Mergers, Acquisitions and International Financial Regulation

Analysing Special Purpose Acquisition Companies

Daniele D'Alvia

• Publisher: Routledge
• Year: 2021
• Print ISBN: 9780367609887
• eBook ISBN: 9781000507911
• Edition: 1
• Topic: Business
• Subtopic: Business Law
• Index: Business

This is a much-needed work in the financial literature, and it is the first book ever to analyse the use of Special Purpose Acquisition Companies (SPACs) from a theoretical and practical perspective. By the end of 2020, more than 240 SPACs were listed in the US (on NASDAQ or the NYSE), raising a record $83 billion. The SPAC craze has been shaking the US for months, mainly because of its simplicity: a bunch of investors decides to buy shares at a fixed price in a company that initially has no assets. In this way, a SPAC, also known as a "blank check company", is created as an empty shell with lots of money to spend on a corporate shopping spree.

Could the trend be here to stay? Are SPACs the new legitimate path to traditional IPO? This book tackles those questions and more. The author provides a thorough analysis of SPACs including their legal framework and how they are used as a risk mitigation tool to structure transactions. The main objectives of the book are focused on finding a working definition for SPACs and theorising on their origins, definition, and evolution; identifying the objectives of financial regulation within the context of the recent financial crisis (2007–2010) and the one that is currently unfolding (Covid-19); and also describing practical examples of SPACs through a comparative study that, for the first time, outlines every major capital market on which SPACs are listed, in order to identify a possible international standard of regulation.

The book is relevant to academics as well as policymakers, international financial regulators, corporate finance lawyers as well as to the financial industry tout court.

1 Against debt The remarkable story of SPACs

DOI: 10.4324/978100312779-2

1.1 An introduction to SPACs

The sun is shining brightly in Kuala Lumpur in Malaysia in 2014. Mr Jeff Lobao is chief executive officer at Matrix Capacity Petroleum Bhd, a company seeking to acquire energy assets. The potential deal has been predicted to be one of the biggest IPOs in terms of SPACs fund raising. The eyes of the world are upon this historical listing on Bursa Malaysia. Nonetheless, at the end of August 2014, the Securities Commission of Malaysia rejects the IPO application of Matrix Capacity Petroleum Bhd, despite its excellent fund-raising IPO with investors, who have been tempted by the potential profit connected to equity securities and to the uncertainty of the business combination. One could be surprised when reading the decision to delist, which has been taken specifically after consideration of the management’s lack of experience in the oil exploration and production business, following the application of tighter Malaysian Equity Guidelines for SPACs’ IPOs. Indeed, common-sense thinking brings us to consider uncertainty, and, in particular, the uncertainty of the business combination, as the main reason for delisting because of the impossibility of projecting or anticipating future management decisions.

This lack of experience has prevented the management from successfully directing a SPAC. On one level, it appears it is not the uncertainty of completing a business combination but the uncertainty of the board of directors’ decisions that is seen as a ‘bad’ product of SPACs. For this reason, uncertainty itself is not seen as a negative element of financial systems, but it underpins what I will identify later as a core process of money creation.

First, SPACs are investment vehicles that pursue value maximisation by acquiring high growth target companies with high potential revenues. This translates in economic and philosophical terms into a reflection on risk and uncertainty in modern economies. Indeed, money creation and income generation processes are the main features of our capitalist system. Without risk-taking activities, the progress and wealth of the economy are destined to be irremediably hindered. In other words, risk is considered as an opportunity that has to be taken.¹ In the same fashion, managers of SPACs are taking risks when they propose acquisitions in order to generate profits for their stakeholders. Furthermore, any income generation process is always understood as a form of uncertainty rather than risk. Indeed, according to Knight,² while risk is a measurable entity, uncertainty itself is not capable of being measured, because it is a mysterious element connected to an ‘entrepreneurial’ instinct that can be understood only through a subjective reading of risk. This work will explore how those concepts of risk and uncertainty relate to modern economies, in order to present SPACs as financial products or financial innovations that are part of the discourse on risk and uncertainty in the contemporary paradigm of financial markets. SPACs give rise to their own features of risk and uncertainty that can also pose systemic risks for financial markets. For this reason, this work aims to discover whether the uncertainty profiles can be turned into manageable forms of risk-taking in order for SPACs to qualify as alternative investment vehicles. To achieve this objective, it is necessary to reflect on the role of law in financial markets in terms of financial regulation.³

