for deals placing pressure on private equity groups to invest and heightening competition between funds for the acquisition of external targets. The ability of Private Equity to outperform the wider market has been disputed, with detractors accusing the industry of not delivering returns to investors sufficient to justify the management fees.= charged. Nevertheless, one key reason for the preference of institutional investors towards Private Equity has been the ability to guarantee lower volatility than public equities markets and the considerably higher leverage (or debt) which can increase returns. With rising interest rates expected to increase the cost of borrowing in 2022, it remains to be seen whether the current growth trends in private equity will be seen in the future. An additional trend likely to shape the industry is the emergence of private equity firms in public markets through initial public offerings. London based buyout firm Bridgepoint joined a growing number of publicly listed private equity firms during its successful initial public offering earlier in the year, reflecting investor optimism and enthusiasm towards the business model behind private equity. At the same time, much of the recent success in private equity and in the largest and most dominant private equity firms has been in the wake of high relative valuations across public and private equity markets. The year of record deals in private equity and with record activity in mergers and acquisition was also accompanied by a record year for Initial Public Offerings (IPOs). The year saw several successful initial public offerings across global equities markets. At the same time, there were some notable failures, such as the recent failed IPO of Indian digital payments giant Paytm. Paytm joins an ignominious list of high profile companies which failed to live up to the expectations of investors such as the UK based food delivery service Deliveroo, Swedish food and beverage manufacturer Oatly, and Chinese ride-sharing service Didi. While the causes of each individual IPO’s failure are different, poor performance of 49% of the 43 IPOs in 2021 which raised more than USD 1 billion, compared to 27% the previous year, raises concerns among investors of overexuberance and the questionable valuations. While conventional IPOs remain the main route for most companies seeking to raise capital from private investors, 2021 saw a record year for financing through Special Purpose Acquisition Companies, or SPACs. The funding mechanism, which entails the initial public offering of a blank check company, has seen a rapid increase in popularity in recent years and particularly since the beginning of the COVID-19 pandemic, with investors being drawn by the lower amount of disclosure requirements in contrast to traditional listings. The United States, and more specifically, the Nasdaq and New York Stock Exchanges have seen the majority of global SPAC listings in 2021. A disproportionate share of SPAC fundraising continues to occur in both exchanges due to favourable regulatory conditions and access to investors. The centre of global commerce One of the key events of 2021 was the renomination of Jerome “Jay” Powell for a second term as Chairman of the Federal Reserve, the Central Bank of the United States and the most powerful financial institution in the world. Jay Powell, who assumed office in 2018 following nomination for the position by Former President Donald Trump, presided over an unprecedented era for the Federal Reserve as US equities markets reached new all time highs prior to the COVID-19 pandemic. There remain several challenges for Jay Powell in his second term. Managing high inflation, tightening monetary policy and interest rates, and responding to calls for increased scrutiny with regards to financial regulation are some of the challenges which Jay Powell faces in his upcoming term. Increasing inflation, the main concern, across global markets, has an unclear origin, with an ongoing debate among policymakers as to which factors; supply chain disruptions due to the pandemic or loose monetary policy, are to blame for the issue. Efforts to resolve high inflation through a tightening of the money supply are likely to result in higher costs of borrowing and decreased exuberance in equities and debt markets which have allowed for a record year of deals. A mixed year for emerging markets. 2021 saw a mixed outlook for Chinese markets, with corporate debt markets being rattled by overleveraged property developers. The Chinese property market faces new strains as the rates on Chinese high yield debt have risen to a record level not seen since the Financial Crisis. At the heart of this crisis is fear of impending defaults by heavily indebted property developers, the largest of which is the Evergrande Group, which for several months, has held the ignoble title of being the most indebted property developer in the world. With government imposed deleveraging, and falling home prices across the country, various property developers face severe liquidity issues with many owners of developers resorting to using their personal wealth to make payments to creditors. The default of China’s Evergrande Group is likely to expose further faultlines and vulnerabilities in the country’s real estate and construction industries, worsening the outlook for industrial goods and commodities markets. The slowdown in the country’s crucial property sector has been accompanied by a regulatory crackdown on the country’s technology companies, occurring in the backdrop of a larger state sanctioned “common prosperity” drive. Tech monopolies held On a larger scale, while the first half of 2021 saw significant capital inflows into emerging markets, monthly inflows into emerging market debt saw a gradual decline as the year progressed. Net inflows into emerging market economies turned negative by November 2021, indicating an outflow of capital from emerging market debt and equity. Concerns related to the ability of emerging markets to service the additional debt burden, combined with higher interest rates in the United States, might combine in the future to prompt a sell off in debt and equity markets across emerging economies. A repeat of the 2013 ‘taper tantrum’ and sell-offs in emerging markets is unlikely in 2021 given the more cautious approach of the Federal Reserve and the actions of Central Banks in key emerging economies such as Russia, Brazil, Mexico, and India. Nevertheless, the possibility of interest rate hikes by the United States Federal Reserve is likely to impact commerce across emerging economies.