Legal road ahead in 2009

What seems to be completely unavoidable is the fact that the entire financial system across the globe is going to go through an overall downturn. We are going to look at different capital market regulations and at stricter regulations for banking and the financial product industry. Hendrik Haag, Partner at Hengeler Mueller, Dilhan Pillay, Managing Partner of Wong Partnership LLP, Adam Emmerich, Partner at Wachtell, Lipton, Rosen & Katz, George Goulding, Partner at Slaughter & May, Barnabas Reynolds, Partner at Shearman & Sterling LLP, Cyril Shroff, Managing Partner of Amarchand Mangaldas and Bharat Vasani, Group General Counsel at Tata Group, some of the finest minds in the legal profession who attended The International Bar Associations Business Law Conference discuss the legal road ahead in 2009.

 

Here is a verbatim transcript of The Firm aired exclusively on CNBC-TV18. Also watch accompanying video.

 

Q: What do you expect to see and do you think that as a reaction to everything that's happened right from 2007 we may cross the line of over regulation?

Reynolds: I certainly agree there is going to be regulatory reform. I think it's inevitable. This crisis could have been prevented by better regulation. Having said that I think the fundamentals of the current regulatory structure are sound. So my personal hope is that there won't be a reaction that that involves completely tearing things up and starting again and it doesn't look if that's happening. There needs to be an international response however to prevent one of the features of the current crises recurring which has been regulatory arbitrage and I think there will be five different types of regulatory reform that we will see.

 

First in relation to the disclosure Senior Asset Manager of some of the major banks say that they can't looking at their rival's balance sheet, work out what their positions are and that's clearly unacceptable. We need to expand the disclosure regime so that it's more effective internationally and that will involve looking further at role of credit rating agencies and also the ----of regulation and bringing into regulation people whose positions are currently is somewhat that includes offshore funds, hedge funds and private equity funds.

 

The second category is prudential regulation, regulation of financial institutions, management how they operate. I think there they will be much more attention paid to the sorts of people that run the institutions and there also be more attention paid to the compensation structure to stop perverse incentives taking hold and actually running away from the management.

 

Third, I think there will be much greater sophistication in the regulatory capital regime to take a better accounts of the various risks that the institutions are running which under the current system are still somewhat crudely covered for instance in relation to what is called operational risk and that needs to be broken down and deal with a far more sophisticated way to cover legal documentation, management and other types of risks.

 

Fourth, there is going to be system regulation or whatever one likes to call it i.e some sort of oversight of the system as a whole to make sure that we do not again have a situation where bubbles can emerge without anyone pricking them at the appropriate moment. Quite how one deflates bubbles when they are emerging is a very difficult question to address but nevertheless its clear that will be systemic regulation and that probably will begin by Central Banks as well as by regulators.

 

Finally, I think the cross border issues between regulators; institutions doing business around the world where at the moment the recipient -the country where the business is done, the regulators there aren't allowed to question the position of the institution and they have to defer to the regulator of the state in which it is being corporated. I think that's going to be re-examined because we had extreme cases of institutions which do not do very much in the state in which they are established, doing a huge amount of business in someone else's state and causing problems which the receiving state can't do anything about because they no jurisdiction effectively over the levers of regulations for that institution. 

 

Q: Would anyone like to add to that?

Haag: I think that this covers all the areas that are likely to be looked at. Whether this is going to be a global solution, I think the jury is still out about this because right now we are seeing the tendency that each country is trying to protect its own financial industry at the expense of the others. But I think in the centre of the financial crises and that's also the centre of the new regulation are the so-called toxic assets. Why are they toxic? I think for the first time the financial industry has created an instrument where it's totally impossible to trace it back to real assets; they have become so intransparent, a triple repackage CDOs (Collateralized Debt Obligations) for e.g. that the only absolute indicator of value was the rating and if you lose the trust in the rating the price becomes absolute an arbitrary. We do not actually know what the losses are that because the assets are toxic, it's like you have poisoned baby food in one glass you can't sell the 5000 others - no one knows about it and that is.

