Podcast: Brain Food for General Counsel

We look at the impact of coronavirus on five vital sectors of the economy and hear from Pinsent Masons experts about what actions companies are taking now to survive and thrive. 

Transcript

Matthew:

Hello and welcome back to Brain Food for General Counsel from Pinsent Masons. My name is Matthew Magee and I'm a journalist here at Pinsent Masons and we are back sooner than expected to help you to make sense of one of the most extraordinary times any of us has lived through.

Businesses are at the sharp end of the coronavirus crisis, from looking after employees to setting up hundreds, even thousands of home offices to providing the essential goods to keep society running, not to mention coming up with a vaccine which will hopefully bring this crisis to an end.

So having taken an overview of the immediate situation two weeks ago – do check out the last programme, which contains fascinating lessons from past crises – we are now going to dive into some of the nitty gritty.

Pinsent Masons focuses on five sectors: Advanced Manufacturing and Technology; Infrastructure; Financial Services; Energy; Financial Services and Real Estate. So we will hear from the heads of those sectors at Pinsent Masons about the priorities in each of their areas and we will get a sense of what actions companies are already taking to mitigate the effects of the upheaval.

Governments around the world have stepped in with unprecedented support for business, but is it enough? Is there enough finance available to keep companies in operation? And will the crisis spur companies to innovate earlier than they had planned?

We will hear about all that in the course of the programme, but first we will hear from Florian Von Baum who leads Advanced Manufacturing and Technology, firstly about what the issues are that clients are bringing to his attention.

Florian Von Baum:

I think most imminent at the moment of course is labour law issues, how to reduce labour costs effectively by use of government programmes. Other issues related to supply chain challenges, are companies obliged to deliver? What about damages resulting from the delivery? These are the more imminent and immediate needs clients have and why they come to us. I think on a mid-term and a longer term basis, probably issues around financing and probably reorganisation and restructuring of certain parts of the companies will be a feature.

Matthew:

All eyes are focused now on one area of manufacturing and technology – life sciences, biotech and pharma, from where we hope to hear news in the coming weeks and months of a vaccination against Covid-19. But even there the coronavirus complicates things.

Florian Von Baum:

The first assumption would be that pharma, biotech and medtech are the winners of the virus crisis, if you can say so. Indeed when you take a look at the stock markets, share prices of many companies in that sector increased significantly and in particular areas which are close to the virus challenges, research on therapy or antibodies for instance but also medical or diagnostic equipment. However, whether this reflects the real situation in all cases in my view, quite doubtful, in pharma and biotech is always risky in subject of failure and setbacks, so we have to see what the development brings. We find some very practical problems also affecting the life sciences industry, like immediate supply chain problems in shortage of certain components. Expert bands for crucial medicines, fraud and quantifiers in particular for hygiene products.

Matthew:

Demand for manufactured goods is now tightly focused on material that can help in the fight against coronavirus – especially medical devices such as ventilators and protective clothing for health and social care workers. So is everyone turning on a sixpence to change what they produce?

Florian Von Baum:

In particular, in manufacturing some companies have already started to change their product portfolio with products which have a more immediate demand now such as ventilators for our masks. To give one example, Volkswagen uses hundreds of 3D printers to produce medical equipment now. Companies which have flexible productions facilities or can do additive manufacturing have a clear advantage here and in life sciences we also see some shift to R&D to move research capability from existing programs to Covid-19 problems.

Matthew:

If the government measures that we have seen around the world are going to be a success they will have to help companies such as manufacturers which cannot be productive while their workforce is at home. But are the measures enough? Will there be a sector to come back to when this is over?

