Climate change risk is serious business – are you doing your due diligence?

It’s been a hot summer. Cities around the world have experienced record-breaking temperatures and heat waves are now being recorded all over the world. In Eastern Canada alone, there have been nearly 100 heat warnings. In Oman, the town of Quriyat registered the highest minimum temperature in the world in June this year: 42.6 degrees for nearly 51 hours. Bushfires have devastated California, reached the Arctic Circle in Sweden, and at the time of writing, are being battled in in northern Ontario.

Climate change is associated with an increased frequency of extreme weather events and the impact on business is obvious, ranging from physical damage to buildings, products, supplies and equipment to reputational risk. Extreme weather events can also halt manufacturing or prevent employees from getting to work, and businesses affected by droughts or pollution can experience water shortages or the lack of drinking water or food, or be more generally impacted by a reduction in economic activity.

There is no shortage of examples. In Europe, this summer’s heatwave has already caused the shutdown of nuclear power plants in France and Sweden and plants in Switzerland, Germany and Finland have reduced the amount of power they produce, since the river, ocean or lake water used to cool them is too hot to use. Last year, Hurricane Harvey caused the shutdown of refineries and ports in Texas and Louisiana and halted most fuel exports towards Latin America. Closer to home, the Fort McMurray wildfires caused $1.4 billion in revenue loss for producers in 2016.

As a result, investors are considering climate-related risks in making investment decisions and are consequently demanding more disclosure. After all, without effective disclosure of climate-related risks, the financial impacts cannot be correctly determined. Institutional investors, such as Vanguard and BlackRock Inc. are pushing companies for information on their how their assets will fare in a low-carbon economy. The Caisse de dépôt et placement du Québec, Canada’s second-largest pension fund, has taken steps to make climate-related factors central to its investment decision-making process.

Pressure is also coming from shareholders and investor rights groups. For example, NEI Investments successfully put forth a shareholder proposal to enhance Suncor Energy Inc.’s climate-related disclosures. 98% of its shareholders represented at the meeting voted in favour of the proposal.

The Task Force on Climate-related Financial Disclosures (TCFD), founded by Michael Bloomberg, consists of 32 members from across the G20’s constituency, covering a broad range of economic sectors and financial markets. The TCFD seeks to develop recommendations for voluntary climate-related financial disclosures and in 2016, published a report outlining its recommendations.

Securities regulators have responded. The CSA recently undertook a review of climate change disclosure made by reporting issuers, and published its findings on April 5, 2018 in CSA Staff Notice 51-354 Report on Climate Change Related Disclosure Project. The CSA found the following:

  • Disclosure is lacking: Although disclosure of all material risks is required, only 56% of the issuers reviewed provided specific climate change-related disclosure in their MD&A or AIF, with the remaining issuers either providing boilerplate disclosure, or no disclosure at all. Only 28% of respondents to the issuer survey indicated that they provided any climate change-related disclosure at all in their regulatory filings. In addition, when climate change-related risk was disclosed, the risk most discussed was regulatory risk rather than risks specific to the issuer’s business, and very few issuers disclosed their governance and risk management practices.
  • Most industries are underrepresented: The oil and gas industry was most represented in the review sample, with other industries providing significantly less disclosure or no disclosure at all.
  • Investors are dissatisfied with the disclosure: Substantially all of the users consulted, being institutional investors, investor advocates, experts, academics, credit rating agencies and analysts, were dissatisfied with the current state of climate change-related disclosure and believe that improvements are needed.

As a result of this review, the CSA has indicated that it intends to consider mandating new disclosure requirements for non-venture issuers in relation to climate change risks, and will continue to assess whether investors require additional types of information, such as disclosure of certain categories of greenhouse gas emissions, to make investment and voting decisions.

However, given the current state of the public disclosure, investors are best advised to conduct climate change-related due diligence. The TCFD 2016 report provides examples of the types of disclosure companies should provide, which could serve as the basis for engaging in this type of due diligence. For example, the due diligence could inquire into the resilience of the company to climate risks and opportunities, how climate-related issues serve as input into the company’s financial planning process, and how climate change might impact the company’s products and services, supply chain, operations or investments.

