Global Financial Services Industry: M&A and Capital Market Landscape H1 2022 Review

Global Financial Services Market 2022: Turbulent times ahead

The global financial services market continued its frenetic pace of M&A and capital market activity at the start of 2022, keeping pace with a record-breaking 2021. However, it must be noted that the deal volume in 2021 did not yield an easy number that could be effortlessly replicated. Therefore, instead of increasing the volume of deals, companies seem to have begun focusing on closing the right deals to foster strategic growth and capital returns as economic and geopolitical unpredictability takes its toll.

At present, inflation and geo-political uncertainties are impacting decision-making, indicating that the rest of 2022 might turn out to be quite challenging for the global financial services market when it comes to M&A and capital market activity. However, investors have voiced their concerns about a probable recession, which may increase defaults and spur activity across the sector.

The global financial services industry is under tremendous pressure and is transforming rapidly due to the rise of disruptors such as fintech platforms and a more stringent regulatory environment. Moreover, the emergence of local banking leaders has come under regulatory scrutiny, which could stifle the announcement of megadeals in 2022.

The following key developments are likely to have a tremendous impact on M&A and Capital market activity across the global financial services market in 2022:

• Global political instability, which has led to historic inflation and global economic uncertainty
• Regulators focus on introducing stringent due diligence processes, which may slow down M&A transactions and affect investment across sub-sectors
• Higher cost of borrowing as central banks step up their efforts to contain inflation
• Financial sponsors have largely been cautious to deploy their ‘eager capital’

Financial Services Sectoral Performance: Tale of 4 Key Sub-Sectors

Global Financial Services M&A 2022: Growing concerns for businesses

The first half of 2022 saw muted deal activity compared to the blockbuster volumes in 2021. Governments across the globe have started hiking interest rates, which in turn has increased the cost of capital. Additionally, supply chain problems have grown due to trade restrictions and high geopolitical tensions have hastened the rejection of globalism and cross-border transactions. Investors were primarily forced to hold off on deal making because of the uncertainty regarding the global growth outlook.

The industry witnessed limited deal closures and is yet to see the conclusion of some ‘big ticket’ deals. The volume of deals withdrawn till date is comparable to that at the onset of the pandemic. As a result, dealmakers are having to amend their strategies to bridge the valuation gaps. They are conducting deeper analysis of the targets thereby extending duration of negotiations and due diligence

Some of the key observation during the 1H’22:

• Some major consolidators are leaving the M&A sector because of the current market conditions with private equity firms are becoming mere spectators due to rising interest rates
• Corporate dealmakers continue to explore potential deals; however, sellers need to recalibrate their expectations to reduce valuation gaps
• M&As and divestitures poised to pick up steam as banks, insurance companies, and asset managers try to optimise their cost structures, grow their top lines, and boost efficiency and profitability in the businesses

Financial Services Funding: Geopolitics and Volatility Curbing Demand

The financial equity and debt capital markets (ECM and DCM) witnessed contrasting demand this year. In 1Q’22, the DCM witnessed borrowers rushing to refinance and extend debt maturities before the potential rate hikes later in the year. However, the momentum was short-lived, with volumes reverting to pre-pandemic levels as seen by the 78% fall in high-yield instrument issuances in 1H’22 (indicating a ‘flight to quality). The syndicated loans market almost came to a halt due to the geopolitical crisis, with investors pausing to review their portfolios and the related primary and secondary risks. The recent scrutiny of SPAC IPOs and their redemption pressure plus the lack of investor demand for traditional IPOs have essentially stalled global ECM activities. The revival of market sentiments, inflationary pressure, fear of recession, geo-political scenario, and impact of rising interest rates are expected to be the key factors determining the capital market activity for the rest of the year

Financial Services SPACs: Deal Innovation to Counter Regulatory Headwinds

The heightened regulatory scrutiny has put the brakes on SPAC IPOs. In March 2022, the Securities and Exchange Commission (SEC) of the U.S. proposed new rules and amendments to enhance disclosure and investor protections in SPAC IPOs and business combination transactions between shell companies, such as SPACs and private operating companies. Along with concerns around mixed post-deal performance, rising redemptions during De-SPAC, a weak PIPE market, and overcrowding, this has resulted in growing investors’ doubts about SPACs’ ability to deliver high-quality companies. Though funding has dried up this year, innovative deal structures can still revive investor faith and stability.

ESG: Key to long-term and sustainable value generation

The COVID-19 pandemic has demonstrated that adhering to ESG factors is key to crisis-resilient long-term value creation. Companies with dynamic business cultures were relatively more resilient during the shutdowns, given their ability to absorb the shock. Globally, investors have started to recognize the potential benefits of announcing an acquisition that is ESG accretive. By directly linking ESG factors to long-term value creation, companies can substantially alleviate investor concerns by de-risking their investments

As the ESG investment market continues to grow rapidly, Banks are strategically deploying fintech ecosystems to drive sustainability in their products and operations which is referred to as ‘Sustainable Digital Finance’. Several banks have joined the UN-convened Net-Zero Banking Alliance. Under this, they have committed to aligning their lending and investment portfolios with net-zero emissions by 2050.

External rating agencies are including ESG criteria for their rating. As a result, banks are now strictly adhering to ‘soft’ sustainability criteria. Additionally, legal provisions or authorities’ expectations obligate banks to screen their assets, disclose the green asset ratio, and include ESG aspects in their credit-approval processes.

From a funding standpoint, the cost of capital for companies with better ESG scores is lower than for companies with weaker scores. For instance, there is higher investor demand and better pricing for issuers for many green, social, or sustainable bonds in comparison to traditional non-ESG issuances

Outlook 2022: Spotlight on Adaptability and Rebuild

Despite the recent slowdown, the long-term fundamental M&A themes remain intact. We continue to expect the deal activity along with funding to rebound during the latter part of the year although not at the levels witnessed in 2021. In the light of these developments, we foresee the following trends to define the overall deal-making for the remainder of 2022:

1. Economic Upheaval: Pressure on organic growth and capital appreciation, as well as lower valuations, are expected to act as currencies for M&A. Overall, geo-political and inflationary headwinds have significantly increased economic risks, making policy tradeoffs even more challenging. Cross-border deals are expected to remain muted in the near term as corporates re-evaluate their expansion plans.
2. Regulatory Environment: The global regulatory and tax conditions have been favorable though authorities have started enhancing scrutiny for megadeals. This increased due diligence will likely slow down the execution process, e.g., work-from-home compliance, cybersecurity, privacy, data protection and accounting regulations.
3. Technological Changes: Digital transformation is necessary for fraud management, cybersecurity, and digital client servicing. M&A remains the quickest way for organizations to build these capabilities. As a result, technology is set to remain at the forefront of corporate strategies to build market position, especially in the current Fintech wave.
4. Financial Market Support: The credit market is expected to remain active though funding levels are expected to be more normalized vs 2021. Private equity firms continue to deploy their dry powder in life insurance and annuities and payments sub-sectors. Higher interest rates, recalibration of expectations of SPACs, and mixed after-market performances will however curtail demand to a certain extent.
5. Evolving sectoral dynamics: Themes such as the rise of domestic champions, challenger bank M&A, focus on deleveraging balance sheets and reconfiguration of operating models should continue to play out