The market as it stands
The immediate impact of the Covid-19 pandemic on the M&A market appears to have passed its negative peak for the moment. Markets experienced a record year in 2021 both in terms of number of transactions as well as of transaction volume. A total of more than 63,000 transactions moved a volume of more than USD 5.9 trillion – an increase of 64%.1 It comes as no surprise at all that such increase has led to yet another boom in the transactional insurance industry and affected the way policies are or can be placed into the market also on a synthetic basis for policy purposes.
While certain policy discussion items such as unknown tax risks, adjustments or enhancements of loss definitions and of course knowledge scrapes remain the go-to topics when it comes to synthetic coverage elements, full synthetic cover is not yet something the market seriously wants to transfer from mere discussions into reality. While recent articles and social media posts still do suggest differently and won’t stop doing so (and there is reason behind it, namely flexibility), it is worth the check to see where the market in fact currently stands – whether it is in need for yet another level of synthetic elements or whether this is and remains a theoretical discussion that is likely to pass the bore-out barrier for the moment.
Motives and motivation
Of course parties’ interests under a standard transaction matrix are quite different, no surprise at all so far. While there is natural limitation in place (the SPA) when it comes to bridging the gaps between seller and purchaser, it is of course tempting to regard synthetic coverage as the golden share and quite an elegant alternative to facilitate transactional flexibility and a positive outcome for the transaction itself. We do count at least twelve scenarios from the past two years where synthetic elements along with dedicated contingent risk policies which in fact facilitated that potential show stopper were put out of the competition. But still, it remains highly in doubt whether a full synthetic coverage can honestly be regarded as desirable from an entirely motivational perspective. Of course, problems remain and they won’t go away simply because an insurer is now stepping into the shoes of a seller or purchaser that would need to be convinced. Underwriters have recently shown great market perception when it comes to commercial decisions where synthetic elements can potentially be justified or where this would not be possible at all due to lack of information? Not only does it normally add additional complexity to the policy structure and negotiation but also it should not be regarded as an exit for any kind of due diligence gaps that were not capable of being overcome for purposes of the SPA warranty catalogue in the first place. So why would an insurer go for a risk derived from a synthetic warranty that has not made it into a “real” SPA provision?
Motivation of course is to match market demands. When brokers do see potential and the relevant portion of risk appetite to obtain a synthetic coverage for a certain risk or risk area that may well be within the limits of commercial reason for certain insurers then it is unquestionably on the agenda of the underwriters as well. Let’s take synthetic tax indemnities: They have been in the market for quite some time now but only the last two years or so really showed huge demand for providing such element as an integral part of the policy. Challenges from market competition do contribute to the development of innovative market drivers anyways.
So when there is room in the market for bridging gaps via synthetic coverage it is just and fair to discuss how this could work. While formal restrictions (if at all in place) as to the degree of synthetic coverage available do not create significant hurdles and also would be counterproductive for the entire business, there is no such thing in regard to legal limitations under most jurisdictions either. Therefore, the window seems wide open and the market motivation would need to meet reality under the current market conditions. So where do we stand?