29 June, 2019
- M&A veterans still focusing on financial due diligence, including P&L and tax, without properly examining compliance issues
- While US dealmakers are now taking these risks much more seriously, Asia is playing catch up
- Lacklustre, or non-existent, compliance due diligence frequently leads to overpayment for the asset or failure of the transaction.
- China is most challenging jurisdiction in terms of understanding compliance risk
(Singapore/New York/London, 27 June 2019) Dealmakers in large corporates and financial institutions often significantly under-resource compliance due diligence (CDD) when entering into a merger, acquisition or joint venture, a failure that can erode or even destroy deal rationale and value a long time after a deal has closed.
That is one of the key conclusions from a new study into dealmaking and compliance risk: Taking Center Stage: The Rise and Rise of M&A Compliance Due Diligence. In the report, Baker McKenzie and Mergermarket canvased more than 300 leading transaction specialists (financiers, lawyers, transaction focused executives), from money centers including New York, London, Dubai Hong Kong and Singapore, on the impact of compliance issues on M&A.
Despite the apparent blind spot regarding compliance risk by some dealmakers, the report did find a some transaction specialists becoming more willing to abandon transactions due to compliance issues.
In fact, two thirds of those dealmakers surveyed said they had seen at least 25% of the deals they were involved in over the past three years abandoned because compliance issues were identified. There were significant variations across countries and regions, with those in North America most readily walking away from deals due to compliance issues. Conversely, many Asian dealmakers were seemingly ready to take on much greater compliance risk.
Those that did abandon transactions say their CDD discoveries often acted as a key stop-loss mechanism.
The study found that the understanding of CDD and how best to roll it out also varied markedly across the world. In North America, a full 94% of respondents would describe their M&A CDD program as either very or at least moderately effective. That drops to 74% for Europe, and than drops precipitously from there. In Asia (ex Japan), just 42% of respondents believe they have an effective CDD program, dropping to 37% in Japan.
Commenting on the difference between Asia and the West, Andrew Martin, Head of M&A, Baker McKenzie.Wong & Leow, Singapore, said:
"With some exceptions, notably the more seasoned Japanese buyers and government-linked companies in Singapore, many Asian companies are either in the early stages of their compliance programs or are prepared to deal with the risk if and when it arises. In part, this comes from the absence of extra-territorial laws of the like of the US Foreign Corrupt Practices Act and UK Bribery Act in their home jurisdictions, and in part because of the lack of enforcement of compliance rules both at home and in other Asian jurisdictions where the bulk of their deals are done. Whilst there is increased awareness of the mind boggling settlements in monetary terms with US and European authorities for incidences of ABC infringement, antitrust and now data breaches, this is still seen as a problem for companies from the west – but this is changing. We are increasingly approached by Asian clients to help with compliance programs and issues."
In terms of the regions that were the most challenging in terms of M&A and compliance risk, Greater China, Africa, South Asia (including India) and the Middle East rounded out the top four. Interestingly, this does not seem to deter those respondents looking to grow via acquisition, with China and India still the top two geographical targets globally.
However, across all markets compliance requirements and therefore risk is only increasing. One such area is in anti-corruption enforcement.
According to New York-based William Devaney, Co-Chair, Global Compliance and Investigations, Baker McKenzie:
"In the past, anti-corruption enforcement was largely the realm of the United States. Now, even as US enforcement may be waning somewhat, other nations are picking up the pace, both with new corporate criminal liability legislation and increased enforcement. We are also seeing greater regulatory and criminal money laundering enforcement both related and unrelated to bribery.
"You can buy these problems. As such, anti-corruption and money laundering trends (not to mention increased enforcement in many other areas) only serve to underscore the importance of vigilant pre-transactional compliance due diligence and post-acquisition integration."
In terms of specific compliance risks, the most pressing regarding deal success is still the area that receives the most attention – anti-trust. However, other areas were predicted to increase in importance over the coming year, including export controls/trade sanctions, data protection, and environmental and labor regulations.
Samantha Mobley, Partner, EU, Competition & Trade Practice, Baker McKenzie, London, said:
"Failure to identify and deal with anti-competitive conduct pre-acquisition could leave the buyer exposed to lengthy anti-trust investigations and penalties. Cross-border deals will often be scrutinized by regulators, who are increasingly demanding to see large volumes of internal documents and using sophisticated IT forensic tools for their review. This raises the risk of the regulator uncovering potentially problematic conduct, which could jeopardize the deal itself, and create complications which the buyer will have to handle post-acquisition."
When asked whether conducting proper CDD increases the chances of success of M&A or JV deal completion and value creation, 55% of those surveyed globally said it would, compared with just 30% who didn’t think it would help.
But these same senior transaction specialists admit they are simply not doing enough to understand compliance risk. More than half (55%) of respondents said they wish they had spent more time on CDD relating to a deal they had already closed, while only around half of those surveyed have developed standardised pre-transactional protocols regarding CDD.
For further information, please contact:
Milton W. M. Cheng, Partner, Baker & McKenzie
milton.cheng@bakermckenzie.com