Ultimately, if the target company has not developed the necessary strategies, expertise and associated governance structure to manage climate change risks, and does not have a climate change risk management process in place, investors may have to rely on representations and warranties and indemnities in the transaction agreement. Such provisions should be carefully drafted and be appropriate to the target’s industry and size.

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M&A and the advancement of the RegTech industry

The rapid advancement of technology has moved at an unprecedented pace, offering the ability to automate “trust” and “quality” of the products and services being provided on a daily basis. Nevertheless, after the financial crisis in 2008, billions of fines and penalties were imposed on companies that failed to carry out regulatory standards. This exposed market inefficiencies and focused attention on solutions required to stay on top of compliance matters.

To avoid repeating history, regulators and governmental authorities have reformed the regulations by repealing traditional rules and replacing them with new and efficient ones. These intricate and new regulations can be seen as a hindrance to upcoming technologies. Modern technologies such as blockchain, machine learning, big data or smart contracts have caused an uproar with the regulators as they require rigorous rules on data privacy to be enforced. These compliance requirements have spawned the need for regulatory based technology, commonly known as RegTech.

The average bank has 160 regulations, causing them to undergo continuous pressure to comply with the latest requirements. Regulators are now issuing non-compliance fines through financial regulations that have been enforced such as GDPR, PSD2 and MiFIDII. Some start-up companies are developing smart solutions to solve compliance issues by using cloud computing technology through SaaS (software-as-a-service). RegTech companies are increasingly known to use cloud based software to manage cash, financial risk, liquidity and hedging activities. The industry seems to be rising as a CBInsight report indicates that in 2016 there were 29 M&A transactions and 1 IPO related to RegTech companies.

So how is this new phenomenon going to assist us in the long haul? RegTech aims to assist in assessing and mitigating future risks and cutting back costs. This can be done by automating tasks that are time sensitive, scrutinizing and developing an audit pathway, and discovering non-compliant behaviors.   For example, current regulations can delay the process of integrating  new employees into an organization or familiarizing new customers to products and services. Integrating RegTech in a compliant manner helps curtail the time taken and cuts back costs while generating greater revenue.

Specifically, RegTech companies try to work together with regulatory bodies and financial institutions via cloud computing and big data to share the data quickly at a reduced cost. They simultaneously focus on protecting banks from any potential risks to comply with the rules imposed by the regulators. It’s imperative for any financial institutions to conduct a thorough assessment prior to investing in third party technologies such as RegTech. These assessments should be done prior to providing access to their internal processes to resolve any intricacies.

With the accelerated growth of FinTech, financial institutions may soon start to embrace the concept of RegTech. Fintech Global has recently reported that, in the last 5 years, investment in RegTech companies have dramatically increased. This in turn has drawn significant interest from venture capital firms, who appear to be heavily interested in RegTech companies. Further, RegTech will not only impact the financial institutions, but will also trickle down to affect industries such as the health care and insurance industry.

Frost & Sullivan forecasts that the RegTech industry will reach $6.45 billion by 2020. Such a rise is worth tracking and may bode well for M&A activity going forward.

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

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Not all bad news amidst African M&A decrease

Recent reports have suggested a precipitous decline in mergers and acquisitions (M&A) in Africa. In the first half of 2018, total deal volumes and values of M&A transactions declined with a 44% decrease in deal volume and a 57% decrease in aggregate value, in comparison to figures in the preceding year. In fact, M&A transactions on the continent have been on a steady decline for a few years now, as their value has dropped from $64.9 billion in 2015 to $32.4 billion in 2017.

Several theories have been posited in the attempt to explain this decline, including corruption and bad governance coupled with strong anti-bribery and anti-corruption laws in investor countries. Other reasons include economic and political instability, and generally poor business climates in the region.

However, despite the decline in M&A activity, opportunities for growth exist on the continent and make it a region to watch for investor countries, Canada being no exception. As Africa’s middle class grows, so too does the market for financial services. Given that the continent is deemed to be lacking communication and banking infrastructure, this makes the region primed for investment in the area of financial services and technology or “fintech”. This may be an opportunity for international banks to cooperate with those in the technology sector and be in the forefront of development in the continent.

Moreover, deal-making in certain African countries including Nigeria and South Africa is anticipated to improve in 2018. This is important news for Canadian companies interested in oil and gas production as well as mining, which are large sectors in these respective countries. In fact, it seems as though some Canadian companies are already looking to the continent for the purpose of tapping into its natural resource markets.