The main question is centred on whether or not law, as an emanation of the state, should govern financial markets, and therefore money creation processes, which are informed by uncertainty. SPACs are investment vehicles that are not currently regulated on the markets, except for a few exemptions that will be examined in this work, and can be defined in general terms as ‘SPACs without law’.⁴ For instance, the Malaysian regulation of SPACs is dynamic, and it is influenced by Islamic law, which presents a different conception of risk and uncertainty in the markets, based on the evolving and dynamic concept of Gharar.⁵ Furthermore, the Securities Commission of Malaysia (i.e. the regulator) has implemented a possible sustainable regulation of uncertainty in relation to SPACs by virtue of ‘quasi-legal frameworks’ enacted through the adoption of soft law guidelines.⁶ Therefore, strictly speaking, Malaysia does not over-regulate SPACs because any regulation is commonly understood as the product of a state regulation, or at least of governmental agencies inspired by paternalistic imposition and supervision. By contrast, SPACs in Malaysia are regulated by Equity Guidelines that are a form of soft law regulation enacted directly by a regulator, and not by the state. Therefore, it can be argued that the Malaysian regulation of SPACs is entirely centred on a self-regulation approach which has been developed by the market itself as a form of market discipline, and then registered through the reception, or better, codification of such market practices into a soft law instrument, namely the Equity Guidelines. This is what I define as the codification of uncodified market practices.⁷

1 See further Chapter 3. 2 Frank Knight, Risk, Uncertainty and Profit (first published 1921, Martino Publishing 2014). 3 See Chapter 4. 4 See Chapters 2 and 4. 5 Daniele D’Alvia, ‘Risk, Uncertainty and the Market: A Rethinking of Islamic and Western Finance’ (2020) International Journal of Law in Context 1; Daniele D’Alvia, ‘(Legal) Uncertainty: Takaful between English Common Law and Shari’a Law’ (2017) 10 (1) International Review of Law 1, 4. See also further Chapter 3 for the study of risk and uncertainty under Islamic Finance. 6 See Chapter 4.

Indeed, this reading of the Malaysian regulation provides an understanding of SPACs as a financial innovation characterised either by a standardisation of market practices or a legal standardised regulation. Currently no legal standardised regulation exists except – as we shall see – for South Korea and Turkey.⁸ Therefore, it can be anticipated that the role of law in relation to financial regulation, and specifically in relation to SPACs, has evolved through fostering a market approach in which the law stays behind the scenes. This last sentence can also open a broader discussion as to whether law has ever succeeded in regulating financial instruments.

For these reasons, the next sections introduce the 2007–2010 financial crisis with a specific focus on the main features of risk and uncertainty in the markets that is further explained in respect of the upcoming new crisis determined by the external factor of the pandemic known as Covid-19. This is because in financial markets it is important to evaluate whether uncertainty can be regulated or controlled. Indeed, SPACs are mainly seen as risk-taking operators in financial markets. Their appetite for risk is high because SPACs are risk-takers. Nonetheless, it is also important to recognise that a risk-taking activity alone is never capable of generating profits. Indeed, as is explained below through a reading of Knight, uncertainty is the distinguishing feature of financial markets today; it is essentially the only element that can underpin money creation processes and profit.

The financial crisis is an important example for introducing those concepts of risk and uncertainty as well as evaluating whether risk management can constitute an efficient tool to avoid future crisis. SPACs, as is seen in the sections below, are vehicles through which risk and uncertainty is conveyed. For this reason, the financial crisis is seen as a macroexample of profit-making and failures, whereas SPACs represent a micro-instance of such economic mechanisms. Furthermore, this illustration serves as a theoretical background for further consideration of the role of financial regulation, and specifically the role of SPACs in a post-pandemic regulation environment.

1.2 The financial crisis (2007–2010): the welfare price of under-priced private debt

The financial crisis (2007–2010) has been defined as ‘the biggest crisis since the Great Depression’.⁹ It started pre-eminently as a mortgage-lending crisis in the US,¹⁰ although the diffusion of speculative derivative contracts traded on over-the-counter markets is identified as one of several causes.¹¹

7 See Chapter 4. 8 See Chapter 4. 9 Ioannis Kokkoris, Rodrigo Olivares-Caminal, Antitrust Law Amidst Financial Crises (1st ed., CUP 2010) 90. Although crises are seen as a recurrent feature of financial history (see Charles Kindleberger, Manias, Panics and Crashes. A History of Financial Crises (3rd ed., John Wiley & Dons 1996).

