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The primacy of politics: Why governments can make or break any deal

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It is an underrated risk: Within the next few years, the political and regulatory environment will become one of the most decisive factors for private equity firms and companies that want to do a deal. It is a trend that started more than a decade ago. The aftermath of the global financial market crisis in 2008 marked a comeback of the “primacy of politics”. After several decades of constant deregulation and governments taking the backseat, politics once again became a dominating factor in society. Some of the most recent global episodes have turbo-charged this development: Be it the rather erratic style of political decision-making by former US President Donald Trump, the COVID-19 pandemic and most recently the Russian war on Ukraine – we experienced a cascade of events and external shocks that destabilized global markets, impacted global supply chains and made companies and economic players turn to politicians and regulators for support and guidance. The fight against climate change and the digitization-driven transformation of societies are further indications that the influence that governments exercise over markets will only increase further.

Regulation has become a market-making force as powerful as innovativeness. Seminal political decisions are proof of that. For instance, the decision to phase out nuclear power after the events in Fukushima 2011 deemed Germany a first-mover market for renewable energy technologies. And with the recent Russian aggression against Ukraine, energy policy has become national security policy, turning the state into an even more dominating player in this sector.

The European Green Deal, and more precisely the EU taxonomy, is another example: A promising attempt to go beyond merely pushing companies towards more innovation, it re-directs capital flows towards more sustainable business models, thus shaping the market for investors. But the influence regulators and politicians have on transactions is even more direct; in the past few years, FDI screening regimes were tightened not just in Europe, but in the US, China and other regions as well.

The success of a transaction as well as the future return on invest are more than ever closely linked to the regulatory and political environment. Companies and private equity firms ignore these risks at their own peril. And those who embrace and prepare for it will emerge as winners.

Three questions to Christoph Seibt

1. How much more significant has the political and regulatory environment become for companies in recent years?

Up until the global banking and financial crises in 2008 it was the predominant legal view that the fiduciary duty of both, the executive board and the supervisory board, is directed primarily to the financial interests of the company’s shareholders. Today, boards are experiencing a fundamentally different legal landscape, and board members must understand three key trends:

Firstly, legislators have introduced and will continue to introduce new corporate as well as financial and non-financial (i.e., sustainability) reporting law duties to bring about change with respect to more diversity in boards, observance of human rights within the supply chain, transforming the business models towards carbon net zero or other ESG topics. However, the legislators are also introducing more players to the forum: new shareholder competences, new regulatory supervision authorities as well as litigation rights in favour of NGOs and trade unions to police the new duties. This all increases the need for multi stakeholder communication, and any failure in following the new policy rules is also – due to the rise of multiple policepersons – magnifying factually the liability exposure of board members.

Secondly, the geopolitical turn, in particular the US/China decoupling in the tech world, has originated a new field of law, comprising of public interest foreign investment laws, such as the German AWG and AWV, the EU Screening Framework Directive, or CFIUS in the US, new import and export control laws, new sanctions and counter sanctions laws, and new “Know Your Business Partner” due diligence requirements.

Thirdly, it`s not all about the financials anymore. In a VUCA world, i.e., an environment that may be characterized by the notions of volatility, uncertainty, complexity/connectivity, and ambiguity, adequate corporate reputation management as well as corporate resilience management, which are both interlinked to some extent, are highly important for building up a sustainable and profitable business. Such management demands recognizing the interests of the relevant company stakeholders, i.e., its customers, business and financing partners, employees but also governmental authorities, and their respective expectations of the company. If one needs a recent example, take the decisions taken by German corporates on how to deal with their Russian business operations.

All three trends translate into a new duty for boards to understand politics, its relevant players and to act accordingly.

2. What does this "new duty to be political" mean precisely?

Three consequences are of utmost importance: Firstly, within both boards certain members must have the respective fields of expertise or they must at least have direct access to political expertise. And supervisory boards must take the duty of understanding politics to heart when planning for the next own board refreshment or for the next executive board member appointment. Secondly, boards must analyse as part of their strategy planning as well as risk management process how possible political developments, on a global, regional or more local level, might create business opportunities or business risks. Thirdly, all important investment decisions must take into account not only the direct financial consequences but also the still so-called non-financial consequences, such as consequences for the corporate reputation with the company’s stakeholders, of a certain action, including the counterfactual non-action. That requires a broad information basis as part of a risk radar that also includes data relating to the political environments, and a thorough balancing of pros and cons.

3. What kind of corporate activity needs the "political risk radar"?

Boards must expand the traditional risk radar into one that includes political opportunities and risks and must use such political radar when developing and reviewing the company’s strategy, the business planning but also when deciding on material business decisions. This includes, for example, decisions on supply chain partners, locations for productions, joint venture structures and partners, M&A targets, and IP policy.

Christoph H. Seibt is a partner at Freshfields Bruckhaus Deringer in Hamburg and an honorary professor at Bucerius Law School. He primarily advises listed companies on strategically important management decisions, M&A and capital market transactions, corporate governance issues and in crisis situations. He is considered one of Germany's most innovative business lawyers, has received a variety of awards and is known for incisive contributions in the media, including a column in Manager Magazin.

Your contacts for Political & Regulatory Due Diligence :

Daniel Schäfer | Partner Frankfurt
Cecilia Siebke | Associate Director Berlin
Marla van Nieuwland | Associate Berlin