Ultimately, while M&A activity seems to be on a general decline in the African continent, there are still opportunities for investment in particular regions and growing industries and sectors.

The author would like to thank Basmah Osman, summer student, for her assistance in preparing this legal update.

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Pension plan considerations in the M&A context

In any acquisition, whether for shares or assets, employee benefits and obligations must be taken into account. One of the potentially most onerous obligations includes the provision of pension benefits to employees – this makes it all the more important for companies contemplating acquisitions to consider potential employee pension plan implications.

In a share purchase context, the buyer will typically assume all liabilities of the target company, and if the target company has a pension plan in place, this will often be included. However, if there are significant pension fund deficits, this may be one reason an asset purchase agreement is more desirable. With an asset purchase agreement, the pension plan is not automatically transferred to the new company. An asset purchase allows companies to come up with creative options for addressing pension plan considerations. The options include closing plans, merging plans, moving employees to different plans, or changing the formula by which benefits are provided.

Further, the nature of the pension plan will likely impact the scope of the liability. Defined benefit plans, have a fixed formula in place that depends on an employee’s length of service and salary at retirement. Based on this formula, a benefit is guaranteed on retirement. On the other hand, in a defined contribution plan, the benefit at retirement is dependent on the contributions deposited during the employee’s working years, whether made by the employer alone or by both the employer and the employee. For this reason, a defined contribution plan imposes less of a liability upon acquisition. These guidelines may be further complicated by any legislative obligations, regulatory obligations, collective agreement obligations, or individual contract of employment obligations for pension benefits that the buyer is assuming.

These liabilities need to be taken into account when pricing companies. These can be difficult calculations to undertake because they are dependent on a complex combination of economic and demographic factors. Actuarial methods can vary from employer to employer therefore if the actuarial approach of the target company is more stringent than the actuarial approach of the buyer, the buyer may want to use their own approach to gain a more accurate sense on the ongoing long-term financial implications.

Although onerous, careful due diligence is critically important to avoid problems down the road. Of particular interest may be plan documents, pension fund liabilities and assets, and actuarial reports. Finally, due to the scope of the undertaking, it is useful to keep in mind that pension plan changes may take time to set in that extend long after the closing of the transaction.

The author would like to thank Jessica Silverman, summer student, for her assistance in preparing this legal update.

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Q1 review: major deals lead the mining resurgence

Our 2018 Mining M&A forecast predicted that there would be an increase in Canadian mining M&A activity in 2018. It appears that our prediction may be correct: industry reports suggest an 86% increase in the value of the transactions in the first quarter of 2018 (Q1 2018), as compared to the first quarter of 2017 (Q1 2017). The increased value in deals was not accompanied by an increase in volume, however. The deal volume decreased by 16% in Q1 2018 compared to Q1 2017. While this does not perfectly follow the “small is beautiful” gold mining acquisition trend, it does track predictions that deals in lithium and cobalt, materials used in the making of electric car batteries, would lead the pack in 2018.

Additional industry reports suggest that replenishing reserves through small, opportunistic deals in gold mining is and will continue to be emphasized in mining M&As this year. This allows senior gold miners to refocus on growth. Additionally, much of the value in Q1 2018 was likely driven by some major merger activity in early 2018. This trend appears to be continuing in Q2 2018, as certain industry giants have recently announced intentions to merge.

The prospects continue to be optimistic for the remainder of 2018, as McKinsey reports modest increases in global mining productivity in 2018. This, coupled with an increase in price and demand for the lithium, copper and cobalt, suggests that while activity may solid moving forward, the “wait-and-see” mood persists.

The author would like to thank Kiri Latuskie, summer student, for her assistance in preparing this legal update.

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Gauging M&A trends in agribusiness

Although the agricultural sector has largely been segmented in the past, there appears to be a continued trend of consolidation in the industry. As the global population has grown, so too has the demand for food and associated goods. But the appetite for food is changing rapidly and has fueled the rise of M&A activity. A recent report by KPMG discusses the trends driving M&A activity in agribusiness.

A notable trend involves the rise of health products, which stem from consumer desires to seek more health conscious and sustainability-focused options. The increased focus on health and sustainability has begun to reach developing nations, and this demand has necessitated that that nations without the infrastructure to produce higher quality food be active in the market and pursue opportunities to produce higher quality food.