Florian Von Baum:

I think at the moment you can never say enough is being done, but I think the right things have been done by the governments. We find in almost the all the countries new laws which, for example, to have companies to reduce workforce temporarily and corresponding labour costs across many countries have implemented respective regulations also short notice loans and credits to secure the cash flow of companies of all sizes have been introduced to get companies over the next few months. In Germany a new law has been adopted which prohibits a termination of rental agreements because of non-payment of rent at least for the next two or three months and make maybe longer. That is good on the one hand, on the other the companies should be very mindful of what actions to take in that respect. I think companies should be really mindful and be aware that all actions could have some negative effects also in the public opinion. In a mid and long term perspective government subsidy programmes are in my view not enough in particular not for the manufacturing sector, there is an absolute need to increase the demand side and it will be interesting to see what governments will do in that regard in the future. And last but not the least, the financial strength of industries in our sector must be secure, we already see that central banks are taking respective actions to inflate the markets with money but this will probably raise other challenges in the future of course.

Matthew:

Companies have to wrangle not only with whether those government measures are sufficient, but with the task of knowing what they are and how they operate. For infrastructure companies which might be active in scores of countries around the world the task simply of keeping up is a major one, according to infrastructure expert Ian Laing.

Ian Laing:

One of the biggest challenges is making sure that the business, your business is up to date with current advice and establishing a means of communicating across the business in a clear way is a challenge for all business including those in the infrastructure sector an when you are operating, you know, in an environment changing daily, sometimes hourly, and across multiple sites and potentially multiple jurisdictions with employees who are being flooded with information constantly and clear concise intra-company information is really really important. That is definitely a challenge that we and everybody else are dealing with.

Matthew:

Construction companies will have spent recent weeks poring over contracts to look at clauses, such as force majeure clauses, that allow them some leeway in case of extraordinary events. But that leeway typically allows extensions of time but does not protect you from the cost consequences of that delay. And companies have to balance exercising those rights to that leeway with the sense that they are part of a long chain of activity seeking to achieve common commercial aims. So what approach are infrastructure companies taking? Is it a pragmatic commercial one? Or are they seeking to enforce the rights they have in their contracts?

Ian Laing:

All of those contracts that I am involved in where we are discussing issues around the impact on performance of obligations of contracts, force majeure comes to the fore, and that is largely because of the way that the constructions supply chain works and the contracts within the market really requires contractors to notify often as a prerequisite of a right to notify of an event within a limited period of time, and therefore even if one is willing to take a commercial view down the line one has to serve the notice in order to make sure that you have the ability to take that decision later.

As to whether people are taking commercial judgments at this this stage, I think the answer is not that we have seen, and I say that living and working in Asia and having worked through some of the issues here now for over a couple of months, we are not seeing major commercial decisions being taken, people tend to be taking an approach whether maintaining their contractual rights but that is not to say it will not come and it is possible that the industry may seek to share pain.

I think the real problem for the infrastructure is they operate on such narrow margins, they do not have buffers on which to take more pain and therefore for many of them they just feel they do not have a choice. I think where one sees differences, and it would be interesting to see how this plays out in time, is where large, and they are generally Asian, state sponsored corporates with access to cash are able to take a more commercial view and we will see how that plays out.

Matthew:

The position companies take – to co-operate, not invoke clauses about performance of the contract versus maintaining their position for future protection – is bound up with infrastructure companies' financial position – it is not an industry where companies sit on enormous cash reserves and this will inform every decision they are now taking.

Ian Laing:

As we said margins are tight in the industry and so the longer term implications are potentially very significant indeed. You have a sector large parts of which is not operating a sustainable level of profitability before they went into this crisis and you can imagine with the physical strain that will come from taking the cost consequence of delay even with the government policy of support that is available is going to be a huge challenge.

The financial health of the infrastructure sector has never been particularly rosy. CBI did a report in relation to the UK market recently in relation to the financial health of the tier 1 contractors which demonstrated an aggregate loss position over the last financial year for them, that is true in other parts of the world, and even where there has to date been a boom, so in parts of Asia you will hear talks about the profitless boom, so yes there is a lot of work available in the market but making margin from it has proved hugely difficult.

