After a half-decade of steady growth, markets in Europe, the Middle East and Africa (EMEA) are beginning to face significant headwinds. Geopolitical and macroeconomic uncertainty, rising populism and volatile stock markets have all weighed on dealmaker confidence. Deal value in EMEA fell by almost a quarter over the first six months of 2019, yet demand for deal-related M&A insurance solutions remained resilient. In this report, the third in Aon’s global M&A Risk in Review series, we look at how the use of M&A insurances continues to increase and shape the M&A industry landscape.
M&A deals were announced in the
first half of 2019 for targets in EMEA
deal value was reported in the
first half of 2019 in EMEA
increase in the number of Aon
insured transactions in the region
Aon is not a law firm nor does it provide legal advice. This article is based solely on Aon’s experience as insurance practitioners. Aon recommends that you consult with your own legal counsel as respects the content of this article.
After a half-decade of steady growth, markets in Europe, the Middle East and Africa (EMEA) are beginning to face significant headwinds. Geopolitical and macroeconomic uncertainty, rising populism and volatile stock markets have all weighed on dealmaker confidence.
Issues affecting cross-border trade are having an especially strong effect on the region. After a series of delays, the final outcome of the UK’s exit from the European Union – initially scheduled for the end of October 2019 but now delayed once again, likely until 2020 – is still unclear. The intensifying trade war between the US, China and the EU has put a further dampener on prospects for economic growth, and stock markets remain volatile. As a result, it should come as no shock that deal value in EMEA fell by almost a quarter over the first six months of 2019, according to Mergermarket data, declining 23% from $683.8B in H1 2018 to $528.4B in H1 2019.
Yet despite the drop in M&A and diffcult deal backdrop, demand from Aon’s clients in EMEA for deal-related M&A solutions – particularly, warranty & indemnity (W&I), tax and contingent risk insurance – has remained resilient. Both the volume of M&A on related deals in which Aon has been involved, and the aggregate amount of M&A insurance placed in relation thereto by Aon, have remained constant. In H1 2019, there were 165 insured deals with $9.1B limits, consistent with the 166 deals with limits of $9.2B in H1 2018.1
The appetite for M&A insurance remains robust because deals are still trading at high prices, despite increased uncertainty in the economic and political environment. The most recent Argos Index, for example, which tracks the multiples of private European mid-market deals, shows that average multiples are at an all-time high of 10x Ebitda. The combination of rising risk and high valuations has made M&A insurance an increasingly important part of the deal execution toolkit.
“In this report – which is part of a four-part series covering M&A insurance trends in North America, EMEA and Asia-Pacific as well as a comparative global round-up at the end of 2019 – we take a detailed look at the uptake and use of transaction insurance products in EMEA,” says Simon Tesselment, Chief Broking Officer, M&A and Transaction Solutions. “The coverage includes analysis of data on how M&A insurance is being used, as well as a survey of corporates, private equity firms and M&A advisers, exploring their insights into the risks and opportunities present in the EMEA transaction market. We explore how deal professionals are assessing and mitigating risk when the economic and political backdrop is unpredictable, and prices remain full.”
1 Aon M&A and Transaction Solutions EMEA internal information
When combined with the results of Aon’s Transaction Solutions teams in North America and EMEA, global utilization of M&A insurance in 2018 resulted in:
in limits placed
M&A deals were announced in 2018 for targets in EMEA
total deal value represented the second-highest annual total seen in the region in the past decade
The uptake of W&I insurance over the past 12-24 months in EMEA remains strong:
increase in the number of Aon-insured transactions in the region
were done in 2018, up from 195 deals the year before
The uptake of W&I insurance in EMEA has been strong over the last 12 to 24 months, mirroring the situation in other jurisdictions, as buyers and sellers seek cover to facilitate deal execution and cover off downside risk during a period of uncertainty. The number of transactions in the region insured by Aon has increased by more than two-thirds (67%), from 195 deals in 2017 to 326 deals in 2018.
The rise in W&I use comes despite expectations that deal activity will fall over the next year. More than half (52%) of survey respondents expect the number of M&A deals to fall by between 2% and 5%, or by more than 5%, over the next 12 months. Only 8% predict an increase of between 2% and 5%, and 40% say they expect activity to remain within 2% of figures for the last 12 months.