 

Q: When you say centre of future regulation do you mean that to some extent innovative products if I may call what you described is innovative - will no longer be welcome for the next three to seven years still human memory wipes out what happened in 2007-08 or at least the memory fades to some extent or do you think the different kinds of products will replace what we now call toxic asset?

Haag: I think the transparency issue is a key issue in the further discussion. Together what is the role of the rating agencies? Will the rating agencies continue to have the role which they had in relation to these products up to now? Will different transparency requirements be imposed in the sense that it must be possible to trace the value of a security backed to real asset or the other way round will you penalise the banks for holding intransparent products by just putting extra capital charge on them 

 

Emmerich: When Hendrik talks about this, at least I hear the problem effectively has already been solved because as you put it the problem is effectively one of rampant animal spirits and so people bought this products understanding they weren't transparent but relying upon the rating. That is what happened at least for considerable period of time. So when we talk about regulatory responses which is something that lawyers tend to think of, one could propose that the problem could already been solved and it's working its way through the system but that regulatory reform is not what is necessary to prevent people for at least some period of time in the future purchasing things, they don't understand because someone else tells them its good. Everyone feels good for a while; no one will feel good about this kind of transaction for some period of time to come.

 

Goulding: Presumably the most difficult aspect of what you are talking about is the 5th category, the international corporation and I can see that being very difficult to implement.

 

Reynolds: Within Europe I think it's achievable, we already have a structure of house state regulation which I outlined which doesn't quite work but nevertheless with some small adjustments its capable of being made to work and I don't think it requires a single European regulator to make it effective. In the sense you need regulators on the ground where the business is dumb, not someone speaking a different language in another country on the phone, sort of regulating from afar.

 

But internationally outside Europe particularly across the Atlantic, I agree it's the key question and if there can be an agreement  Europe and America then we can solve this, if that cannot be it is going to be much more incrementalist and we have got to rely on self policing by the people.

 

Q: are we making a case for supera regulator, Mr Shroff has also spoken about it in the previous conversations. Sort of Pan Countries, pan market regulator - is that even possible?
Emmerich: It's going to be difficult for one reason and that is, we have heard this today the sort of old world, new world kind of discussion and not without justification. A lot of people look at the USA and the UK and criticizers for what we did or failed to do and I can see that making this process very difficult.

 

Q: The point about fund oversight and this worries a lot of people here in India because we are very dependent on hedge fund money and private equity fund money and there seems to be the sense that there are now going to come under the purview of regulation whether they like it or not. What kind of regulation do you think the hedge fund industry or sovereign health fund industry has to see and what kind of impact will that have on global credits.

Pillay: If you look at the hedge fund industry, I think most people would argue that you would need some form of regulation. One can't believe that in a particular sector there is such a massive impact on capital flows and investment decision could actually remain unregulated for so long.

 

The question now is the form of regulation. Are you going to now regulate them by licensing them, using a test on who should be employed and whether they are competent enough to do their jobs? Are you going to regulate all their activities? And are you also going to regulate how much leverage they can take on?

 

In Singapore we tend to regulate almost everything except we decide not to regulate hedge funds and that is competitive reasons. Your regulate even stock brokerages by requiring capital set aside for adversity but we decide not to do it for hedge funds because if we did that this is going to go to Hong Kong, so the idea of regulatory arbitrage that Reynolds brought up is a big significant issue in the context of hedge funds.

 

Reynolds: Even in the case of US and Europe the first example I have seen of even the US shy away from regulation for fear of losing the business. Normally they go ahead and things happen but in this particular context they have effectively done very little

 

Q: What do you think that some of this conversation that we are having here may not pertain to India because we haven't seen this sophisticated kind of toxic assets, in this country and we will really not have that kind of wipe on the banking system. But some of it will have repercussions on the Indian capital markets and the regulatory system?
Shroff: I think the Indian context has got couple of variations. As you heard from the some of the speeches today, firstly we believe that the problem did not start here, it started outside and we are the victims of some of it rippling through the system and flowing into India.

