Deal-making activity levels were modest at the beginning of this year in contrast to what the market, and we, anticipated. However, with high levels of dry powder across both public companies and private equity, as well as a more stable macroenvironment, there is cautious optimism for an increase in deal-making activity over the remainder of 2024.

There was a flurry of deal-making activity in the last quarter of 2023, with 58 deals completed in the UK in Q4, relative to only 100 deals throughout Q1-Q3 2023. The significant number of transactions expected in 2024 is driven in particular by anticipated levels of private equity (PE) activity, with the industry entering 2024 with £2.0 trillion unspent investor cash and £2.2 trillion of ageing deals that need exiting.

However, rising borrowing costs are leading PE to go “back to roots” so to speak, through sourcing good deals, making operational improvements, and pushing larger firms to resort to financial engineering, e.g. borrowing across portfolios, “recycling” through funds. In this context, the devalued British pound and improved pension scheme funding may make certain UK companies with defined benefit (DB) pension schemes more attractive assets than they may have been in recent years.

Transaction may be a platform for enhancing journey plan and/or risk transfer solution

While M&A activity could be positive for covenant, for example in increasing economies of scale through consolidation or providing opportunities to expand into new markets, covenant risk dynamics will be altered and will need careful consideration. While scheme funding is generally much-improved, pension scheme trustees should consider using the transaction as a platform to strengthen the scheme’s journey plan (and reflect the post-transaction covenant risk dynamics), and/or secure a risk transfer solution as part of the transaction irrespective of this.

More generally, despite the general improvement in funding levels, trustees shouldn’t be complacent when it comes to covenant and corporate events. We encourage trustees to stay close to their sponsors and ensure they are considering the covenant implications of corporate events as they arise. This should not just be M&A activity but events that may happen in the ordinary course of business, for example, restructuring, refinancings of debt, and internal re-organisations.

Company insolvencies, challenging refinancings and restructuring are on the rise

On the other side of the spectrum, company insolvencies are at a 30-year high, driven by a stagnated economy, surging costs and wage rises. While insolvencies have been primarily affecting smaller businesses to date, these are now also extending to mid-market and larger companies, with businesses across the construction, retail and hospitality industries particularly hard hit last year.

A number of challenges remain for UK companies in 2024, including refinancing hurdles, noting that Cardano does not expect the Bank of England’s monetary policy to loosen until Q3 2024 based on the Bank of England’s 9 May decision (and even then, is only expected to drop to 4.75% by year-end 2024), and persistent inflationary pressures, with inflation not expected to settle firmly below target until the middle of 2026. Moreover, ‘zombie’ companies suffering from ‘long Covid’ are increasingly exhibiting triggers for restructuring activity, such as debt maturity and increased costs of debt. This is expected to drive activity across distressed M&A and special situations, with restructuring activity anticipated to ramp up into H2 2024.

Trustees should engage with sponsors around upcoming refinancings

In this context, trustees should remain cognisant of upcoming debt maturing and engage with sponsors to understand how refinancing is progressing. This should provide trustees with an early indication of any issues with refinancing which could lead to potentially distressed scenarios and allow trustees to engage with advisors and other stakeholders at an early stage. The latter can be a critical step to help facilitate negotiations in good time and achieve an outcome that is in the interests of all.