Analysis

Global M&A Market In Limbo As Russian Sanctions Unfold

Law360 (February 28, 2022, 5:54 PM EST) -- Sanctions imposed by the U.S. and other countries over Russia's invasion of Ukraine are causing significant uncertainty in the global markets, which could reverberate in the mergers and acquisitions and private equity spheres for months to come. 

There is concern that the uncertainty might not only hamper an otherwise busy year for global mergers and acquisitions, but could cause issues for private equity deal making and fundraising as firms grapple with investors in their funds that have Russian ties.

Peter Wand, a partner with Baker McKenzie in Frankfurt, Germany, told Law360 that Russia's invasion will have a "chilling effect" on the deals environment both in Europe and across the world.

"Uncertainty and deals do not go well together," Wand said.

Here, Law360 explores four potential effects of the sanctions on M&A and private equity.

Global Deal Making, Fundraising May Falter

Global M&A activity has been very strong for some time now, save for a COVID-19-induced blip in early 2020 that only lasted a few months before deals picked up again. Similarly, private equity fundraising has been robust, with the total amount of dry powder — or capital that has been raised but not yet spent — having risen in each of the last 10 years, according to data from research firm Preqin

Heading into this year, experts had predicted that M&A and private equity activity would continue apace despite looming headwinds like a heightened regulatory environment and an anticipated spike in federal interest rates.

But the invasion of Ukraine has thrown everything out of whack. The U.S. and other Western governments quickly took action by imposing economic sanctions last week on Russia and certain individuals and entities. Those sanctions were sharpened over the weekend, including by cutting off certain Russian banks from the SWIFT global financial messaging system and blocking the country's central bank from liquidating assets held abroad. 

"We're often hearing about new sanctions without having an understanding of how they are going to be implemented," Zachary Brez, a partner in the government and internal investigations group at Kirkland & Ellis LLP, explained during a media call the firm held on Russian sanctions.

Brez said the situation is evolving so rapidly that no one, not even the people issuing the sanctions, know exactly how they'll affect sectors such as M&A and private equity.

"The folks issuing [these] sanctions are drinking from a fire hose with a thimble," Brez said.

"It has been a breathtaking pace," he added. "I can only imagine what it might be like for folks where this is all brand new."

Supply Chain Woes, Inflation May Worsen

The effects of the sanctions on global deal making become even more complicated when considering potential impacts on the supply chain and inflation. According to Wand, it will be months before the full effects of the invasion and sanctions on supply chains and exports are known, adding that the disruption will be "very significant and affect a broad range of industries," such as energy, food and metals, the lattermost of which is important for global chipmaking.

"The number of 'tier one' Russian or Ukrainian suppliers in Western supply chains is limited," he said. "However, things become much more complicated when factoring in lower-tier suppliers, raw materials and energy. Rising raw material and energy prices will send companies' operating costs soaring and increase inflation sharply."

Scott Flicker, a partner at Paul Hastings LLP who leads the firm's global trade controls practice, said that because Russian and Ukrainian assets and companies only comprise a small part of the overall global M&A market, it's not completely clear what the direct impacts of the crisis will be on deal making.

"But the indirect effects could be substantial, as the instability of the situation could both spook investors and fuel more inflation across the Eurozone," he said. "Even $100[-a-barrel] oil will not be able to counteract those macro effects."

And given the speed at which everything is changing, including the situation on the ground in Ukraine and the sanctions and other actions from governments across the world, there's no telling how long it might be before the market goes back to normal. 

"We are likely to be in this environment for not days or months, but years," said Mario Mancuso, a partner at Kirkland who leads the firm's international trade and national security practice.

New National Security Concerns May Arise

The situation also underscores the growing prominence of foreign investment regimes like the Committee on Foreign Investment in the United States, explained Mancuso.

"You can expect governments to utilize other national security regimes, like foreign investment governance regimes, to address this circumstance," he said. 

A private equity fund that has any affiliation with a Russian investor, for instance, may have a hard time convincing CFIUS and similar regimes across the globe that it should be allowed to go through with the acquisition of assets in the U.S., U.K., Australia, Japan or Canada, among other countries.

When it comes to deals that may go before CFIUS, "very focused, very granular analysis will be required," Mancuso added.

It's well-known that CFIUS takes a hard look at any deal involving Chinese entities or investors, and while Russia has been a focus of CFIUS before, the committee will clearly double down its efforts on examining transactions that involve Russian-affiliated investors or businesses.

"Who knows how many Russian companies are going to be looking to invest in U.S. companies right now with what's going on?" said Ama Adams, a partner in the anti-corruption and international risks group at Ropes & Gray LLP.

Limited Partners With Russian Ties May Complicate Funds

Although at first glance it might seem like U.S.-based private equity firms should have little to worry about, that's not entirely true, Adams noted. The private investment industry has gone global over the years, and it's not necessarily uncommon for today's PE funds to have limited partners, or investors, that are either based in Russia themselves or have ties to Russian entities. If one or more LPs in a fund's investor base is directly affected by the sanctions, then a general sponsor is not legally allowed to do things like send distributions or redeem payments, Adams explained.

"How do you deal with the reverberations and cascading effects when a limited partner in the investor base for a fund is suddenly a persona non grata?" she asked. "PE firms need to be looking at their [limited partner agreements] to understand what sanctions compliance, representations and warranties and covenants they have in place to deal with these types of situations."

Making matters more complicated is that the question of whether a person or business has Russian ties isn't black and white, according to Kirkland's Brez.

"By definition, anyone who is sanctioned, anything they own is also sanctioned, even if it isn't specifically named as being sanctioned," he said. "The work is left to us and our clients to figure out."

For lawyers based in the U.S. attempting to wrap their head around what's going on and how it might affect their practice, it can be helpful to lean on peers located elsewhere in the world. Adams, for instance, said Ropes & Gray attorneys are coordinating across offices in the U.S., Europe and Asia to ensure everyone has the most up-to-date information about moves being made by governments in each of those regions.

"We coordinate with our teams and track what's going on across the world," she said. "We rely on the colleagues in our offices in those places to help understand what laws and regulations are being put in place and how they are going to impact companies that are subject to such laws and regulations."

--Additional reporting by Najiyya Budaly. Editing by Alanna Weissman and Kelly Duncan.

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