In recent report entitled The conflict of interest? Rising rates effects on M&A, MergerMarket was commissioned by Toppan Vite to examine the effect of potential rising interest rates on the effect of M&A activity in the coming year.

U.S. M&A activity was at peak performance in 2014 as deal activity increased to over 5,051 deals worth $1.5tn U.S., up from 3,995 transactions worth $937bn U.S. in 2013. However, with a potential rise in interest rates coming in 2015 from the Federal Reserve, many are concerned about its effect on deal activity in the coming year. MergerMarket interviewed seven leaders in the field to determine their views.

What kind of impact will changing interest rates have on the level of M&A activity?

The experts were of the opinion that a key factor related to the impact of rising interest rates on M&A activity is the speed at which the rise in interest rates occurs. A slow, gradual rise in interest rates that comes from a strong economy will likely be coupled with rising corporate confidence that could increase deal activity, whereas a sudden, large increase in interest rates could create higher volatility in the market due to rate shock, ultimately dampening deal activity for a period of time.

Additionally, the type of acquisition ought to be considered. For example, in mid-market M&A, the main impact of interest rates is the price that someone is willing to pay for companies. As interest rates go up, private equity sponsors will have to pay more for the loans underlying the acquisitions, and ultimately, will want to pay less their acquisition. Until a new balance is reached, a slowdown in activity may result.

Do the current high levels of capital negate the effect of rising rates?

Capital markets today are the deepest that they have been in a long time, perhaps ever. Some experts believed that overall market liquidity, both corporate cash and private equity capital, may have a buffering effect of higher interest rates with capital being available to fund despite an increase in borrowing cost.

However, some experts gave a more skeptical view that as the cost of debt goes up, the price that a company can pay goes down. If interest rates are higher, then fixed charges are higher, which raises concern for lenders who are cautious about overleveraging companies because there is now ultimately less cash flow.

How do interest rate changes impact cross-border transactions differently from domestic deals?

The experts were of the opinion that cross-border deal activity is driven by a  number of factors including absolute and relative interest rates, growth rates across countries, country risk and taxes. A fundamental element to consider with respect to the impact of interest rates on cross-border transactions is the rise in U.S. interest rates as compared to the rise in global interest rates. If a rise in the former is not accompanied by a rise in the latter, an increase in deal activity may occur. In such a situation, U.S. companies may perceive overseas targets as an attractive way to take advantage of rebound global growth, especially in light of a strengthening U.S. dollar.

The author would like to thank Jillian Hyslop, articling student, for her assistance in preparing this legal update.

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