* Source: Pitchbook and CB Insights
Market analysts were expecting a downturn in 2022. The unprecedented highs of 2021 were unlikely to be sustained. It was a year that saw the S&P 500 notch 70 all-time highs, a record that’s second only to 1995. This was the story across financial markets, with global venture investment last year seeing a 92 per cent growth (year over year).
Expectedly, 2022 was subject to pessimistic forecasts, but has it been all doom and gloom?
As the financial world transitions into H2, it is worth considering how markets have fared thus far across different jurisdictions.
European PE dealmaking has been incredibly resilient in H1. There has been a 16.2% YoY increase in deal volume, which amounted to a 34.8% in deal value. It is the size of transactions powering the optimistic statistics. In the US, however, PE deal activity slowed relative to the pace set in 2021.
VC saw a sharper downturn than PE in the year’s first half. Nevertheless, European VC was relatively robust, with only a 13% drop (compared to 25% in US/Asia). Interestingly, angel investors have been more active than any other investor group. The median deal size for the pre-seed investors was up by $1M from 2021.
European VC is alive and kicking. As Sifted reported, 2022 has been an opportunity for new funds to emerge across Europe due to lower valuations. 16% of European VC funding has come from first-time fund managers or established managers launching a specialist fund.
It is probably too early to begin dissecting and analysing. H2 may paint an entirely different picture than we have seen. At the same time, some have suggested that the macro environment has dictated the market landscape.
According to an analyst at Pitchbook, “US sponsors have suffered from a particularly harsh dealmaking environment. In response to the increase in gas prices, supply chain disruptions and ballooning housing prices, the Federal Reserve has been swift to hike interest rates, thus slowing the economy and lessening demand.”
Corporate lawyers operating in the PE/VC space remain busy. Whilst companies and investors attempt to navigate their way through complex markets and alternative financing (venture debt, for example), lawyers need to anticipate what comes next in this turbulent and exciting industry.
The Ukraine-Russia conflict impacted the export payments significantly and negatively around the world. To tackle this, the Indian government resorted to making international deals with Russia in the Indian rupee (INR) against the US Dollar, with the latter being the uniform global currency for international transactions.
This step is positive for India. Considering this, the Reserve Bank of India (RBI) has said it is establishing a system for rupee-based foreign trade settlements. The mechanism behind the directive, which goes into immediate effect, is intended to encourage global trade growth with an emphasis on exports.
The new structure will be implemented for invoicing, payment, and settlement of exports/imports in INR to encourage the expansion of global commerce, with a focus on exports from India, and to further support the growing interest of the international trading community in INR.
The Foreign Exchange Management Act of 1999 outlines the general framework for cross-border trade transactions in rupees in the following manner:
The RBI exclaimed that it would accept export transactions in rupees upon granting approval. This system will completely bypass the US altogether. A bank will be set up in India by a foreign country called the Special Vostro account. The exporter will transfer rupees to this account. An exchange rate will be set up, and the exporter will be paid in its currency. The rupee lying in the Indian account would be used for any imports the exporter may want to make.
This especially comes at a time when the rupee has hit an all-time low. This move to internationalise the rupee will increase the value of the rupee globally. The trade imbalance with India would probably decrease if the rupee became a global currency. The value of the rupee will rise on the international market. Other nations may begin using the rupee as their trading currency.
Last month around 40,000 members of The National Union of Rail, Maritime and Transport (RMT) Workers participated in Britain’s largest strike in 30 years, and many more workers are set to follow suit. Not only has the RMT Union threatened further strikes on 27th July and 18th and 20th August, but thousands of others, including BT workers, barristers, NHS doctors, teachers and Royal Mail managers, also intend to take strike action for better pay. This flood of threats comes as the inflation rate reaches 9.1%, the highest it has been in 40 years.
As the cost of living soars, unions argue that wages must be increased to keep up with higher prices. For example, the Communication Workers Union, representing employees of BT, has announced that approximately 40,000 workers are to participate in two 24-hour strikes for better pay on 29th July and 1st August.
The strike proceeds the Union’s rejection of BT’s offer of a £1,500 per year pay rise, which it argues is essentially a pay cut when the inflation rate is considered. Similarly, the British Medical Association has threatened walkouts by doctors unless they are granted a 30% increase in their salaries over the next five years to counteract the real terms decrease in income that they have faced since 2008.