This expansion comes at the same time as the boom in M&A activity continues in North America as well as globally. There were 6,800 M&A deals in North America last year valued at a total of $1.65 trillion, according to Mergermarket data, representing an increase of 318 deals and a 16.8% surge in transaction value compared to 2017. Despite potential macroeconomic risks on the horizon, deal-making appears to be primed for further growth over the coming year – a full 80% of participants in our survey of M&A professionals said they think the number of deals will increase in the next 12 months.
“This is a very challenging environment. Political uncertainty is adding to a very complex situation, with a direct impact on the level of M&A activity,” said a partner at an Italian law firm.
Despite the recent drop in deal volume in EMEA, the increase in W&I uptake comes as buyside M&A investors pay closer attention to evaluating macroeconomic and political risk and to remaining disciplined through deal processes to avoid overpaying. In our survey, these two issues (25% each) were cited as the main challenges private equity and corporate dealmakers faced when executing deals on the buyside, ahead of securing financing on favorable terms (19%), identifying attractive targets (19%) and overcoming regulatory obstacles (12%). When questioned on the biggest risks facing potential M&A targets over the next 12 months, almost two-thirds of respondents (64%) chose macroeconomic risks.
“Over the next 12 months, global trends and influences of events such as Brexit should be monitored. Investors will remain cautious and more reservation will be shown towards taking risk,” said the chief investment officer at a German private equity firm.
As risk assessment has become increasingly important for M&A execution, and uptake of W&I cover has increased, the limits on cover have ticked higher as well. In 2015, the total limits for cover for private equity and corporate EMEA deals came in at around $3B. By 2018, total limits had increased to more than $14B
Data broadly shows that smaller deals buy proportionately higher coverage limits, as this represents better value for money. This is because most insurers tend to charge minimum premiums meaning that the purchase of limits below €10M can begin to look expensive. Larger deals tend to buy coverage limits of 10% of deal value or less, due to cost and market practice in non-insured deals. In a large transaction, however, a limit of 10% still represents hundreds of millions of dollars of protection from insurers. Although premium rating tends to spike for larger deals, the actual effect when considered in overall context of deal value is negligible (see chart on page 5).
Overall, total current market capacity in EMEA stands at approximately $1.5B per transaction. This ceiling has expanded rapidly in recent years, and in 2018 alone it climbed by approximately $330M, as an increase in capacity deployed by incumbent providers and new entrants drove capability higher. There are currently around 33 insurers writing transaction solutions insurance in EMEA, with additional capacity available from the US, Bermuda and Asia. Aon used the increased capacity in 2018 to place the largest W&I (€1B limit) and tax ($750M limit) policies written to date in EMEA.
Three regions in continental Europe accounted for the bulk of EMEA activity in 2018. The UK (including Ireland) was the largest deal market by volume and value, with 1,826 deals worth $338.3B, followed by Southern Europe, where there were 1,410 transactions worth $199.9B, while DACH posted 1,318 deals valued at $171.7B.
The Middle East and Africa recorded 224 deals worth $48.8B and 237 deals worth $20.9B, respectively, in 2018.
This spread of activity is broadly reflective of the policies placed by Aon’s broking teams across EMEA. Aon EMEA provided cover for transactions involving target companies in 34 jurisdictions in 2018.The UK & Ireland was the largest market for Aon last year, with limits running around $2.75B, followed by the DACH region (circa $2.5B) and Benelux (circa $2B). The Nordics market increased three-fold to more than $1.5B, and southern Europe more than doubled in size to more than $1B.
Dealmakers that have used W&I cover in EMEA have generally tended to make use of the product for both domestic and cross-border deals. In our dealmaker survey, 40% said the use of W&I was usually the same for cross-border and domestic deals, with 40% saying it was somewhat more common for international transactions. Only 20% said W&I insurance was much more common in domestic acquisitions.
Transaction Solutions and Public M&A
An additional and developing aspect of the EMEA M&A insurance marketplace is public M&A. Aside from public offering of securities insurance (POSI), insurance products have historically had little application outside of the private deal space. There are typically very few, limited, or no warranties provided by the target company or its shareholders in public deals, meaning that W&I insurance is simply not relevant.
Aon, however, has recently challenged the market to come up with more innovative solutions to meet client demand for greater downside protection in the public markets, whether in an M&A context or otherwise. This has meant engaging with insurers both in and outside of the current M&A space and has resulted in a number of groundbreaking placements.
