The commercial year: 2011-12
updated on 30 October 2012
A lack of confidence in the likelihood of immediate economic growth readily explains why commercial law firms are currently cautious when awarding training contracts. Now more than ever, applicants must possess the right commercial mind set: it gives a recruiter confidence that an applicant will flourish in the tougher business world and be more able to connect with clients.
Banking: one problem after another
Four years after the financial crash, we are still part way through a long phase of depressed economic activity that now affects countries that had previously appeared immune. The pivotal moment in 2008 – often referred to by the single word 'Lehman' – marked the end of easy, cheap credit and the start of an era of deep mistrust, of banks and among banks. If credit is petrol in the engine of the economy then the pumps have run dry, not only for individuals seeking mortgages, but also small businesses in need of bank funding for growth. Meanwhile, corporates with cash reserves are reluctant to spend, financial institutions are too scared to lend, and Western governments are overburdened with debt, many barely keeping afloat in the wake left by powerful bond markets.
It's worth understanding the story of the crash. The catalyst was reckless lending, epitomised by 'subprime' mortgages in the US and property speculation in countries like Spain and Ireland. Subprime mortgages turned people into owners of homes they couldn't afford, yet the banks bundled these worthless loans together and sold them as attractive investment products through a process called 'securitisation'. The bundles were so complex that, when the US housing market collapsed, it became impossible to value them. The ancient bank Lehman Brothers folded because it had invested in too many of these worthless securities. Its bankruptcy was a seismic event. Whereas investment banks had previously lent money to each other freely, using LIBOR to determine the interest rate, after Lehman they were simply too scared to do so. They couldn't tell how deeply each of them had bought into these 'toxic' securities and the financial system seized up.
Imagine Lehman's bankruptcy as a stone being thrown into a pond, with everything that has followed being ripples spreading across the water. As turmoil hit the financial sector, the 'real economy' of butchers, bakers and electrical retailers kept calm and carried on. Governments averted total global financial collapse with bank bailouts: £500 billion was deployed to stabilise the UK system, which is why taxpayers now own a majority share in RBS and a large chunk of Lloyds. Within months, however, the real economy began to suffer as business confidence ebbed away.
It was hoped that bailouts would lead to a more compliant banking sector in which reckless 'casino' behaviour was replaced by safer lending. Sadly, lending to small businesses declined and resentment grew as bumper bankers' bonuses continued. Lending was slow because the banks were trying to deleverage themselves. International rules about how much capital they should hold, compared to their total liabilities, were revised by something called 'Basel III'. In came bank stress tests and out went over-reliance on the unsupervised third parties that monitor the creditworthiness of financial institutions. These third parties are the credit rating agencies – Standard & Poor's, Moody's and Fitch being the Big Three – whose AAA ratings were blindly assumed to guarantee risk-free investment. Far fewer financial instruments now earn an AAA rating and the agencies' reputations have suffered.
UK banking regulation was found lacking and the government declared it would abolish the Financial Services Authority. In September 2011, the Independent Commission on Banking published the Vickers Report, recommending that UK banks ring fence their retail operations from the their riskier investment banking arms; that the implicit taxpayer guarantee be eliminated for investment banking; that capital requirements be increased above Basel III levels and additional competition be created in the retail banking sector. Lloyds Banking Group agreed to sell 600 of its branches to the Co-operative Group, with completion due in 2013; however, the ring-fencing elements of the proposals are unlikely to be effective until at least 2019, given the technical and commercial complexity of achieving separation.
The shareholder spring
The banks' failure to curb excessive pay was unacceptable to the general public, much of the media and, eventually, many of the banks' own shareholders. In 2012 several banks' boards were chastised by shareholders no longer willing to allow senior executives and traders to reap sky-high rewards despite poor profits and falling share values. Scalps were taken at the AGMs of Citi, UBS, HBOS and Barclays, and the trend spread to other sectors, affecting advertising group WPP, insurer Aviva and Air France, among others. Barclays' CEO Bob Diamond (the poster boy of casino banking) was replaced by Antony Jenkins, a safer pair of hands from its retail banking arm. There have also been calls for more women on the boards of big companies, the argument being that less testosterone equals less risky behaviour.
An international social movement emerged in 2011. Occupy, characterised by its anti-capitalist protest camps and Guy Fawkes masks, was briefly the subject of impassioned debate. The London group's occupation of ground in front of St Paul's Cathedral forced the Church of England into a dilemma involving loyalty to the City, religious ethics and sleeping bags, and this in turn gave the debate a wider audience. The concept of good capitalism vs bad capitalism was given voice, and then soon enough context in the form of a fresh series of banking sector scandals: Payment Protection Insurance mis-selling, credit default swaps mis-selling, LIBOR rate fixing, money laundering and even allegations of sanction busting. The City of London was accused of all manner of incompetence and skulduggery, with one of its loudest critics being a Wall Street keen to steal some of its thunder. In truth, few would disagree that the City's regulators should have been more powerful and more agile over the past decades. The challenge ahead is to create an effective supervisory regime that neither stifles growth nor snoozes on the job. Regulation has never been the most glamorous field of legal practice, but it will certainly increase in importance.