 

My guess is that the Indian regulators will first watch what is happening in the West and then tropicalise it and then adapt it ourselves. I doubt if we are going to get ahead of the world and start regulating this before the West does. In terms of the regulatory scale we are already at a more conservative point compared to lot other markets in the world. So the incremental action that we need to take probably is less, we just need to wait and watch and see how the world reacts.

 

But some common themes like regulation of hedge funds, these probably have standalone position of their own and we might see some movement over there. Or for instance regulation of our mutual funds and broadly in terms of the over the counter (OTC) products and exchange credit products, the entire OTC regime is coming into this repute now and they are probably going to see - to start with more disclosure and then moving on to probably more rigorous regime.

 

Vasani: I agree with Mr Shroff, the only thing I believe is that the Indian government would not immediately react. The Indian regulators primarily Sebi and RBI may fine tune or tweak the regulations here and there but I don't expect whole host of new regulations coming in at this stage because I don't thing the problem is as acutely felt here as it is in the West.

 

Q: The big problem which seems to be facing corporations across the world and that is protectionism whether it's by America or import duties that we put in on steel imports coming into this country is going to increasingly put a spanner in the works when it comes to corporate expansion and it will have some sort of spill over effect on merger and acquisitions as well which is the other theme that I want to touch upon this evening. What do you think how bad is this going to bet?

Emmerich: It's difficult to predict. The impulse to protectionism is a strong one throughout the world when economic conditions are bad when unemployment increases and none of us quite know of course how deep creator we are in is and if we are in a truly great depression like downturn, I think you may see not only in United States but throughout the world protectionist impulses that are allowed to blossom into protectionism. I think one thing is important to remember when you are thinking about this in United States at least today is that the American system of democracy is quite different to a parliamentary system where you have either ruling party or ruling coalition and when it proposes a policy generally put its into effect. When you hear from American news that either the administration which sounds like something official or members of Congress have proposed some measure or other often times that - almost always in fact that's simply the beginning of a debate. It's a negotiation position, it's a proposal, it's design to sometime scare people, sometime to evoke a reaction from trading partners - they have all measures of protectionism. So we haven't yet seen implemented any serious measures of protectionism and I certainly cannot guarantee it but I am confident that it's a reasonable possibility that we won't see very much protectionism at least in the US.

 

Q: Since you represent the corporate side in this panel, is it a big fear as you go about. I know you have done 40 deals in the last three-four years and Tata Group is almost in every conceivable country in this world in every conceivable business. Is it a real fear?

Vasani: Some concerns for the IT sector certainly. We do believe that the H1B front we will have issues with regard to the number of employees we can send to US now.

 

Q: But that we have dealt with now and again over the last five to eight years so it's not so tough?

Vasani: Yes, I also have a fear that perhaps the WTO is becoming irrelevant very fast. It was already becoming irrelevant before this crisis, its becoming irrelevant very fast and more and more countries would tend to adopt more and more protectionist measures and I do not think India would be able to complain because we also be doing same thing in India. So we do have genuine concerns with regard to ability of Indian corporate to help the free movement of capital labour the way we wanted to do it so far.

 

Q: What does it mean for globalisation? Are we rewinding globalisation to some extent and if yes then what happens to existing multinational businesses across the world, are they going to have to see renegotiation of contracts, is it going to be an area littered with dispute?

Reynolds: I think there will be a winding back of globalisation to the extent that my view is starting with the financial sector, institutions in financial trouble are going to pull back in from the countries in which they are doing business. We are seeing it potentially with RBS in UK, I do not know what's going to happen with some of the American institutions that the government has invested so heavily. One would assume that in many of these cases one of the first thing they divest themselves off are the assets overseas which aren't outperforming which are detracting from the main gain which is protecting their consumer base in the country where they are established and I think that's pulling back will filter through to the corporate market and therefore reduce the amount of international capital available across the world for the corporate.

