A look at trends and influences which we expect to impact mid-market banking and finance in 2022.
Last year’s article heavily featured COVID-19, its impact, and expected patterns of recovery. While the pandemic continues to have a huge impact on our lives, most stakeholders have learnt to live with this uncertainty and businesses have adapted accordingly. Other topics, such as environmental, social, and governance considerations (ESG) and challenges, such as supply chain issues, now feature just as heavily on board room agendas. It has been a relatively strong year in the market, but there are tests ahead.
The resilience of the market post COVID-19 has been surprising. Since the initial shockwave, there has been no lack of liquidity and we’re now seeing many of the British Business Bank loans (BBBLs) refinanced, having not been utilised as originally expected. As reported last year, high street banks have focussed on supporting existing customers through the pandemic, which has definitely played a part in avoiding the number of distressed businesses initially anticipated. However, with moratoriums on rent arrears expected to cease in the spring of 2022 and government support slowly lessening, it remains to be seen whether our economy can face the level of financial trauma caused by COVID-19 without suffering more deeply.
Merger and acquisition (M&A) levels and terms
The UK M&A market has remained strong; levels are not unprecedented but have been surprising given the events of the prior 18 months. We’ve seen really good quality transactions in the last year, with businesses and lenders running very competitive processes, particularly in industries that have fared well during the pandemic: healthcare, e-commerce and all things ESG and technology. That said, businesses in some sectors, hospitality being the obvious one, have struggled. We expect the polarisation of the market to continue through 2022 and beyond.
Liquidity has driven strong borrower terms, with lots of trends from the larger syndicated loans market moving down into the mid-market. Borrowers now often insist on preparing first drafts of facilities agreements and consequently more borrower-friendly terms are becoming commonplace. We now regularly see grower baskets, more flexibility around equity cure provisions, default triggers, synergies and earnings before interest, taxes, depreciation and amortization addbacks - with conversations around the latter often initiated as a result of COVID-19 related exceptional items. Previously these would have been the preserve of only the strongest borrowers.
We’re also seeing smaller and non-bank clubs starting to appear more regularly. Both as a way to spread risk up front in order to offer more competitive terms, and to provide liquidity comfort and ‘future proof’ lends - accordions are still routine. There is a level of uncertainty about what the next few years will bring. Portability and transferability have been heavily negotiated in a number of recent deals as a result.
Market challenges ahead
Pipelines remain stable but there is some anxiety around how much is post COVID-19 ‘catch up’, and when and how quickly things will slow. We know interest rates will continue to rise, as will inflation, Brexit has resulted in increased import duties, energy and fuel costs are at all-time highs, there are supply chain bottlenecks and stiff competition in the labour market. Combined with additional COVID-19 restrictions, these could result in casualties as we move through 2022.
Any volatility in the market will inevitably bring about changes in terms and we might see that reflected in pricing as well as bespoke terms over coming months. That said, we don’t expect much reprieve in good terms for strong borrowers if industry polarisation does continue.
We couldn’t write this article without mentioning the importance of ESG for all stakeholders. The current state of play, opportunity and risk around ESG and related products are each worthy of articles in their own right and we won’t try to summarise those here. What we can say is that we’re expecting to see lots of new products come to market – all of which will no doubt be introduced with caution to avoid any future ‘greenwashing’ scandals. We’re expecting that ESG will feature on all term sheets by the end of the year, particularly given the LMA’s recent recommendation and the fact that ESG credential scrutiny is now an everyday part of good governance for borrowers and lenders, whatever their business. Upskilling existing employees also needs to become a focus.
More generally, we’re seeing a shift in emphasis as the market acknowledges that an economy-wide view requires investment in carbon-heavy businesses as well as those considered sustainable, those being the businesses with the biggest room for improvement and innovation.
This is the most likely area for increased regulation in the short term with the FCA noting in November that ”there is a risk of harm if the financial sector responds to rising consumer demand and awareness of ESG issues without a supportive regulatory foundation and adequate guard-rails”. For a summary of what we’re seeing in sustainability linked loans see our article: [What we’re seeing: Margin Ratchets in Environmental, Social and Governance (‘ESG’) Loans (shoosmiths.co.uk)].
LIBOR: Risk Free Rates
This could be the final year we mention the cessation of LIBOR! The transition is in its final stages and for the most part we now wave goodbye to LIBOR for sterling. It remains to be seen how many loans will be badged ‘tough legacy’ and how closely the FCA scrutinise that. We anticipate the transition to risk free rates for USD and other IBORs will be relatively smooth – following the path already laid down for sterling based LIBOR loans.
Technology and security over IP
This is an area in which the law, in nearly all jurisdictions, needs an overhaul. The Law Commission has recognised this and consulted this year with market participants (with the final consultation paper expected mid-2022). Unsurprisingly we increasingly see digital assets and IP considered key when valuing and funding a business. The Law Commission’s consultation may lead to a reform of English law in order to “lay a strong foundation for the development and adoption of digital assets”. For more information on how this might impact our market directly, see our article: [Cryptocurrency – The Future of Banking? (shoosmiths.co.uk)].
National Security and Investment Act 2021 (“NSI Act”)
Another regulatory change we expect to impact our market is the NSI Act, which creates a national security screening regime for acquisitions (both share and asset transactions). The NSI Act is wide-reaching: a number of specified sectors are affected and there is no definition of “national security”, giving rise to the potential for a large number of transactions to be captured. It will be interesting to see how the lending market deals with this in documentation, and what impact the NSI Act will have on transaction timetables. For more information on how this might impact our market, see our article: [What the National Security and Investment Act means for banking deals (shoosmiths.co.uk)].
We are expecting a year of change as the pandemic ceases to exert so much of a hold on decision making – and that change will bring with it both opportunities and challenges.