Eurocrisis drags down the rest of the world
Let's stick with watery metaphors. If Lehman was the moment the tide of credit flowed back out to sea, then it revealed naked and vulnerable swimmers – individuals, banks, companies and governments, all without the means to cover their embarrassing indebtedness. But where did all the cheap credit come from? Consider first the process of leveraging: if a bank had £100 in its vaults it could lend £1,000. Second, as the West borrowed ever more money to fund individuals' consumption and corporate or government spending sprees, so the East found willing borrowers for their vast surplus earnings. Eastern thrift enabled Western profligacy, as manufacturing and oil-producing economies in effect lent the money with which other countries bought their goods.
The rise of China as an economic power is not a new story. It is, however, worth understanding, not least because the latest chapters underscore the interconnectedness of the global economy. The convulsions of the Eurozone and the stubbornly sluggish American economy are now affecting the likes of China and India, whose rampant growth has eased. The danger is that certain emerging economies have grown so far so fast that their own domestic demand for goods and services cannot now take up the slack left behind by the once-ravenous appetites of the West. The ripple in the pond created by the Lehman stone is reaching the so-called BRIC nations (Brazil, Russia, India and China). It is said a picture is worth a thousand words: recent photographs of Chinese ports now show lines of vast coal heaps, reflecting slowed demand for manufactured goods. In Russia, oil and gas revenues have been slipping as global demand slows.
As for other raw materials and commodities – such as metals, grain, rice, coffee and cocoa – there is much to be observed. As Asia boomed, so its appetite for these resources grew, leading to price rises around the world and heavy investment across parts of Africa and countries such as Australia. Who can be unaware of how much more we now pay for fuel, pasta, a latte or our favourite sweet treat? These goods are traded on exchanges in much the same way as company shares or government bonds, and the businesses involved in producing them have prospered. Yet a proposed £60 billion merger of commodities trading company Glencore with mining company Xstrata (which was shaping up to be 2012's biggest transaction) was hindered by doubt on the part of one of Glencore’s major shareholders, the Qatar sovereign wealth fund. Uncertainty struck again as the Qataris noted the softening market for raw materials and questioned the price of the deal. Soon after, another major shareholder, the Norwegian sovereign wealth fund also questioned the terms of the deal.
As for food commodities, we can expect the pain of price rises due to supply shortages following crop depletion in climate-challenged areas. The summer of 2012 brought the hottest temperatures on record across the soya bean and grain-producing regions of the United States, a nation responsible for 40% of the world’s total supply. Other countries have also suffered problems with agricultural yields.
Can Europe pull itself together?
The economic difficulties of the Eurozone are both worrying and confusing, and neither the national governments of EU member countries, nor the union's institutions, have found a solution. The fundamental issues are banking sector indebtedness and government indebtedness, whether or not the latter resulted from attempts to fix the former. Here in the UK we can also add consumer indebtedness to our list of woes. Since Lehman, the Great British public has deleveraged household indebtedness, which in turn is hindering both domestic growth and growth in the countries from which we import.
If Europe's politicians and bureaucrats can’t identify an effective remedy to the Euro-crisis then, rest assured, you as a prospective commercial lawyer won’t be expected to pronounce with confidence on the right way forward. Simply stay as up to date as possible with the twists and turns of the crisis by regularly reading the business press. Keep an eye on the key players, be these the struggling Piigs economies (Portugal, Italy, Ireland, Greece and Spain) or the economies showing greater resilience (Germany, the Scandinavians, the Netherlands and the UK). Make sure you know a little about the relevant institutions – the European Central Bank (ECB), the European Financial Stability Fund (EFSB), the International Monetary Fund (IMF) – and try and follow the debate about the viability of the euro as a single currency. Fortunately the Internet is awash with articles about the challenges businesses would face if there were a wholesale break up of the euro, or if certain countries quit the single currency.
In the United States there is deep frustration at European dithering: they just can’t understand why no one has produced a 'Big Bazooka' to blast away the EU's problems. One bailout after another – be it to the cornered Greek government or the rocky Spanish banks – has failed to calm jitters in the bond markets. To explain briefly, governments use bond markets to raise money to pay public sector wages, keep lights on in schools and hospitals, and service existing national debt. The more precarious a nation's finances, the more interest it must pay on the bonds it issues to the investors who choose to loan it money. A 'yield' of over 6% on a bond that is repayable after 10 years is usually viewed as a sign that a nation needs a bailout. In 2012 Spain’s bond yields repeatedly topped 6%, and Italy’s also gave concerns, whereas German and British government bond yields remained far lower at well under 2%, reflecting their status as a safer bet. At times, the flight to ‘safe havens’ such as gold or Swiss francs meant investors actually paid a premium to keep their money away from danger.