 

What will that mean - yes there could be more litigation there could be divest interest but of course then that will rise on people being able to afford the prices being asked for their assets being divested off and if the right price can't be attained that may lead to consolidation. But I think its going to be quieter period anyway for the foreseeable future than it has been.

 

Q: That's protectionism has taken slightly more extreme turn because there is talk now of institutions that have received bailouts or even access to top one being forced in some sense or being wade upon by the American government to only lend domestically. I know its just talk, we do not know if it's actually the way these banks are going to work but that could be worrying because for instance in India we source a lot of our funding, whether its for project expansion or M&A from outside the country, do you really think this could take on an extreme colour like this?

Goulding: I don't actually know. I think that the pressure that you are talking about at least in the UK are more directed at the domestic, retail market rather than corporate lending, so I do not think so.

 

Q: That brings me to M&A: What's the future of M&A. I know everyone say, this is the perfect time to consolidate; values are so good and great, perfect time to buy but where is the cash?

Emmerich: Recently we have seen many stock transactions either effective or proposed, one very interesting one is in the fertiliser area where there are two hostile bids currently pending. One company Terra bid for another one CF Industries then the third Agrim and bid for the first bidder and said, if you buy this second one we do not want to buy you and so you better stop and we will buy you instead and both are stock proposals. The Wyeth Pfizer combination which is a very large combination in the pharma sector is largely a stock deal. So we see transactions happening and certainly the volumes are very far down.

 

But I think it's largely not so much a question of finance but more a question of confidence and those who are of the belief that the consolidation or an acquisition is a larger call and have some sense of what the value of what they are buying is will proceed. The finance is an issue but I think a secondary one.       

   

Q: Has Asia been spared that slowdown in M&A at all?
Pillay: No it hasn't been. There is some belief that in Asia the second half of the year we will see an uptick in M&A activity but I do think that finance has an important factor to play in Asia. If we look a the activity in 2007-08, a lot of it was private equity driven activity which today if you ask me will not be there in the same way it was there before. I cannot see buyouts happening, because the expectation gap between sellers and buyers is just a way too wide right now and the unavailability of bank financing is a critical issue in key markets in Asia.

 

Even in markets which have significant amount of liquidity like Malaysia and Singapore. You don't get that much M&A activity going on because the banks are not willing to take counter party risk to some extent and no one is willing to put a lot of money into a deal without having other bankers together with them. So this is becoming a big issue for buyers and sellers.

 

Also the valuation gap between buyers and sellers will continue to be an issue because no one quite knows how this crisis is going to see itself out; no one knows when the end is going to happen. Some people say it's towards the end of 2009, some say towards the end of 2010. If you were to buy a company right now, are you buying too early in the game- that is the big issue?

 

Singapore's Minister Mentor was quoted in the Financial Times yesterday saying Singapore went into the banks too early, they saw the value come down, they went into Citigroup and UBS and they have lost a significant amount of value. Many buyers today are again looking at same thing, looking at strategic deals as well.

 

Q: So mix of risk aversion, how do you call the bottom, getting the right price, getting the banks to fund you for it?
Pillay: Yes. The interesting thing that we are going to see in Asia is that in the last few years a number of countries have put in place competition regimes. In Singapore we had done it, as a result of Singapore-Europe free trade agreement. I am not sure if the issue of anti-competitive mergers will be looked at in the same way as 2-3 years ago in countries in Asia. I think in national interest number of deals that which otherwise would have fallen short of standard would be allowed to go through.

 

In Singapore for example in our Competition Act we have a provision that says the commission can approve a deal if it's in national interest to do so and I believe national interest exception will become more and more available in this sort of market. This sort of market will see the need for consolidation of companies within a particular domestic industry not because of any impact on domestic market but to make them stronger to look for opportunities outside of market and that to me could be a factor in seeing more activity coming out of Asia outward bound; so say from India into China, from China into Singapore and so on and I think we should watch and wait for that sort of thing.

