This crisis will go down in history as a defining moment in our lives – a permanent change which will, like 9/11 or the fall of the Berlin Wall, close out the chapter that came before it and come to define an era.
Indeed, the pandemic may be remembered less for what it did than what it revealed about ourselves. It has highlighted many of the existing fault lines in our societies, from supply chain vulnerabilities and socio-economic inequities to privacy concerns and monopolistic concentration. It has also been an accelerator of existing trends, including the shift to e-commerce and digital commerce, decisions to buy local; work from home; and investments in firms that promote progressive environmental, social and governance (“ESG”) policies. The durability of these trends will shape how we come to view the crisis in the future.
Finance & Economy
This has primarily been a service-sector driven recession, self-imposed by government lockdown rules. Some sectors, including retail, travel and hospitality have been particularly hard hit, whereas some manufacturing firms have seen increased demand (good luck finding cross-country skis this winter). But the line between winners and losers is drawn less clearly by economic sector than by organizational size. Generally speaking, larger firms across sectors have fared much better than the small, able as they were to draw on reserves of capital, credit facilities, an online workforce and e-commerce to soften the blow.
While production indicators are still down, rosy outlooks for 2021 have the markets heating up. Measured by funds raised in initial public offerings, rising stock indices or frothy asset prices, 2020 has been a favourable year for day traders and institutional investors alike.
Following a brief dip in the spring, institutional investors remained very interested in public markets and did not meaningfully change their allocations. Communication between fund managers and investors was proactive, which limited withdrawals and market turmoil. By the summer, dealmakers returned to opportunity shopping after a brief stint getting their houses in order.
In 2020, the fundraising environment continued to be relatively strong, leading to a significant accumulation of dry powder. Creative capital deployment, including investments in managers, private investments in public equity (“PIPEs”), and special opportunity funds, are likely to follow. Similarly, we will continue to watch whether the trend in popularity of SPACs in the US migrate to the Canadian market and Canadian managers.
Amongst sponsors, a key question this year has been how to value companies given the varied impact of COVID-19. Are we nearing the end of inflated valuations and the era of the founder’s ride? Apparently not. Investors are however factoring in observations of a company’s and its management’s ability to pivot under stress (focussing on impacts on customer and supplier relations, digital workforce, performance management, relationship with lenders, etc.) to better model an appropriate enterprise value.
In 2020, as a general matter, Canadian banks were supportive of businesses and accommodating with respect to credit arrangements between borrowers and lenders. Modifications to calculations of EBITDA and financial covenants, relief to payment schedules, and other waivers by lenders proved invaluable to their clients. However, lenders increased their credit diligence with respect to certain matters such as cash leaving the business (ie. distributions paid to shareholders), permitted investments, permitted acquisitions, and certain types of capital expenditures. Banks were also more vigilant about reporting requirements, requiring more disclosure and information around cash flow forecasts and updated financial models.
In 2021, expect leverage and liquidity to be in focus as lenders and financial sponsors look to longer term financing solutions. COVID-robust business models will continue to be attractive for capital providers and financial sponsors alike, and there will be more granular analysis as to whether the pandemic has caused a secular change to business and operations (e.g. changing fundamental EBITDA forecasts and adding new hard costs to operations). Ultimately, the sheer amount of dry powder from asset managers, as well as high savings rates/ household account balances among consumers have contributed to a cautiously optimistic 2021 in terms of robust deal activity.
If anything, the pandemic, which has had a disproportionate impact on women and people who were least equipped to weather the crisis, has fueled and accelerated the existing ESG movement, capitalizing from the boost it received in 2019 from being centre stage at Davos and the Business Roundtable and the energy of the protests following the death of George Floyd in 2020.
In 2021, there will be a real and increasing spotlight on the social aspect of ESG – principally but not exclusively employee health & safety, including mental health. HR, once focused squarely on employee retention and performance must now also look to the branding and reputational impacts of their social policies. There is however a growing debate on how to compare these human capital indices. Though embrace is widespread, inconsistent data make measurement across organizations difficult.
Some government aid has been conditional on ESG reporting, a change we expect is here to stay. Indeed, governments are highlighting plans to continue spending significant amounts to support the recovery, in particular on green infrastructure.
Numerous sectors are being supported artificially but the music will eventually stop. Nationalizations are possible in some industries, such as aviation, where unrepayable loans may be turned into equity. We have not yet seen the end of a potential wave of insolvencies and bankruptcies. Indeed, we may just be seeing the beginning.
Trade & Supply Chains
American protectionism is likely here to stay, though a Biden presidency will likely implement its agenda in a more predictable and purposive fashion than the outgoing administration. “Buy American” provisions in prospective spending bills may limit Canadians’ opportunities to win U.S. public procurement contracts. If Canada reciprocates, North American economic integration will take a hit, though such contracts make up a small fraction of the billion-dollar daily trade between the neighbours.
Across the Atlantic, the UK and Canada have reached an interim agreement to roll over the provisions in the Canada-EU Comprehensive Economic and Trade Agreement (“CETA”), which will not longer include Britain on January 1. Canada and the UK will commence negotiations to formalize a bespoke bilateral agreement next year. Canadian firms will benefit from regularized trade with both regions, although a hard Brexit next month could complicate business for those seeking to access EU markets by first exporting to the UK.
Around the world, governments are increasingly protective of their weakened businesses and wary of opportunistic takeovers. National security review (a black box of discretionary approvals) is being wielded more aggressively to deny takeovers by big foreign rivals.
With China’s economy roaring back, production availability has largely been restored, though supply chains continue to suffer from transportation delays. It is crucial that firms continue to diversify their supply chains and, where possible, leverage AI to increase efficiency on trafficking issues.
Despite their best efforts, shipping delays have raised vexing contractual issues for many businesses. We continue to see businesses leverage Material Adverse Change claims, force majeure, and other provisions to leverage their rights and remedies both in court and out. With Canadian courts still in a COVID-induced backlog, businesses are increasingly choosing arbitration, a trend we expect is here to stay.
Lockdown and Masking Rules
There is a significant amount of regulatory overlap between different levels of government. For businesses operating nationally, the difficulty keeping pace with competing rules, needs, and restrictions in different jurisdictions across the country is straining operational capacity. Unfortunately, we don’t expect this to change quickly with the vaccine’s rollout.
The Information and Privacy Commissioner of Saskatchewan has released an advisory on vaccines and privacy, particularly for employers and employees, which includes considerations for employers in developing a vaccination policy. It should be noted that a number of health-industry workplaces have always required that their employees be vaccinated.
Potential developments related to vaccination, such as limitations imposed by employers, or by businesses as a condition for service (boarding aircraft), remain to be seen.