Examples include structuring and placing a W&I policy for a public-to-private transaction in Poland and placing a tax policy for a public company to preserve the tax treatment arising from a redomicile of its IP assets. We have also seen an increasing number of public companies using W&I in private M&A, having realized that they are able to drive comparable benefits to those enjoyed by their private equity counterparts for many years. These examples barely scratch the surface of what Aon perceives to be the unmet needs for solutions in the public M&A transaction arena. We expect the market to develop over the next few years. Watch this space.
But even though W&I cover is now commonplace in cross-border deals involving EMEA targets, only 28% of those polled had negotiated a W&I policy for a US buyer making a cross-border deal in the region.
This could be down to the differences between US policies and those in EMEA (see “Warranty & Indemnity vs. Reps & Warranties” on page 8). All respondents who had negotiated W&I policies for US buyers making a cross-border acquisition in EMEA reported policy durations different to what was typical in EMEA policies, and said there were no exclusions for matters disclosed in the buyer’s due diligence report. Some 43% noted fewer general exclusions, with 29% noting policy wording that is friendlier to the insured.
With regards to sectors, the industrials and chemicals industry delivered the largest deal volume in H1 2019, with 758 deals valued at $120.9B. Pharma, medical and biotech was the largest sector by deal value over the period, with a value of $135B across 275 transactions. Business services and technology were the next busiest sectors by volume, with 626 deals worth $27.6B and 585 transactions worth $30.3B, respectively.
The insurance market remained relatively agnostic on industry, with market sector policies secured for clients operating across a broad range of industries (see chart on page 9). The largest sectors were energy (23%), industrials (21%) and real estate (17%).
In addition to the rise in W&I uptake, the use of tax insurance is also growing rapidly. We estimate $3B of tax risks were insured in EMEA and APAC in 2018, across approximately 100 separate deals.
Pricing for tax insurance has remained steady over the past 18 months, although competition among insurers is improving pricing for certain types of risks, particularly for certain real estate and M&A-related issues. Competition and provision are on track to increase further this year following the entry into the market of new tax insurers. Aon estimates that by the end of 2019, there will be around 20 insurers offering the product.
Private dealmaking has remained the predominant driver of tax insurance uptake, but clients are now increasingly insuring tax risks in other situations too, such as restructuring, financings and in public deals. Indeed, transactions outside of M&A now account for almost a fifth (19%) of tax insurance. Financial investors represent the largest buyer group for tax insurance, accounting for 57% of the client base, followed by corporates at 41%.
As the application of tax insurance has broadened and its use increased, Aon has expanded its tax team and now has specialist tax insurance brokers in London and Frankfurt, with German, UK, Luxembourg, Spanish and Finnish M&A tax backgrounds.
In parallel to the huge surge in the litigation funding market, where clients can pursue the upside of litigation with the backing of a funder, we continue to see increasing interest in the insurance market to protect clients against the downside of litigation – and not just by providing the after-the-event (ATE) cost product, which is a necessary adjunct for funders.
Ongoing litigation and other contingent legal risks pose a major hurdle to successful M&A transactions, as risk allocation between seller and buyer in those circumstances can be difficult. Not all cases lend themselves to insurance, but as the M&A community becomes more educated about the wide repertoire of transaction solution products, we anticipate a major uptick in successful cases, in which litigation or other contingent risks have been ringfenced by imaginatively structured products.
Considering that only a small number of claims have been litigated in the UK or European courts, and that the terms of private settlements are usually confidential, it can be difficult to assess the full scale of W&I claims. While it appears that both W&I and tax insurance claims have been manageable for insurers in the market to-date, claims handling is still being tested.
Quantifying loss can be especially complex and typically involves instructing forensic expert accountants. Whereas in English law loss under a W&I policy will ordinarily mean that the buyer is entitled to claim the difference between the “true value” of the company and the “as warranted” value (unless some other express agreement has been reached), the position is different in other European jurisdictions.
The split between types of warranty breaches will vary depending on the book of business and geographical locations, though common areas of dispute include, but are not limited to, financial statements, tax, compliance with laws, and material contracts. Due to the bespoke nature of W&I policies and the varying positions under different legal jurisdictions, the policy and underlying deal documents need to be carefully considered in the event of a claim.