 

Q: Would you like to add to that?
Hang: I can only talk about the European market; I think M&A is certainly in recess. Private equity was a very important factor which is totally absent right now but there are strategic M&A. It is actually the hour of strategic investors because in the last couple of years private equity has bought the prices in many respect but what is a very difficult situation now is the volatility in stock market because even a strategic buyer with a strong balance sheet will have to borrow money on basis of stock it purchases and if that stock is to lose 20-30-40% in just a quarter then that becomes very difficult.  It happened with some major acquisitions in Germany now that are in deep trouble.

 

Goulding: I am just going to emphasize both in the UK market and in Hong Kong market where I operate, the value point and also to say that in the UK market what we are seeing an increasing amount of interest in and this could well be the feature later in the year is quite large consolidations on an All Share Basis and that is something to look out for.

 

Q: All shares transactions are not something that happen often in India, if at all and so what do you thing is going to happen to domestic M&A in India not the out bound variety?
Shroff: There are couple of issues over there, it is not just not availability of cash but I think corporate in India and so far as M & A in India is concerned particularly midsized to large M&A is pursuing a much more cautious note now and it's a bit schizophrenic  because on the sell side the valuation expectations haven't adjusted yet, people are still expecting unreal values, especially when they look for a strategic buyer, they think he valuations they receive should be much higher but there is a big disconnect over there so whilst there is interest I don't see the gap closing very quickly in terms of deals get struck,

 

On the buy side they are not able to call the bottom and its not just unavailability of cash but I think their priorities are currently to get healthy again and to make sure they are able to correctly assess what the impact of global downturn is going to be. So there is a note of caution. If they do go out and make acquisition, I think they are going to rely more on equity rather than on debt. It goes back to part of Indian culture being bit more debt averse and I think we are going to see some of that cautious approach at least in the foreseeable future but at some point of time or the other our animal instincts will back to fore, that is how I see it when I talk to our corporate clients.

 

Q: Should we be happy that the competition regulation in India is not yet been put into place?
Vasani: Absolutely and if you do it at this stage then I think the M&A activity would come to a grinding halt.

 

Q: Give the corporate perspective, are you looking at deals right now and if you are then are you being more debt averse, looking at equity, share swaps are not that popular in India so- what do you do?
Vasani: most of the corporates are trying to concentrate at what they have acquired and unless there are real strategic reasons. We certainly are looking at in some of our companies but where there are strategic fits for example for raw material. Tata Steel may still look at the mines available in the world but we are much more cautious now.

 

Q: Since now commodities have come off considerably?
Vasani: Absolutely

 

Q: I must get a Satyam word on this and the reason why is because there has been so much talk of the kind of impact it will have on India, businesses in India, family owned businesses in India - leave that all out. In the deal making that's happening with regards to India are you seeing clients ask for more disclosures, are they more worried, are they more tensed about the kind of information they are getting, are they putting in more clauses any safeguards governance?

Emmerich: As shocking and upsetting as the Satyam situation is, its certainly in one sense shouldn't be a surprise to anyone considering a merger or acquisition. We have seen massive fraud and scandals all around the world from Refco ,to WorldCom to Siemens, regulatory problems that cost hundreds of millions of dollars, pounds and euros and so anyone who is making an acquisition in India who somehow thought that there was absolutely no chance of any problem ever occurring within Indian corporation certainly wasn't advised by any of us and this is true before Satyam and after as well.

 

So while there is a momentary increase in awareness of this possibility anytime there is a scandal anywhere in the world every acquirer thinks maybe one extra second before they buy something have I done everything that I possibly can do to make sure. But I do not think if there is a scandal in India in Satyam for e.g. people buying a company in Germany are equally all of a sudden thinking I better double-check and vice versa . So what I am saying is that this is something that is on acquirer's mind globally regardless of origin and destination and Satyam hasn't change that calculus.