RiskMap 2022 and Private Market Investors

These are heady times for dealmakers, with global M&A activity surpassing $4 trillion by the third quarter of this year. While concerns over inflation are dampening some expectations of a prolonged bull run, dealmakers appear to have carved a path out of the pandemic with confidence – and cash – in abundance.

A year ago, we summarised our outlook as “A world with long COVID” and we expect the competition for value to persist and ripple effects from the political, economic and societal “long COVID” to shape how dealmakers refine their investment approach. In January we pointed to three issues for dealmakers to have in mind – the pre-eminence of sustainability and environmental policies for most governments; the complicating factor that regulation presents to deal execution; and the pace at which expectations of deeper insight into a target’s footprint and value chain were changing. Here we revisit these issues with an updated outlook for 2022.

Environment and Sustainability

Two of our Top Risks for 2022 focus on environmental and sustainability issues. The dangers of a misstep in your approach to ESG issues is our top reputational risk, and the threat of extreme weather and natural hazards caused by global warming presents the prime operational risk.

The pandemic accelerated the existing trend of investors looking more closely at sustainability and the environment. This has made widening the lens when it comes to doing diligence on deals even more important. Dramatic weather events in 2021 along with renewed impetus and expectations following the UN COP26 meeting have reinforced the interest in these areas.   There is a new sense of urgency among dealmakers as they work to understand the challenge and opportunity, a focus and drive that has taken place even in the absence of genuine coherence at a political level. As significant climate-related disasters become a more regular feature of our world in 2022 and beyond, their disruptive power to business and their supply chains is likely to intensify, while tolerance of governments and consumers alike for disaster-related disruption is likely to reduce. But there is opportunity: new ventures stemming from innovation around mitigation of climate risk, as well as government incentives to shift consumer behaviours, are likely to intensify. The level of disruption, not just to people, but markets and buying patterns, is enormous. In this context, despite trends moving towards a consensus on environmental, social and governance issues, investors will continue to be challenged in defining what “good” looks like. For this reason, that wide lens in diligence will be crucial, taking care to understand impact while not ignoring critical social and governance risks as the focus on environment and climate intensifies.   Meanwhile, managers will find opportunity with effective intelligence pre-transaction and create value by championing these issues and the broader concept of resilience in the companies they invest in.

Geopolitics and Regulation

Our top political risk for 2022 comes from the geopolitical repositioning and its many fallouts. Businesses will need to monitor and manage geopolitical risk more closely than they have done for years. Geopolitics will touch everything: from securing energy supplies, ensuring supply chain resilience, achieving sustainability, to providing values-based leadership, security, and growth.

Over the past five years, many of the assumptions underpinning businesses’ and investors’ worldviews have dissolved – Brexit or the escalating US-China rivalry are the pre-eminent examples that challenged the received wisdom of economic co-dependence supporting stable geopolitical relationships. We hope that based on even a brief scan of the global political landscape the reader will forgive us - a company that has been working on stakeholder analysis and political risk for more than 40 years - for highlighting geopolitics and politics as critical issues. Deal makers, taking so many factors into account to formulate their investment theses may make assumptions about geopolitics or the far-removed idea of a ‘world order’ implicitly and unconsciously. This leaves room to be surprised and has left some investors scrambling to figure out responses to sanctions or export controls they didn’t see coming or having their value proposition wiped out overnight by an unexpected regulatory intervention. In 2022, the complexity is set to go one step further, not just due to China and the US’s fractious relations, but also a not entirely monolithic EU seeking to flex its geopolitical muscles. This presages a new era in terms of how states align and interact with one another, their companies – and their adversaries’ companies. Understanding political and geopolitical risks to overall strategy, as well as individual deals, will become more critical. In the near-term, regulatory changes such as the proposed Biden tax reform have the potential to directly and immediate change the calculation for dealmakers. We also expect forward-looking investors to factor a range of geopolitical scenarios when examining the regulatory agendas relevant to their business or investments. Within deal diligence, we expect this complexity to encourage buyers to take a wider lens on deals and question the exposure of supply chains and business models to changing policy and downstream regulatory action, from tax changes to foreign investment screening.

Digital and Cyber Security

In 2022, escalating cyber threats globally become a matter of survival for organisations, who face the challenge alone. States are failing to deter aggressive behaviour as offensive cyber capabilities proliferate among growing numbers of state and non-state actors.

The area in which this complexity could most easily see investors lose their footing is around data and technology, and related to that, how cyber security risks are understood and managed. Technology adoption and digital transformation present enormous value creation opportunities for corporates, as well as private investors. Yet they are also bound up with core strategic and national security objectives and therefore most subject to political risks. Understanding a new business with data or new technology as a critical element means going beyond considering a target’s cyber vulnerability and diligence at a high level; it means asking questions about the digital supply chain and the physical infrastructure that may be vulnerable. Many companies have all but accepted the inevitability of a cyber incident. To safeguard value, as well as reputations, investors will have more impetus to ensure that they have not only considered the potential disruptive impact of outwardly hostile cyber actors, but also the steps that governments in ostensibly friendly jurisdictions could take that destroy value in the process.