More protective and sustainable – Europe’s post-pandemic investment environment
While most of Europe remains in the grip of another wave of the COVID-19 pandemic, M&A activity in the region has already rebounded, even despite some large deals encountering political opposition. Low interest rates, private equity investors’ eagerness to deploy their funds and companies looking for fresh capital to finance their transition to a post- COVID future are just a few of the conditions that are conducive to dealmaking. Against this backdrop, this article examines some of the key trends shaping the landscape for overseas investors in Europe, particularly the EU.
CO-AUTHORED
Jean Devlin, Partner, Control Risks and her team.
Longer-term outlook brighter than it seems
The pandemic has hit hard a region where some areas were still dealing with the long-term effects of the Eurozone crisis, such as high youth unemployment as well as growing nativism and political polarisation. Moreover, the EU was facing – and continues to face – questions about how to transform its economic model to remain competitive internationally. The bloc is lagging behind the US and China in key new technologies, particularly digital ones, while facing growing societal demands to decarbonise its economy in response to the climate emergency.
At the same time, the human and economic suffering wrought by the pandemic has galvanised the EU and its member states to mount an unprecedented effort to tackle the challenges the bloc faces. National governments not only quickly mobilised large rescue packages to safeguard jobs and businesses but, together with the EU, they agreed a joint comprehensive recovery fund – Next Generation EU. Critically, the EUR 750bn fund provides financing in the form of grants and loans to support much-needed structural reforms and the bloc’s economic transformation. About half of the money will target projects and initiatives to make the EU greener and more digital.
“The EUR 750bn fund provides financing in the form of grants and loans to support much-needed structural reforms and the bloc’s economic transformation. About half of the money will target projects and initiatives to make the EU greener and more digital.”
This is not to say that all funds will be deployed effectively and coherently, but the EU’s response to the pandemic provides a more coordinated and purposeful approach to transforming the bloc’s economy than pre-pandemic initiatives. Increased public investment in digital infrastructure and services, energy transition measures and the circular economy will be a key driver of investment opportunities going forward. Moreover, despite widespread frustrations within the EU about the perceived slow roll-out of COVID-19 vaccination programmes in member states, the bloc has secured enough doses to inoculate its population this year. The region is likely to reach critical mass on vaccinations ahead of much of the rest of the world, assuming available vaccines remain effective against new COVID-19 variants. Disruption to business activity and day-to-day life will ease significantly during the second half of 2021, offering relatively greater certainty to investors in terms of operational risks and the prospects of a strong economic rebound.
But the pandemic is accelerating changes in the business environment
EU and member state efforts to address some of the structural challenges to competitiveness and long-term growth will benefit investors in the years ahead; however, some aspects of Europe’s political response to the pandemic will require increased attention on the part of those searching for opportunity in the region.
The pandemic has reinforced existing trends to increasingly scrutinise foreign investment in strategically important sectors. Several EU member states and the UK tightened their frameworks for foreign investments in 2020 and are continuing to do so in 2021, giving governments greater authority to examine deals, impose conditions or even veto transactions. Moreover, since October 2020, the EU’s investment screening regulation has entered into force, requiring member states to share information and coordinate.
One common challenge at the member state level is that the definitions of “strategically important” or “sensitive activities” are often vague, giving governments some discretion to become involved.
They have also been expanded beyond sectors traditionally covered by such rules, such as defence, telecommunications or utilities. One notable case in January 2021 involved the French government ruling out its support for the takeover of one of the country’s largest supermarket chains by a Canadian investor, citing “food security” as justification. Paris’ decision raised eyebrows because it rebuffed a company headquartered in Canada, which, like Japan, is a close European ally and has high regulatory standards.
“Deals involving “iconic” or symbolically important companies or those with large workforces are more likely to attract political scrutiny. ”
While such cases should not distract from the fact that most transactions subject to investment screening pass without objections across the region, they serve as a reminder that even seemingly innocuous deals can attract government attention. In addition to transactions in security-sensitive sectors, deals involving “iconic” or symbolically important companies or those with large workforces are more likely to attract political scrutiny. Authorities are also likely to be more inclined to become involved where popular dissatisfaction with governments is low, where populist parties seek to mobilise against “sell- outs” or if a transaction takes place in the run-up to elections or important parliamentary votes. In the context of the pandemic, pre-deal diligence should involve analysis of the potential for political opposition, both at the local and national level, to avoid potential delays and additional costs later in the transaction process.
Government intervention in deals may be rare but will remain a feature of the investment landscape. The pandemic starkly exposed external dependencies, which has strengthened policymakers’ convictions that the EU needs to be more proactive in guarding its economic and political interests.
Focus on sustainable business practices
The strong emphasis of the EU’s recovery package on the green transition reflects the bloc’s overall ambition to position itself as the global leader in doing business sustainably. This ambition is broad and extends well beyond environmental issues, even if these currently attract the greatest attention. But investors need to be aware that the broader direction of travel in the regulatory sphere – from emissions standards and carbon pricing, data protection to labour standards in supply chains – can be characterised as a “race to the top” by global comparison.
In practice, this means that the EU and its member states will maintain high standards where these already exist, such as in data protection and security, will continue to enforce them, and will move to tighten them in other areas. Regulatory proposals that would require businesses to carry out environmental and human rights due diligence along their global supply chains are being prepared both at the national level, such as in Germany, as well as at the EU level. While current proposals will evolve, there is little doubt that mandatory rules will be imposed across the EU, probably by 2023.
Increased reporting requirements from 2022 under the EU Non-Financial Reporting Directive on the extent to which a company’s activities are environmentally sustainable will increase transparency for investors. At the same time, this reporting will start shining a light on business activities that do not contribute to greening the economy or may be outright harmful to the environment, which may affect how buyers value a company in the future or complicate access to lending.
In light of the above, overseas investors should place an additional emphasis on evaluating the performance of an acquisition target from an environmental, social and governance (ESG) perspective. From the buyer’s perspective, highlighting their own credentials on sustainability is likely to make them more attractive in competitive processes. In light of the EU’s broader policy objectives and broad regulatory trends, companies with strong ESG credentials will likely be better prepared to adapt to future changes and unlock value for investors.
“In light of the EU’s broader policy objectives and broad regulatory trends, companies with strong ESG credentials will likely be better prepared to adapt to future changes and unlock value for investors.”
Those lagging behind or resisting change, by contrast, may face resource-intensive adaptation processes, even if their present business model looks sound and promising, and a business that may appear to be an attractive acquisition now could be valued quite differently in a few years if it is assessed to be behind on sustainability issues.
Published, 2021