Specifically, the lack of financial regulation and monitoring as well as of correct pricing of financial risk led to a fuelled credit bubble whose first fatal effects were seen in the collapse of the market for subprime mortgages in the US. A subprime mortgage consists of a residential loan or mortgage issued to high-risk borrowers who face bankruptcy or have a late payment history (i.e. they are subprime borrowers). Therefore, the rate of interest charged to those borrowers was higher than a prime mortgage. Nonetheless, lenders such as banks sold – through a system of securitisation¹² – their credit to investors who in turn became holders of asset-backed securities. In light of this, premiums paid on collaterals (i.e. mortgages/loans) were attractive on returns for asset-backed holders due to the higher interest rate, but the effective repayment of the principal of the mortgage would have been convenient for high-risk borrowers only in the case of an increase in house prices.

Furthermore, this form of speculation became even more aggressive when holders of asset-backed securities started to enter into derivative contracts in order to bet on the loan performance to receive additional premiums in case of an increase in housing prices. This circumstance led to a speculation spiral when, between 2004 and 2006, house prices started to drop but debt itself was not downgraded.¹³ As a result, defaults on subprime mortgages began to rise and triggered devaluation of housing-related securities, causing losses to financial intermediaries, raising prices on insurance for default and reducing inter-bank lending.¹⁴

10 Indeed, there are multiple causes of the current economic crisis (see Glen Arnold, Modern Financial Markets and Institutions – A Practical Perspective (Pearson Education 2012) 660). 11 Lynn A. Stout, ‘Derivatives and the Legal Origin of the 2008 Credit Crisis’ (2011) 1 ­Harvard Business Law Review 1, 7. 12 Yuliya Demyanyk, Otto Van Hemert, ‘Understanding the Subprime Mortgage Crisis’ (2011) 24 (6) The Review of Financial Studies 1848. For definition of terms see also ‘Definition of Subprime’, Financial Times Lexicon, available at http://lexicon.ft.com/Term?term=subprime, accessed on 10 February 2015. The sub-prime mortgages were usually packed either into Mortgage Backed Securities (MBS) or Collateralised Mortgage Obligations (CMO), namely two different forms of asset-backed security that use a ­mortgage or a pool of mortgages as collateral (see the definition of mortgage-backed ­securities MBS), Financial Times Lexicon, available at http://lexicon.ft.com/Term?term=mortgage_backed-securities--MBS, accessed on 10 February 2015) and were sold to investors as a form of synthetic instrument having high-risk return prospects. In other words, if the value of houses had continued to increase, the reimbursement of the original loan that constituted the underlying asset of the MBS or the CMO would have been likely to occur. 13 Niamh Moloney, ‘EU Financial Market Regulation after the Global Financial Crisis: “More Europe” or More Risks?’ (2010) 47 (5) Common Market Law Review 1317, 1319. 14 This circumstance is also often defined as credit crunch (see Jorgen Elmeskov, ‘The ­General Economic Background of the Crisis’ (OCDE 2009), available at http://www.oecd.org/eco/42843570.pdf, accessed on 10 February 2015).

Indeed, before the crisis, inter-bank lending and lending activities generally represented the main instrument for financing the investment activities of private equity funds. Private equity firms are a mixture of venture capital and management buyouts. Specifically, the European Private Equity and Venture Capital Association has highlighted that in 2008, private equity investments fell dramatically, due to difficulties in obtaining bank loans to finance new deals.¹⁵ Indeed, the economic crisis (2007–2010) was mainly perceived as a debt securities crisis and contributed to a decline in private equity operations, especially those with a high le...

Table of contents

• Cover
• Epigraph
• Half Title
• Series Page
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• Acknowledgements
• List of abbreviations
• Foreword
• Addendum
• Notes
• Introduction
• 1 Against debt: the remarkable story of SPACs
• 2 Towards a definition of SPACs: origin, limits and perspectives of SPACs in the US
• 3 SPACs between risk and uncertainty, and the role of the law
• 4 The international financial regulation of SPACs
• 5 De-SPAC: M&As, regulatory oversight, and securities litigation
• 6 SPACs: law, uncertainty and the market
• Conclusions
• Bibliography
• Index