Food security is also identified as a significant driver of M&A activity, since it boosts domestic production and helps with securing land or imports from other countries. Different nations may use different means to expand and diversify domestic production. Nevertheless, macroeconomic factors may counteract this trend, particularly as some countries implement protective policies. The current trade tensions between the USA and Canada provide a prime example of how larger trends (e.g., the imposition of tariffs on Canadian dairy) can potentially restrict M&A in the agribusiness industry.

Ultimately, the agribusiness industry is rapidly evolving. It will be interesting to track developments in the industry, particularly as the demand for higher quality of food is juxtaposed against larger macroeconomic trends.

The author would like to thank Bikaramjit Sandhu, summer student, for his assistance in preparing this legal update.

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Increased M&A activity predicted as insurance industry evolves

The insurance industry is an evolving landscape. The emergence of new technologies and increased competition has created pressure to innovate while casting doubt on the viability of focusing on strategies emphasizing organic growth. These factors may drive an increase in M&A activity in the insurance industry, according to a report from KPMG International.

The report, which is based on interviews with insurance executives from around the world, concludes that the majority of insurance companies are seeking M&A opportunities in an effort to deploy their capital in pursuit of transformative growth. However, these companies will likely require significant support from M&A advisors to achieve their goals. While 81% of insurers interviewed intend to seek acquisitions in the next three years, only 10% consider it extremely likely that they will find an ideal target. Further, many insurers seemed less than confident in their ability to source deals and evaluate the strategic fit of potential targets. Taken together, these figures indicate that, though the insurance industry is primed for an increase in M&A activity, it will require significant expertise from M&A advisors in order to locate and evaluate potential acquisition targets.

The report further predicts that the majority of M&A activity will be in North America, with various factors fueling anticipated growth. For example, much of the growth is expected to result from insurance companies expanding across borders by acquiring targets that are already established in the new jurisdiction, allowing the acquirer to reduce unforeseen risks and begin operating without the need to start from scratch. Another driving factor may be the increasing focus on technological innovation. To date, most insurance companies have not focused heavily on acquiring innovative technologies, but this too may be changing as more insurers establish corporate venture capital teams and invest in Insurtech.

To achieve long-term success in an increasingly competitive and innovative market, insurers will need to align their businesses with an M&A strategy that facilitates technological development, inorganic growth, and cross-border coordination. Insurers are recognizing this reality, and most have sufficient capital to implement these strategies. As a result, evolution in the insurance industry cannot be far off, and increased M&A activity may soon follow.

The author would like to thank Brandon Schupp, summer student, for his assistance in preparing this legal update.

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Q1 2018 review: record deal values for the power and utilities sector

A recent report by Ernst & Young (the Report) has concluded that the power and utilities (P&U)  is thriving, as global deal value in the first quarter of 2018 reached an all-time high of US$97 billion. This rise has predominately been driven by mega-deals, with only 15 deals forming 90% of the total global deal value in the P&U sector. Owners of P&U assets can continue to expect premium asset valuations and highly favourable transaction terms as investors compete for a limited amount of attractive investment opportunities within the sector.

The Report identifies the following factors as contributory factors in the significant rise of deal value in Q1, 2018:

Demand based factors:

  • Shortage of desirable investment opportunities: investors have been attracted to large global network deals, which are becoming increasingly scarce.
  • Increased attractiveness of renewable energy investment: nearly half of all investments were in renewables. This increase was driven by support from government policies and reduced input costs for renewable energy production.
  • Increased interest in supporting technologies: the increased use of renewables and electrical vehicles have increased demand for investment opportunities in their supporting technologies. Examples include: batteries, infrastructure, and electrical vehicle charging stations.
  • Demand for integrated assets in the Americas: investments in specifically US integrated assets represented 57% of P&U investment for the Americas.

General macroeconomic factors:

  • Historically low interest rates
  • Robust access to capital markets
  • High stock valuation currency

Not all P&U sectors have faced the same growth. There was a decrease in the deal value in the coal generation industry and a regional divide in interest for nuclear energy investment opportunities. Investors are weary of the coal industry as many governments are developing policies with the goal of reducing or freezing coal generation. With regards to nuclear energy, investment in developed countries is decreasing due to oversupply and unattractive profit margins. In contrast, investment in nuclear energies is generally increasing in developing countries due to a growing demand for electricity.

