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Emerging markets: ballast in the storm?

19 August 2008

When the credit squeeze began in August 2007, mergers and acquisitions activity was at an all-time high in volume and deal size. Cheap financing was available to private equity firms, and the globalisation of cross-border deal flow was increasing.

In the first nine months of 2007, the average deal size reached USD298 million, the highest on record according to Dealogic, and reached a record global deal value of USD3,850 billion.

Fast-forward to the post-credit crunch world, and the credit ratings agencies are reassessing the average transaction. Investors have been hampered by a loss of confidence, and hedge funds (that until recently were an important source of market liquidity) have become risk-averse.

The number of debt issues have been downsized or restructured, while borrowing costs have increased. All these factors have combined to impact the M&A market, which experienced a dramatic downturn in 2007 and 2008.

The volume of global M&A deals fell and the pace of private equity buyouts dropped by 78 per cent in the first half of 2008 due to the banks' tightening of lending standards and reluctance to finance leveraged buyouts.

Stabilising forces

Amid this turmoil however are the emerging markets, which have largely been immune to the effects of the credit squeeze and have instead been able to act as stabilising forces.

Oil-producing countries continue to amass petrodollar capital, which is likely to continue the influx of liquidity to markets through Sovereign Wealth Funds (SWFs), such as Abu Dhabi Investment Authority (ADIA), Investment Corporation of Dubai (ICD), Kuwait Investment Authority (KIA) and Qatar Investment Authority (QIA).

It is estimated that SWFs manage over USD1.5 trillion of assets under management. The surge in reserves of central banks – particularly those in the Asian markets – have amplified liquidity in emerging markets. Asian central banks' foreign reserve assets total USD3.1 trillion.

Recent estimates show that foreign reserves for Mainland China are USD1.3 trillion, USD400 billion for Russia and USD200 billion for each of Taiwan, South Korea and India.

The resources and capital of the BRIC countries (Brazil, Russia, India and China) as well as the Gulf Cooperation Council (GCC) states (Kingdom of Saudi Arabia, Qatar, United Arab Emirates, Bahrain, Kuwait and Oman) are being deployed in M&A markets. The level of global M&A deal flow has been boosted by an increase in emerging market deal activity.

According to Dealogic, firms in emerging markets completed USD14 billion worth of deals in developed countries in 2003, and by 2007 this figure had risen to USD128 billion. Overall, Asia and the Middle East now represent about 15 per cent of global volumes.

A new breed

But how are these levels of deal flow being sustained? Key factors include: strong macroeconomic fundamentals in place, alongside abundant oil-fuelled liquidity; the availability of attractively-priced assets in Europe and the US – especially with the weak dollar; increasing globalisation, as well as the need for companies to expand in market share beyond their local boundaries.

A new breed of dealmakers with global aspirations has embarked on acquisition sprees, targeting a broad range of sectors including basic industries such as heavy industries (steel and metals), mining, energy and utilities, financial services, real estate, healthcare, IT and telecoms.

Geographically, boundaries of investment are being redrawn. Where they had historically focused on the US and Europe, they are now increasingly looking towards North Africa, the Middle East, the Indian sub-continent and the Far East.

Against this background, it is interesting to note the revival of the Silk Route and the growing importance of trade links with Asia, which is counterbalancing exposure to European and US markets.

Cross-border activity is growing and gradually replacing the fast-paced globalisation of economic and financial flows. It now represents 40 per cent of global M&A, up from 20 per cent in 2000 and 30 per cent in 2005.

Bilateral trade between East Asia and the GCC quadrupled in volume between 1995 and 2006 alone according to McKinsey & Co. Total cross-border capital flows between the GCC and the rest of Asia are predicted to climb from USD15 billion today to USD300 billion by 2020.

Allen & Overy's position

And how is Allen & Overy positioning itself to take advantage of this redistribution of capital? By leveraging on our international network, our local expertise and relationships, as well as our familiarity with local customs and practices. Allen & Overy is strengthening its geographic reach across markets such as China , the Middle East, Russia , Brazil, Central and Eastern Europe, which should provide opportunities to act on cross-border acquisitions.

We have an established broad geographic presence in the Far East with offices in Bangkok, Singapore, Shanghai, Beijing and Hong Kong . Allen & Overy is rapidly developing its capabilities in China as well as in India. For example, Allen & Overy implemented a dedicated India Desk and entered into a referral relationship with Indian law firm Trilegal.

Meanwhile, Allen & Overy has been present in the Middle East for over 30 years, and is strengthening its foothold there with the opening of new offices, and the transfer of partners from elsewhere – corporate partner Johannes Bruski is relocating from Frankfurt to the Saudi Arabia office in December 2008, while Tom Levine is transferring from London to the Abu Dhabi office in August 2008. A Middle East Strategic Committee has also been established, with responsibility for the strategy of Allen & Overy's growing practice in the region.

By deploying its expertise across this global network, Allen & Overy is responding to the needs of its clients and is capitalising on the potential of new and emerging markets. It is fundamental that we have the scale and resources on the ground to handle transactions, and to transfer talent to where it is required most.