You can, therefore, expect to see sadly insolvencies, restructurings within the sector, disruption to supply chains, opportunistic merger and acquisition activity for sure, and cash raisings and all the things you would expect in distressed businesses. I think you will also see in an effort to solve that waves of government support in terms of projects, much has happened after the global financial process but you might see some other interesting areas of support, if you look at all the Hong Kong government is looking at advance payments against their existing contracts to kind of change the cash profile of their projects in order to front load them a bit in order to get the industry over this.

Matthew:

Ian is based in Singapore so is able to peer into the future a little bit for those of us based in the western hemisphere – the virus hit Asia hard and early and its spread and the measures to cope with it are two or three months ahead of Europe, the middle east and Africa. And the news from that part of the cycle is encouraging.

Ian Laing:

If you look at China as an indicator of what may happen in the future, you have an infrastructure sector that is in large part back to work and they have at least 80% of constructions sites in China are back to work, albeit at an impaired level of productivity, but they are back. Supply chains are still disrupted for sure, but work is recommencing and the signs are encouraging, now that has really taken two to three months to go from a particularly bleak outlook to something that look much more positive. It is always tempting to see the things through the lens of the now but we could be looking at a very different world in two to three months time.

Matthew:

Let's hope so, but for now the impact is being felt in many parts of the world. Energy expert Paul Rice says that lockdown across the world has caused oil and gas prices to collapse, with wide‑ranging consequences.

Paul Rice:

The biggest impact has been the collapse in the bringing gas price up back to 2002 levels. With more than a quarter of the world in lockdown at the moment we are seeing a collapse of oil and gas demand as well as power demand and a consequent impact over 60% reduction in the oil price at the moment. We are seeing concerns around continued generation as well as a maintenance as a result of the availability of people as a result of the lockdown and illness and then big impacts on the supply chain for new built projects as well as on-going maintenance of project as a result of the closure of factories. Now, factories in China manufacturing are not a lot of parts for solar, wind and other renewables as well as nuclear and conventional power products have re-opened, but we are seeing supply chain impact still on-going principally in Europe and elsewhere.

Matthew:

Paul says that the lack of demand, collapse in the price and the fact that vital workers are not available because of lockdowns is having an impact on the security of energy supply around the world, a serious issue for industry and households alike.

The lack of available workers is also having an impact on deals in the energy sector to purchase assets or build new ones, and is affecting the credit ratings of companies, making those deals even harder to engineer.

So what are energy companies doing to deal with the problems they are facing?

Paul Rice:

We are seeing client dealing firstly with protecting key workers, protecting their staff who are working from home as well as ensuring sufficient staff, sufficient key workers are available to continue with generation and supply of both oil and gas as well as supply of power in the conventional, nuclear and renewable sectors. We are seeing energy sector clients looking at accommodating easier payment terms for domestic energy consumers who are experiencing financial difficulties as a result of either redundancy following our financial cash flow issues in the households. Major cash flow issues for the energy companies themselves and the supply chain. Discussions with government around energy resilience and our clients reviewing their supply chain contracts and having discussions with the wider supply chain around force majeure and change in law as a result of the various impacts we have already mentioned. It is clear that we will need to have serious discussions with procurement authorities, governments, regulatory authorities going forward if there is a much more serious impact on the global demands of oil and gas and power going forward.

Matthew:

So the immediate issue is one of demand, and this has some major consequences for the financial position of energy firms.

Paul Rice:

Cash reserves across the various components to the energy sector are stretched at the moment, oil and gas was coming out of a global slump and has been now knocked significantly by the Covid-19 impact. We are now seeing an oil and gas price that we have not seen for 18 years. So, in an industry that has been very stretched over the past 10 years is now seeing an impact that will not only lead to consolidation but there will be companies that will not survive the current very low price pressure in that industry that do not have the cash reserves to carry them through.

Matthew:

The issues faced by the sector could have ramifications long after coronavirus has ceased to be a threat. One of the things countries will be thinking about now is energy security and supply. Policies and strategies may well change in light of lessons learned in these intense few weeks.