So far, public sector and business employers have not been receptive to the Unions’ demands and claim that pay rises can only be funded via “modernising” reforms. For instance, BT has stated that a £1,500 per year pay rise is its best offer and will not reopen its 2022 pay review.
Employers have also accused unions of being inflexible despite knowing that many industries have suffered increased costs and a shortage of workers due to the Covid-19 pandemic, and according to Andrew Haines, Chief Executive at Network Rail, the RMT Union failed to put its most recent pay offer to members before announcing its plans to strike in July.
In addition to unwillingness from employers, the government has warned of the possibility of an “inflationary spiral” if pay rises are handed out since this would be funded by increasing prices, thereby passing on the cost to consumers.
Despite this, it remains to be seen whether the disruption that will inevitably ensue if these strikes take place will convince employers to give in to union demands.
In May 2022, the crypto world was rocked to its core. LUNA, once hailed the ‘gem’ of decentralised finance by its supporters, the self-proclaimed ‘Lunatics’, crumbled within 24 hours. Its capitulation, alongside its arbitrage stablecoin, TerraUSD (UST), provides a harrowing insight into the risks of cryptocurrencies and reinforces the harsh reality that nothing is ‘too big to fail’.
This article will discuss stablecoins, what they are and why they are so popular. Additionally, we will explore the reasons behind the crash of UST and LUNA, why this is significant, and the global regulatory response.
In summary, stablecoins are cryptocurrencies which are ‘pegged’ against something with consistent value. Broadly speaking, there are two main categories of stablecoins; asset-linked and algorithmic.
Asset-linked coins are commonly pegged against a fiat currency such as the US Dollar and are backed up by cash reserves. For every flat-backed stablecoin, there is 1 of the currency which it is pegged against, thus leading to a 1:1 ratio. The main appeal of such coins is that they retain their value by maintaining a ‘peg’ to the currency’s value. As such, they are often viewed as an attractive alternative to traditional cryptocurrencies as they are generally unexposed to market volatility.
Algorithmic stablecoins are slightly different. Whilst they are pegged to the value of a real-world asset, they are not backed by one. As such, the consistent value of the coin is determined based on an algorithm which aims to maintain an equilibrium. Typically, such coins work in conjunction with a cryptocurrency exposed to the market.
This is the model adopted by UST. Pegged against LUNA, UST maintains its peg to the US Dollar by using a ‘mint and burn’ system. For every 1 UST bought, 1 LUNA coin is burnt, and vice versa. Whilst this model generally withstands slight fluctuations in UST’s price, the algorithm is heavily exposed to mass withdrawals. If a sizeable portion of the market sells UST, the price will fall below the $1 peg. As the system is backed by an algorithm rather than the US Dollar itself, it relies upon its algorithm for stability.
On 8th May 2022, the Terra ecosystem’s worst nightmares came true; UST drastically slipped below its $1 peg. The catalyst, a singular sale of $193 million worth of UST which caused the coin to drop to $0.98. Whilst this was only a $0.02 decrease in value, it was enough to cause widespread panic throughout the market. Mass withdrawals of UST began, further driving down its price. These withdrawals triggered the underlying algorithm to print swathes of LUNA coins to stabilise the price. As the supply of LUNA increased, its value disintegrated.
At the time of writing, LUNA is valued at approximately $1.92 per coin, a far cry from its all-time high of $119. Additionally, UST, the supposed stablecoin, languishes at $0.039 and as of 13th May 2022, Terra’s blockchain is halted. In less than 24 hours, an estimated $45 billion market was annihilated. Owing to the limited legal protections awarded by Terra, investors’ cash was largely irretrievable, leaving them to pick up the pieces of a system crippled by its own design.
Regulation of stablecoins has been on the horizon for several years. In October 2020, the Financial Stability Board (FSB) published a report detailing high-level recommendations for the global regulation of stablecoins. Its primary purpose was to help encourage harmonious regulation by creating a foundation upon which future regulation could be built. Central to the recommendations is an emphasis on proportionality. Whilst the report acknowledged the inherent risks of stablecoins and cryptocurrencies more generally, it recognises the cruciality of finding a regulatory ‘happy medium’.
Accelerated by the Terra crash, Japanese regulators were first out of the blocks. In June 2022, Japan passed amendments to their Payment Services Act which has been hailed as the world’s ‘first clear regulatory framework’ for stablecoins by Chihiro Ashizawa, Head of Capital Markets at Clifford Chance, Tokyo. The amendments limit who can issue stablecoins, with only fund transfer agents, trust companies, and licensed banks entrusted to issue the coins. Prior registration and approval are also required. Whilst it is unclear whether this approach will be mirrored across the globe, the amendments reflect a bold attempt from Japanese regulators to minimise the risk of stablecoins and ensure protection for investors.
