Addressing deal risks in a changing regulatory environment

December 2024  |  FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

December 2024 Issue

In the complex M&A landscape, regulatory imperatives can play a critical role in shaping the viability and success of transactions. To protect their interests, jurisdictions design and implement rules and regulations in order to ensure fair competition, protect national interests and maintain market stability. Key to such concerns are antitrust laws, ownership limitations, change of control regulations and national security reviews, among others.

M&A is facing increased scrutiny from regulatory bodies – scrutiny that has intensified over the last five years or so. Jurisdictions around the world are introducing changes that further complicate the outlook for dealmakers, with the regulatory landscape tightening on both the buy and sell side of transactions. Regulators have introduced and actively enforced a range of review mechanisms, for example. These include merger control, foreign direct investment (FDI) scrutiny and foreign subsidies oversight.

With the expansion of these powers, dealmakers need to devise and implement new strategies to effectively navigate a complex and fragmented regulatory landscape.

Clouded prospects

Despite a brief uptick in dealmaking around the turn of the year – which saw acquirers emboldened by unallocated capital levels, favourable valuations, stabilised inflation and easing fears of recession – uncertainty once again permeated global M&A markets, clouding transaction prospects.

Dealmakers still seem reluctant to pursue targets. The global value of M&A activity in the first half of 2024 was $1 trillion, according to Boston Consulting Group (BCG). Although this figure is 4 percent higher than in the same period last year, it remains well below the 10-year average of $1.5 trillion.

According to PwC, while the value of M&A deals in the first half of 2024 rose by 5 percent compared to the first half of 2023, overall transaction volume fell by 25 percent, continuing a downward trend that started in 2022. In the first half of 2024, deal volumes were just over 23,000 and deal values reached $1.3 trillion, well short of the record levels of activity in the second half of 2021, which saw almost 34,000 deals at an aggregate value of $2.7 trillion.

The technology, media & telecommunications (TMT) space saw the strongest gains in aggregate deal value, driven by technology M&A. Financial institutions, real estate and energy also experienced gains. According to BCG, M&A sentiment is highest in Europe, particularly in the energy, materials, and TMT sectors.

But in recent years, deals in the TMT industry have attracted significant regulatory scrutiny. In 2023, digital and technology-focused M&A faced antitrust hurdles, with 20 percent of deals blocked as authorities ramped up merger control enforcement in the sector, according to A&O Shearman. Prohibited transactions rose by over 50 percent last year, with antitrust authorities unwilling to accept remedies to address their concerns, instead choosing to block deals.

Merger notification in the US

In the US, the US Federal Trade Commission (FTC) announced in February the annual changes to the Hart-Scott-Rodino (HSR) Act notification thresholds (which came into effect for deals closing on or after 6 March 2024) and updated filing fee thresholds (effective for deals filing on or after 6 March 2024).

The 2024 HSR reporting thresholds increased by approximately 7 percent over 2023 thresholds. The application of these thresholds, particularly for cross-border transactions, is not straightforward and requires a thorough understanding of the statute and the complex implementing regulations.

The HSR size-of-transaction threshold for US HSR filings increased to $119.5m in 2024, up from $111.4m in 2023. Transactions in which the acquirer will hold voting securities, non-corporate interests or assets valued above that amount may be reportable if the size-of-parties test is also satisfied and no exemptions are available.

In determining reportability, parties must adhere to the applicable threshold that is or will be in effect at the time of closing. The applicable filing fee that must be paid is based on the filing fee threshold that is in effect at the time of filing.

The HSR size-of-parties threshold will also increase. It generally will require that one party have sales or assets of at least $239m and the other party have sales or assets of at least $23.9m. Previously, these thresholds were set at $222.7m and $22.3m, respectively.

Transactions valued at more than $478m will be subject to pre-merger notification without regard to the sales or assets of the parties, subject to the applicability of other exemptions. This threshold was previously set at $445.5m.

In early October, in collaboration with the Department of Justice (DOJ), the FTC finalised rules proposed in June 2023 that will significantly change the reporting of mergers and acquisitions under the HSR Act.

The final rule and new HSR form will come into effect 90 days after publication in the Federal Register. According to Lina M. Khan, chair of the FTC, the final rule will ensure that the agencies have the information necessary to determine whether a proposed deal risks violating antitrust laws.

The FTC also announced in October that it would lift its 2021 suspension of grants of early termination. Historically, filing parties had the option to request early termination of the initial 30-day HSR waiting period and close a transaction immediately upon such request being granted. The DOJ and FTC grant such requests in transactions unlikely to reduce competition.

