Why and how political & regulatory due diligence will change over the next five years

31 Jul, 2023

A more complex and rapidly shifting external environment will continue to require major changes in political and regulatory due diligence (PDD.)  

We see the following key trends in PDD over the next five years, some of which were discussed at the recent Real Deals’ annual due diligence roundtable, which Flint director Martin Summers attended alongside investors and advisors. 

1. The demand for UK PDD is likely to increase this Autumn once the prospect of a Labour government within 12 months comes into view.   

The nature of this PDD will be different from when the prospect of a Corbyn-led Labour government in 2019 had investors concerned about a variety of high-jeopardy risks. A Starmer-led government would present fewer jeopardy risks but much more complex, difficult-to-read scenarios.  

2. PDD will need to determine how fiscal and economic reality will affect policy decisions.  With the fiscal position as constrained as it has been at any time since the financial crisis, significant tax cuts or spending increases will be very difficult for any government to deliver for the foreseeable future. 

The Shadow’s Chancellor determination for Labour to be seen as fiscally responsible is likely to lead to an equally fiscally cautious approach as the Conservatives, with tax increases likely after the next election regardless of which party is in government. The recent trimming of Labour’s more ambitious policy announcements (e.g., on green investment and childcare) will likely continue to meet these fiscal constraints. 

Our ability to understand these constraints and policy decision-making will be enhanced by our new economic impact analysis offer, which will give us the capability to model the impact – at both national and regional levels – of government policies, proposed investments and company-specific activities. It will be led by Andy King, who has spent five years as one of the three members of the OBR’s Budget Responsibility Committee.  

3. PDD will increasingly need to address political and regulatory developments in the countries that impact an asset’s value chain – not just where they sell their goods and services but from where they are supplied or get their investment.  

National security, energy security, ESG, and national/regional strategic economic concerns are driving much more restrictive trade, FDI (foreign direct investment), and competition policies.   

UK-based firms importing manufactured goods from China, for example, will have to consider UK, EU and US policies in these regards, depending on the goods’ route to market, risk of child or forced labour, or security risk. And companies and investors will need to consider what risks governments might associate with a Russian or Chinese investor (as was the case with Nexperia’s thwarted investment in Newport Wafer Fab).  

4. PDD will need to reflect increasing political complexity, unpredictability, and contestability. This is due to:  

  • greater convergence between Labour and the Conservatives on many issues  
  • the difficulty of discerning the ideological leanings of politicians based on their public pronouncements (as most don’t wish to be pigeonholed)  
  • the secular nature of many policy issues, i.e. they reflect long-standing structural problems where there are no obvious political or ideological responses (e.g. on productivity, training, social care, or infrastructure.)  

This means that PDD will need to draw on a wider and deeper understanding of key politicians, advisors and other stakeholders. Perspectives from just one or two advisors will not provide sufficient proof points for robust predictions. Expert networks can sometimes provide good individual insight, but they can’t offer the breadth and level of triangulation that a firm like Flint can (with over 160 staff and advisors, across Europe, the Middle East, and Asia.)  

5. PDD will become more commercially focused.   
With the decline of simple binary or jeopardy risks (e.g. on a Corbyn government or a no-deal Brexit outcome) investors increasingly want to understand and model how various political, regulatory or fiscal developments could affect the revenues and margins of core offers or could present opportunities for new offers or expansion into new markets. We are consequently working much more closely with CDD teams and informing the modelling undertaken by them and PE firms.   

We also increasingly undertake multi-country assessments for investors keen to compare and understand the relative risks and opportunities relating to the macro and sector regimes of different countries. Some of these differences are becoming starker as governments respond in different ways to the end of relatively cheap and accessible labour, energy and finance. 

6. PDD will address ESG policy more, as ESG agendas are increasingly being driven by public policy decisions rather than by initiatives generated in the business, sustainability or investor communities (e.g. in relation to supply chains and the environment.)  

Investors seeking to futureproof their portfolios on ESG need to get a good understanding of the ESG policy landscape over the short to long term. This is also very relevant for B2G firms, as public procurement criteria increasingly give greater weighting to ESG factors (understood as social value in UK procurement and in some other countries). Specialist ESG consultancies don’t always have a policy-level view.  

7. PDD will focus more on recommended actions. Given the growth of political and regulatory uncertainty and complexity, it is important that investors not only know how and why the landscape might change but what management teams can do to anticipate, shape and manage this change.

This is why we make recommendations around risk management (such as factoring political and regulatory risk into risk registers and committees), stakeholder engagement and policy advocacy (to achieve more optimal policy outcomes), market positioning (especially important in sectors under scrutiny), and risk mitigation through different operational models or diversification (e.g. developing private pay offers where public sector revenues are threatened.)

8. Vendor due diligence and IMs will need to address investors’ political concerns  

Sellers and sell-side advisors will need to do more to help get investors comfortable with greater political and regulatory risk and uncertainty. VDD - and less so, IMs – should map out scenarios for an asset and show how its management team is positioned to mitigate material risks and leverage policy-driven opportunities – and how it has done so in the past.

Martin Summers is a director in London. He co-leads our Funds team, focusing on due diligence and other forms of support for investors, as well as advice for portfolio companies, and has worked on over 80 transactions. Get in touch if you would like to know more how we can help investors.  

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