Paul Rice:

Energy security and energy resilience has been a long term goal of most companies around the world for a long time. I think the interruption to supply chain, the ability of matters in one part of the world impacts a country's ability to keep its lights on has never been more obvious than it is at the moment. So, certainly national energy independence/resilience I think will become a much bigger issue going forward. We are already seeing in the UK continued dependence on the amount of power we import into the UK over interconnectors. Now, if those companies have a major issue around their generation that will have a consequent impact on our ability to import and therefore a much longer term strategy for national resilience in the UK are indeed those countries that are exporting power to other countries will come into sharp focus.

Matthew:

A situation like this one will quickly focus business minds on a few areas which will determine how well their company will weather the storm and one of those is undoubtedly capital.

Many governments have made lots of capital available to their economies to make sure that there is confidence in markets that companies can continue to operate.

This puts financial services companies right at the heart of an economy's ability to survive the crisis and thrive once it has passed. But that process is not always a simple one, as Pinsent Masons financial services head Alexis Roberts pointed out.

Alexis Roberts:

I mean, the great news is that the government is being very clear that it is going to support the banks in relation to lending. So, if they have taken the view rightly it is absolutely critical that there is enough finance in the system for business to be able to continue as far as possible in the circumstances, and the banks are whole heartedly behind that and have been working hard to make sure that they are in a position to be able to extend their balance to sheets to offer that lending. I think that when you get down to the granular detail of it, there are some challenges which particular the banks are having, but say for example, a dialogue will be with customers seeking lending in relation to the government schemes as to whether it is available. And now clearly the banks can have the view a to whether a particular situation falls within those scheme and that clearly there are some quite important interpretation issues which the bank is going to have to work through in order for them to be absolutely comfortable that their lending profile matches the guarantees available from the government in relation to the schemes that have been announced by the chancellor. There is a danger that if they get that wrong that they are lending in circumstances where the guarantee does not apply or indeed that if they are too restrictive that there may well be PR issues which go with being too limited in the credit that they are willing to provide to their customers.

Matthew:

The kind of business disruption that we are seeing is something that many businesses, and individuals, are insured against, meaning another area of financial services is systemically important if our societies and economies are to recover from the effects of the pandemic. So how is the insurance industry set for the challenges ahead?

Alexis Roberts:

I think the first point is that insurers are taking their responsibilities very seriously so, many of them are very committed to their customers in any event but also will be deeply conscious of the regulatory obligation to treat customers fairly. And what that means is that they are looking at the interpretation of the policy to ensure that they are providing their customers with the right cover in relation to the circumstances.

The challenge I think is that often the wordings are not as clear as they could be, not really of any criticism of the insurers but because the circumstances are so new and have developed and changed so quickly that actually a wording was put in place a year ago but often longer ago than that will not necessarily be absolutely on point for dealing with the current circumstances, so there will often be interpretation issues to ensure that the policy wordings are being applied correctly in the circumstances.

And the important point to bear in mind here is that albeit there is some similarity across the market in relation to particular product lines around the cover that it available, often there will actually be very different wordings and so sometimes it is quite complex and difficult to assess whether how those were willing to respond in relation to a particular claims circumstance. And that is true whether it travel insurance or wedding and events insurance.

The good news for insurance customers whether retail or commercial is that there is no suggestion at all at the moment that insurers are not adequately capitalised to meet their obligations, there is plenty of finance available within financial markets and plenty of capital available within insured businesses to be able to respond to this prices and a big part of that is the measures that were put in place as a result of the global financial crisis to ensure that banks insurers and other financial services firms had sufficient capital within their businesses to be able to respond to significant crises.

Matthew:

Financial services companies will be handling and processing enormous amounts of sensitive personal data, but doing so using systems and processes that have been assembled at short notice to allow people to work from home. This generates new risks for firms in a sector where the mechanics of everyday business activity are highly regulated.

Alexis Roberts:

The challenge is that where you have all of the call centre staff, or a very large proportion of them working from home, inevitably you do not have ability from day one to apply the same systems and controls in relation to the way that data is retained, stored, processed, etc. So, for financial services firms, the question is looking at that issue, working out what are the right steps to take in order to mitigate the risk as far as possible and implementing those across, you know, what is now, whereas they might have had 10,000 people in one office, now having 10,000 people in 10,000 offices. They have the ability to be able to scale those systems and controls out across that network will be critical as well.