Adjustments to the European framework

In the European Union (EU), the introduction in October 2023 of the Foreign Subsidies Regulation (FSR) heightened transaction risks for companies engaged in deals with substantial ties to Europe. Alongside this, new filing procedures have emerged, potentially extending deal timelines and raising transaction expenses.

The European Commission’s (EC’s) stance against foreign subsidies, aiming to prevent market distortion within the EU, has been longstanding. While subsidies from EU member states undergo scrutiny and approval under state-aid rules, foreign subsidies have been criticised for skewing the EU’s investment environment. This can unfairly benefit recipients when acquiring European businesses or securing public procurement contracts.

Going forward, companies will need to notify certain M&A transactions and public procurement bids to the EC and wait for clearance prior to closing the deal or being awarded the contract.

Under the FSR, the EC has the power to investigate foreign subsidies and take action if it concludes they adversely affect the EU’s internal market. This includes the power to block M&A transactions and public procurement bids.

The EC can block deals or require structural or behavioural commitments where it considers there have been distortive foreign subsidies. Any deals that fall below the mandatory notification thresholds can also be proactively investigated if the EC believes that they may involve distortive foreign subsidies.

The EC can fine transaction parties up to 10 percent of their aggregate worldwide turnover if notification rules are not followed. Acquirers will need to consider whether the new regime applies to all M&A deals where the target’s group generates significant turnover in the EU. The regime will also affect public procurement processes.

Increased execution risk and longer timelines should be taken into account for pending deals. The new regime follows the same timetable and information-gathering powers as the existing EU Merger Regulation (EUMR), but the two clearance processes remain separate. As a result, it may not always be possible to align timelines, and some transactions may require notification under one regime but not the other.

However, unlike the EUMR process, the FSR does not allow for early, upfront commitments to address the EC’s concerns. This is expected to lead to extended timelines and increased costs in cases involving potential subsidy issues.

In late 2023 and early 2024, the EC launched four FSR probes into Chinese wind turbine suppliers and into Romanian and Bulgarian bids for solar photovoltaics and electric trains. These transactions were scrutinised far more than originally anticipated. Further, the EC carried out its very first dawn raids under the FSR in the security equipment sector in April.

A newly established unit called Directorate K within the Directorate-General for Competition has been exclusively dedicated to enforcing the new FSR rules within the EU. It contains three separate units composed of senior officials with a track record in state-aid enforcement.

These recent developments highlight the EU’s focus on defending its strategic industries, including energy, semiconductors, security equipment and electric vehicles, among others.

According to data from the EC’s FSR brief published earlier this year, within the first 100 days since the notification obligations took effect, the EC was engaged in pre-notification discussions in 53 M&A cases. The vast majority of these cases (43 out of 53) were subject to parallel review under the EU merger rules. Some cases also triggered a parallel review under national merger control rules (five out of 53). In addition, around half of the cases involved FDI screening in one or more EU member states.

More than half of the cases involved non-EU to EU M&A deals, but the FSR also covered purely EU to EU M&A deals, and even non-EU to non-EU transactions. Almost one-third of all M&A cases in pre-notification involved an investment fund as a notifying party.

Analysing regulatory risks

Multinationals and foreign investors must take M&A enforcement seriously. This process should begin well before entering into a transaction, with would-be acquirers assessing the regulatory risks of any potential deal.

Such analysis will inform transaction agreement negotiations and ground a strategy for gaining clearances. Antitrust or competition, industry specific and cross-border concerns will need to be examined and addressed. Reviews may involve FDI, national security or industry-specific commissions.

From an antitrust perspective, companies must consider all possible avenues, including product development plans, as well as current and future relationships between the companies’ products.

Deal parties will have to grasp the prevailing enforcement priorities of relevant authorities and any new principles advocated by key officials, then develop a strategy to address anticipated concerns head-on.

In the current regulatory climate, companies must conduct a trenchant assessment of the regulatory risks at the outset of a transaction, craft a strategy for obtaining regulatory approval, negotiate terms to provide for the possibility of a delayed or blocked deal, mitigate and allocate risks, track progress of the approval process, and be prepared for litigation should it arise.

It is prudent for organisations to appoint local partners with a strong track record. This should provide access to a dedicated team of senior deal advisory executives, associates, analysts and researchers who can help navigate legal, tax and due diligence requirements at all levels of government.

In any jurisdiction, local expertise can play a crucial role in demystifying the regulatory requirements and potential tax implications of a transaction, as well as aiding the due diligence process.

Geopolitical and macroeconomic shifts will continue to create challenges for companies seeking expansion through M&A strategies. Uncertainty will compel organisations to have a well-connected team of legal experts in place in all relevant jurisdictions affected by a proposed deal – preferably with a strong understanding of regulatory nuances and a good relationship with authorities.

© Financier Worldwide

BY

Richard Summerfield