Aon has been notified of 109 notifications on policies placed in the London market since the start of 2016. Based on this sample, most notifications (75%) occur within the first 18 months of the policy and more than half (53%) of claims close within a year. Most claims relate to tax (37 claims), followed by financial statements (32) and regulatory issues (24).
Despite the drop in overall deal activity, M&A markets continue to favor sellers. According to our survey, 44% of respondents say sellers have demanded somewhat more favorable terms on deal terms over the last 18 months, with 28% saying sellers have pushed for much more favorable terms.
Sales via auctions, therefore, remain a constant, and more than half (53%) of the deals Aon has worked on have been structured in this way. Sales processes have become ever more competitive in the deals Aon has worked on, with bidders rarely being granted exclusivity. Instead of working bilaterally, sellers are funneling potential buyers into contract races whereby two or more bidders continue to compete right until a deal is struck with one of them, who then signs a Sale and Purchase Agreement (SPA).
The truncated nature of deal processes and the limited time made available for diligence could explain why 32% of respondents only conduct risk and insurance due diligence “rather often,” and prioritize “core” areas such as human capital diligence and cyber diligence “extremely often.” Indeed, close to a third of those polled say gaining access to information is the most contentious point in a deal negotiation in the current M&A environment. Agreeing on how financial data is interpreted (16%) and negotiating representations, warranties and other covenants (12%) also ranked highly.
The sales-friendly market has helped to push a rise in the number of so-called “hard staple” deals, where around 75% of insurers’ underwriting is completed on the sell-side before the process “flips” to the buyer to complete a compressed buyside process. The survey findings show that for 68% of respondents, W&I insurance is stapled to the bid package to facilitate an accelerated path to signing. This contrasts to a “soft staple” whereby the seller secures indicative and non-binding terms only leaving buyers to take over the process and complete a full underwriting process at an earlier stage.
In order to succeed, a “hard staple” process does need to be supported by fulsome vendor due diligence and strong sponsor or financial adviser backing, such that the stapled policy is mandated into the process in the strongest possible terms.
And while “hard staples” speed up deal execution for sellers, they do place extra pressure and workload on advisers, insurers and buyers. Sellers are increasingly running contract races and requiring insurers and brokers to run multiple clean buyside broking and underwriting teams – so-called “trees.” This ties up significant resources, and because it can make it more difficult for buyers to gain an edge, some buyers are stepping away, which means a loss of competitive tension.
Insurance is now used not only as a tool to facilitate execution but has, in many cases, revolutionized the way in which deals are structured.
Three of the most common innovations are:
Nil recourse, which is particularly common in auctions. It allows sellers to retain little or no liability for breaches of warranty under the terms of the SPA, apart from in cases of fraud.
Knowledge scrapes, whereby the awareness qualification applied to certain warranties is disregarded for the purpose of the policy. This feature is common when management warranty deeds seek to apply a blanket awareness qualifier across all warranties.
Synthetic tax covenants are used in transactions in which sellers refuse or are unable to provide a general tax covenant. Insurers can provide the equivalent protection directly in the policy, although known or identified tax issues will be excluded.
The uptake of M&A insurance across the EMEA region over the last 18 months has continued to climb despite a drop off in deal activity. Although the macroeconomic and geopolitical backdrop has become more volatile and unpredictable, assets continue to command high prices in a market that still favors vendors. M&A insurance uptake has increased as a result, as buyers turn to the product to cover off downside risk and sellers staple cover to deals in order to expedite exit processes. New entrants in the market have created competition, increased provision and helped to keep prices down, which has also supported wider use.
As more M&A practitioners have made use of M&A insurance coverage, insurers have been able to offer more sophisticated and flexible products that can be used across a wider range of scenarios. Around a fifth of policies are now issued for restructurings, refinancings and public deals, diversifying from the staple private M&A market. Uptake of tax insurance, rather than just W&I cover, is becoming more prevalent as well, and insurers have developed litigation cover in response to the rapid growth of the litigation funding market.
Such is the familiarity of dealmakers with M&A insurance that it is now influencing how deals are structured, providing an alternative to SPA terms on nil recourse, awareness qualifications and tax covenants.
Following this analysis of the M&A risk environment in EMEA, the final installment of our four-part series will wrap with a global year-in-review. Keep an eye out for parts one and two of the series as well, which focused on the North American and Asia-Pacific markets.