Matthew:

Alexis says, though, that regulators realise that this is an extraordinary situation and will take account of that when considering action against companies if incidents do occur.

Alexis Roberts:

There is certainly an understanding from the regulators that financial services firms will not be able to operate to the high level of regulatory expectations that would have existed prior to the crisis. I think also there is an understanding that the capital buffers that have been put in place as a result of the global financial crisis have ensured the financial system is in a really robust system now to be able to respond to the crisis but equally as we are in a crisis that it is appropriate to relax those buffers appropriately. So, that does not mean a wholesale relaxation but an acknowledgment that those buffers are there to be utilised in a crisis and we are not in a crisis. So, I think there is an understanding from the regulator that there will need to be a relaxation and that applies importantly to conduct issues as well and to systems and controls that financial services firms have in place to manage regulatory risk within their business. I think the challenge those for businesses is there is a difference between higher level indications from the regulators that they will adopt a less robust approach on the one hand and on the other hand applying that on a day to day basis in relation to how our financial services firm runs its business. So, what exactly is the extent to which relaxation could occur in relation to our range of different data whether around claims whether around sales, whether around processing data, whatever it might be.

Matthew:

And companies themselves, not just regulators, should be vigilant. These necessarily unorthodox processes can create opportunities for financial crime, something companies are already seeing.

Alexis Roberts:

There are some staggering figures currently around the uptake in cyber crime, so the targeting of a whole range of different customers or financial services firms in relation to cyber crime. So, I think inevitably we will see an uptake in that, that will be caught and addressed by financial services firms who have very very sophisticated systems in place to identify it and stop it but equally in circumstances where systems and controls are inevitably not as implementable as they would have been pre-crisis it is likely that a lot more of that will slip through than would have been the case prior to it. I think when regulators come to assess those systems and controls in relation to financial crime after the fact; I think what critically they will look at would have been realistic and reasonable within the circumstances. So, I think in terms of managing financial crime they will not look at financial services firms to be achieving the same level of systems and controls they would have had in place prior to the crisis but they will look at whether in all of the circumstances bearing in mind what is reasonable and achievable in these circumstances, and bearing in mind the severity of the risk whether financial services firms have adapted their systems appropriately to be able to respond to that.

If there is a common theme here in the early stages of coping with the implications of coronavirus then it is cash, and real estate is no different. James Crookes outlines what the implications of a sudden drop off in revenue for different areas of the real estate sector.

James Crookes:

I means, if you just a look at the UK and we know that of the £200 million rent roll that was due on 25 March this year, it's thought it that only about 30% of that was actually paid in full. So, that is clearly going to create a significant cash flow issue for landlords and already we know many clients have been speaking to us around that is there best tactic around that in terms of collaborating with their tenants in terms of rent waivers, deferring rent, perhaps even renegotiating the way in which rent is paid. These are all very important areas that landlords need to get right with their tenants to make sure they are not prejudicing their ability to recover rent in the future and also obviously not damaging their relationship with their tenants in the long term.

It is not all about rent of course, and there is a number of subsectors within real estate that have been badly hit due to occupational demand or lack of it. So, whether that is hotels for obvious reasons and the way in which revenues are received through hotels, student accommodation and a lot of uncertainty at the moment about accommodation that has already been signed up for especially is universities are not able to go back next term. And housing, where government advice is being to delay moving house at the moment and clearly that is going to have a significant impact in house builders in the short term in terms of cash flow. These are all again areas that people need to be looking at, they need to be looking at that contracts that are already in place to see what it says around liabilities around that state and there are costs incurred here as well, additional costs which may be incurred by real estate providers, such as, for example, increased tax liabilities whether that is council tax or other types of tax which have to be borne by the landlord. So, again these are all areas in which is important to take advice.