With such a problematic backdrop, it is unsurprising that corporate deal activity has remained depressed, even at a time when many larger companies have cash to spend. Despite pent-up demand and low interest rates, uncertainty has prevented deals from being struck or complicated them (as we saw with Glencore and Xstrata). It’s big news as and when a sizeable transaction does complete. In the past year brewer SABMiller took over Fosters in a deal worth £6.5 billion, and US retailer Walgreens bought a 45% stake in Alliance Boots with an option to take the rest. Boots was previously owned by a private equity (PE) company, which reaped a nice dividend on its investment. The market hopes that PE activity will grow as soon as possible, and assumes that these funds will want to take advantage of lower company valuations, not least in Europe. It’s worth looking out for commentary about both the PE and hedge fund markets. These businesses exist to do deals on poorly performing companies, with a view to picking them apart and turning around the best bits.
And what happens when a business’ fortunes have fallen too far? Enter the insolvency practitioners and the lawyers who represent all parties in a company administration, bankruptcy or restructuring. The past few years has witnessed the demise of many retailers and brands. Since 2011 alone these have included: Blacks; La Senza; Comet; Barratts; MFI; Habitat; Jane Norman; Clinton Cards; Oddbins; Firetrap; Acquascutum; Julian Graves; Saab and Game Group.
Sometimes insolvency reveals shocking corporate misdeeds. This was certainly the case when New York-based commodities brokerage MF Global went bust following liquidity problems, huge fines for regulatory breaches and the unmasking of a rogue trader – sadly, none of it unique behaviour. While the problems arose in the United States, UK lawyers became involved as the company had UK-based clients. MF Global is the perfect illustration of how national borders mean nothing in our modern business world.
Apple’s Android war and other tech tales
Activity in the technology and life sciences sectors represents a ray of light in an otherwise gloomy economic phase. In an era defying feat, Facebook grew from a geeky boy's bedroom into one of the world’s most valuable companies in just eight years. In June 2012 it made more than half a billion shares available via an initial public offering (IPO) on the Nasdaq stock exchange. Social media businesses have been among few companies to brave the IPO process lately, and it has not always treated them kindly. The creator of Farmville and other social games, Zynga, floated disappointingly in the second half of 2011, and its share value has continued to decline.Amid much hype and some procedural bungles by Nasdaq itself, Facebook shares initially flew out of the blocks. As the banks underwriting the share issue stepped back, the price dropped, leaving many investors disappointed. Some had experienced technical difficulties in placing orders via Nasdaq’s system and one in particular (UBS) actually submitted multiple orders, ending up with three times the desired number of shares. This wouldn’t have been a problem had the share price held up, but it subsequently tanked. UBS announced it would sue Nasdaq for $350,000 of losses arising from its bungle. Nasdaq countered by blaming UBS’s own IT systems. As Nasdaq worked on appeasing disgruntled investors, the IPO’s underwriters (the lead being Morgan Stanley) were attacked for hyping up the initial price. In so many ways, the Facebook share offering was anything but a PR triumph for social media companies, and talk now is of a social media bubble.
IPOs have been thin on the ground in London. Even Manchester United FC chose to float on the NYSE after a brief flirtation with the Singapore exchange. Keep a watch on the IPO market generally. It can be helpful to understand the reasons why household name companies raise new capital in this way and what they use the money for.
Besides showing relentless growth, the tech sector has also become a litigation battleground, particularly in relation to mobile telephony and devices. The biggest names Apple, Google, Samsung, et al are engaged in all-out war over the ownership and validity of patents and designs relating to their latest gadgets, with the war being fought across several jurisdictions. Apple and Samsung’s courtroom confrontations have taken place in Australia, the UK, Germany and California, and with billions of revenue at stake, neither was willing to concede an inch. In August 2012 Apple won $1 billion in damages from Samsung, which was also injuncted from selling several of its products in the USA. The commercial and legal angles to this story are both numerous and fascinating.
The healthcare and life sciences sectors have been no quieter, with major pharmaceuticals manufacturers keen to invest in companies developing gene therapies. A good example is British drug manufacturer GlaxoSmithKline (GSK) which decided to buy Human Genome Sciences for $3.6 billion (£1.9 billion), having already worked in partnership with the smaller company for 20 years. Earlier in 2012 US regulators slapped a massive $3 billion fine on GSK to settle three charges of fraud for promoting unauthorised ‘off-label’ use of two of its best-selling anti-depressants. As regulators flex their muscles across various sectors and countries, clients inevitably turn to lawyers, both to help mitigate the scale of fines and to prevent trouble in the first place. Many commentators argue that the role of the lawyer (not least the in-house lawyer) is shifting, and that their input will be sought by corporate decision makers much earlier.
If the lawyer is to penetrate further into the boardroom then legal training will need to reflect this, hence the current debate about a greater emphasis on broader business education within legal education. The UK's Legal Education & Training Review is certainly well timed in this respect. The commercial lawyer of the future must be more business savvy than his or her predecessor has ever needed to be.
This article appears in Best in Law 2012, available online, at law fairs and in law departments and careers services.