In addition, investigations into Terraform Labs and its founder, Do Kwon, are ongoing. South Korean prosecutors are investigating Do Kwon for potential tax evasion.
Meanwhile, Terraform Labs, the company behind UST, has lost its appeal to impede a Securities and Exchanges Commission investigation.
Terra’s collapse will certainly act as a warning that no one is too big to fail. Whilst the crash has inflicted untold damage on the crypto space, it is individual investors who suffer the harshest after-effects. As crypto continues to evolve, balancing regulation with the proportionality of risk becomes ever more complex.
On 19 July 2022, the Delaware Chancery Court granted Twitter’s appeal for a quick court date, setting a five-day trial in October. This comes after Musk said he wanted to back out of a deal to buy the social media company for USD 44 billion.
Elon accuses Twitter of giving false and misleading information about the number of fake and spam accounts on the site and claims that the social network has not provided him with enough information to verify that fewer than 5% of Twitter’s 229 million daily users are fake or spam accounts. He claims the number is significantly greater (> 20%) and argues that such information is key to understanding Twitter’s ad business. Elon contests that a finding that there are more bots than anticipated constitutes a MAC.
Should the court hold that there has been a MAC, Twitter would be found to be in breach of its representations and warranties, and Elon would not be bound to close the deal in such a case. Such a ruling would mean Elon could walk away without paying any damages or fees.
Delaware courts set a high burden of proof threshold for proving a MAC and have only once found that such an event excused the buyer from closing. For the underrepresentation of the number of Twitter spam accounts to be held as a MAC, Elon would have the burden of proof, on the balance of probabilities, that the spam account numbers not only were false, but they were so false that this would have a significant effect on Twitter’s earnings in the future.
Elon’s waiving of due diligence certainly does not play to his advantage, nor does his multiple declarations that the existence of bots formed part of the reason he wanted to buy Twitter.
While contractual breaches engender remedy equal to the initial expectation concerning the signed contract, merger deal breaches typically trigger liquidated damages, whose price is predetermined and stipulated in the agreement. This fee (fixed at 1 billion dollars in the Twitter acquisition agreement) must be paid as damages for failure to perform under a contract. While, in principle, such a clause would emancipate Elon from the deal, other contractual clauses may preclude him from simply paying the agreed termination fee and walking away.
Twitter will seek to enforce the merger agreement by invoking the negotiated specific performance clause. If the contract can be completed, that is – if all the closing conditions have been met and the debt financing is available – the parties have agreed to permit Twitter to ask a court for an order for specific performance: an order from the court instructing Elon to complete the deal.
Essentially, if Elon is indeed in breach of the agreement, there is a high probability that he will be ordered by the court to perform and acquire Twitter for the agreed $44 billion price against his will. A ruling to that effect is highly probable, especially given that Elon has the funding on hand.
While the underrepresentation of the number of Twitter spam accounts could be of concern to Elon, this does not seem to be a veritable issue. Elon may feel the initial deal was overpriced, and suing Twitter may be a scare tactic to get the company to negotiate better terms of the agreement. This may well be a case of a buyer conjuring an exit plan. It is not uncommon for buyers experiencing remorse to look for a MAC in a bid to lower the initial agreement price, as was the case in the recent Louis Vuitton acquisition deal of Tiffany & Co. Such an argument does not hold weight and would not survive much of a challenge.
Should Elon be ordered to perform the contract in any way specifically, the court’s ability to force his hand is broad.
The appointment of a special master, an individual appointed by the court to take the actions Elon has refused to, could well be envisaged. Such action would include the handing over of properties and the signing of official documents. The court would construe these as the actions of Elon himself. Should the special master fail in his mission, the court could formally take control of Elon’s Tesla shares. Since Tesla is incorporated in Delaware, Tesla shares could be treated as seizable property to be handed over to Twitter to pay off the ordered sum.
Elon could also be fined any amount the court may deem just and reasonable: this means the court could fine Elon millions of dollars for each day of non-compliance. Finally, while, in theory, disregard for an order could lead to contempt of court, which can result in imprisonment, the likelihood of such holding is slim: pressure from Elon’s legal team to comply with orders may mean the court may not have to resort to such measures.