Matthew:

Investors, developers and operators are all going to be looking at significant delays to their projects, James says, caused by a host of coronavirus-related issues.

James Crookes:

We are seeing a delay across the board now in real estate transactions, so whether that is pure investment transactions where due to perhaps barriers being put up and lending whether deals are simply just slowing down because it is more difficult to take duel diligence, it is harder to undertake valuations when there are fewer comparables and also delays because for example, if rent waivers have been put in place, that can have in impact on rent under rights that are agreed as part of an investment sales and development fundings.

So, we are seeing delays in transactions and it is important that again, people re-visit the documentation that has been entered into around those, but more particularly around development work, so whether that is delayed as a result of conditionality around planning, we know that the coronavirus act has brought in new provisions to allow planning permissions to be granted by regulations need to be drafted, they are not in place yet, so what potential delays will that cause to obtaining planning permissions. Also, all your obvious points around supply chain for goods in terms of delivery contract. Once the contract liability is opposed to the developers liability, how are parties going to gain access to the sites to carry out the works and what is the impact of all of this on delays to the programme or even force majeure ability to terminate the contract. These again, really important points, very important to re-visit those documents that are already in place, and if you are currently in negotiations around these agreements, what is the best position to be taking and without seeing development agreements and without seeing agreements for lease.

Matthew:

There are very practical issues for landlords in particular to think about, lots of questions that companies should be asking themselves and their partners to ensure that they are prepared for discussions with clients and suppliers.

James Crookes:

If you own real estate, particularly if you are a landlord or an operator around real estate, what is your ability to provide the services that you need to provide and actually to draw down on the service providers who come and do that for you. What is your ability to close the building completely and what claims might tenants or other occupiers have against you? What about communal areas and your health and safety requirements around providing hand washes and so many other things? So there could be increased costs associated with that, are you able to recover those costs from third parties or simply the ability to provide those services at all or close buildings down? These again, all very important areas where it is important to get the right advice, and of course there is a potential here for this to create disputes and the last thing that anybody wants is to create disputes in these areas, to all areas where it is important to look at documentation so that can inform those collaborative discussions with counterparties to find a communal way through this so that the real estate industry ends up a more successful place once we are out of this coronavirus epidemic.

Matthew:

There is a role for the public sector in helping to ensure that funding and planning are in place for real estate projects on the other side of the situation. But innovation, too, may get a boost as companies learn lessons from the crisis and seek to do business a little differently.

James Crookes:

Situations such as created by coronavirus perhaps the only entity that ultimately can see a way through and collaborate with everybody to make sure that deals continue to happen and the wheels keep turning is the public sector. And therefore, the extent to which we might see grow a collaboration between public and private sector, a lot of those models exist already and have been through various reiterations but I can foresee time that greater public private collaboration will take place especially around, for example, some of the garden villages, the garden cities, the garden communities that have been talked about already developing tens of thousands of new homes with all the social infrastructure around them. The ability to bring together the public and private sector in a coordinated way to create the regulation and the funding and the programme for bring this forward I think might become increasingly important. And I suppose a final area is around prop tech, whether that is how deals are done, how real estate is constructed, how it is operating, or how buildings are operated to be more efficient and to be better attuned to the occupational requirements of people. I think that we find that the use of prop tech is accelerated now to again create greater efficiencies as to how people use real estate and people fins a new norm where perhaps real estate is used in a different way but also how buildings are designed and can be operated more cheaply.

Matthew:

The business issues caused by Covid-19 are many and varied and we can't hope to capture them all here, but do check out the hour by hour coverage from our Out-Law reporting team at www.pinsentmasons.com/coronavirus, where you can sign up for updates.

But hopefully this has given you a sense of the challenges in each of the five sectors we have looked at, and an indication of how companies are rising to meet them. Thanks to our sector heads James Crookes, Alexis Roberts, Paul Rice, Ian Laing and Florian von Baum for their insight.

Don't forget to subscribe to us wherever you get your podcasts, and stay safe and well. Until next time, goodbye.

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