Both sellers and buyers in the P&U sector should remain aware of investment and valuation trends as they will be significant in the negotiation of both asset pricing and contractual terms.

The author would like to thank Arron Chalal, summer student, for his assistance in preparing this legal update.

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Borrowers, beware: Bank of Canada announces interest rate hike

Recently, Bank of Canada governor Stephen Poloz announced an increase in the interest rate from 1.25% to 1.5%. The increase comes as the Bank of Canada predicts a continued growth in the Canadian economy from exports and business investments. However, household spending may represent a smaller percentage of future economic growth due to the effects of a higher interest rate on consumers given that variable-rate holders may be forced to put their money elsewhere.

An increase from the Bank of Canada usually comes with increased costs for consumers. If precedent holds, the rise could lead to financial institutions increasing their prime rate, which results in Canadians paying higher borrowing costs on financial products, such as variable rate mortgages. Financial institutions have raised their prime interest rates three times since last summer, which is in line with the Bank of Canada’s increase. This may raise concerns for Canadians, as a number of mortgage holders are worried that rising interest rates could affect their ability to repay debts. In a recent consumer debt index, 43% of surveyors said they are feeling the effects of higher interest rates – a 5% increase from just three months ago.

The impact of the increase on M&A activity cannot be understated either, as a healthy economy from rising exports and investments could result in a higher number of acquisitions, given the increased optimism in the Canadian economy.

The Bank of Canada has three additional rate announcements scheduled for this year. They are set for September 5, October 24, and December 5. Stay tuned.

The author would like to thank Manon Landry, summer student, for her assistance in preparing this legal update.

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Digitalization – the pill for M&A failures?

It is a generally accepted fact that a significant number of M&A deals fail to deliver value post-closing. In a recent survey (the Survey) discussed in the Deloitte 2018 M&A trends report (the Report), 55% of respondents agreed that up to 25% of their M&A deals fall short of meeting or beating expectations. We’ve discussed the factors that can contribute to this failure on a previous blog post and in a recent article, including: cultural and business integration issues, poor due diligence, negotiation errors, lack of involvement by owners, and an overall lack of clarity. Moreover, a lack of discipline and control has been linked to human error and miscalculations, lengthening the M&A process and placing undue financial stress on the transaction, all of which increase the risk of deal failure.

Despite the risk of failure, the Survey indicates that 40% of respondents consider growth through M&A as their best option. With companies facing challenging business environments, intensified transaction speed, and exponential increase in data volume, there is a need to leverage other tools to be able to create value from M&A transactions. Digitalizing the M&A process appears to provide a solution.

Digital tools are not new in the M&A world. Most CFOs are familiar with Excel spreadsheets and virtual data rooms. Thanks to recent advancement in technology, however, new tools have emerged to assist in the digitalization process. Examples include natural language processing systems, which can help analyze large amounts of contractual data in a highly automated manner, and data visualization software, which can be used to reveal the stories behind the abstract numbers of an M&A deal.

These digital tools can contribute to the success of an M&A transaction in several ways:

  • freeing up the need to commit resources for repetitive work, minimizing the potential for error, bringing greater accuracy and allowing the team to focus on the areas where a human touch creates more value, such as cultural integration and strategic decision making;
  • allowing the deal team to have a fulsome perspective at each stage of the M&A process, keep up with the pace, monitor the anticipated synergies as the deal progresses and keep the progress in track; and
  • assisting CFOs in expanding their traditional roles in an M&A transaction, which previously centered around post-deal integration, to the earliest stages of the process, including identifying targets, articulating the thesis and addressing due diligence in a broader context.

Although digitalizing M&A transactions does not guarantee value creation, Survey respondents suggest that these tools have been shown to smooth out the post-M&A integration process, reduce costs and shorten deal cycles.

That said, it may be a significant undertaking for many companies to approach M&A transactions from a new digitalized angle. As pointed out in the Report, it is critical for companies to conduct a careful assessment to determine whether and how a given tool can be used at a particular facet of the transaction to be able to benefit from the new technology.

The author would like to thank Alexandra David, summer student, for her assistance in preparing this legal update.

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