What is Regulatory Due Diligence and why is it important?
Performing comprehensive due diligence is paramount to securing a profitable deal during any Mergers and Acquisitions (M&A) process. Regulatory Due Diligence (RDD) is a key component of transaction due diligence, and involves the systematic review and evaluation of the Target’s current and likely future regulatory compliance status, and of upcoming and anticipated regulatory reforms. This allows a clear-eyed view of potential business impacts and related risks associated with the transaction [1] [2].
RDD allows acquiring companies to develop a comprehensive understanding of the Target’s regulatory obligations, risks, and issues, and is essential for managing risk during M&A deals. Regulatory risks have the potential to be among the most damaging to business reputation and performance, and can carry material financial implications for the Target and/or related entities (including parent companies). These consequences may arise unexpectedly if not robustly and systematically managed.
The objectives of RDD are to:
Provide a detailed view of the Target’s regulatory framework and obligations;
Confirm the legitimacy of business operations;
Reveal previously unknown or undisclosed issues or “Red Flags”;
Evaluate the potential business impact of those issues; and
Identify potential mitigants that the Target or acquiring company may use to reduce regulatory risk.
Many M&A deals fail as the result of issues and risks that are revealed throughout the course of due diligence investigations. It is equally important for the Target/sell-side to perform RDD before buy-side entities are engaged to identify and address regulatory issues early and enable the transaction process to run smoothly, efficiently and without unnecessary frustration.
What does the Regulatory Due Diligence process involve?
Rennie’s RDD process focuses on identifying key policy and regulatory issues, risks, and opportunities to inform decision-making during the transaction process. Our approach to RDD consists of five core phases:
Scoping and hypothesis generation: Conducting rigorous scoping and planning activities at the outset of an RDD process is crucial. Initial activities involve confirming expectations among the Client, RDD and Project Management Office teams; reviewing key documents in the Target’s Virtual Data Room; identifying and mapping the relevant policies, regulatory frameworks, and regulatory reviews; developing guiding hypotheses; and designing a detailed research program.
Information and data gathering: This second phase of work is heavily research-based, and involves investigating the current state of all applicable policies and regulatory frameworks that have been identified, recent and potential future reforms, and other regulatory change processes.
Identification of Red Flags: The team will analyse the gathered data, and identify and assess any potential risks and opportunities for the Target’s gross margins and growth outlook. Findings will be presented in a Red Flag Report.
In-depth analysis of key issues: Detailed analysis of any high-priority issues identified in the Red Flag Report will be undertaken. Based on the findings, the team will review the assumptions in the Target’s financial model and evaluate their suitability in the context of the current and likely future regulatory landscape. This may include proposing adjustments to the financial and/or growth assumptions.
Regulatory Due Diligence assessment: All findings of the RDD program will be documented in a comprehensive Final Report, including all scope items agreed in phase one and any additional requirements specific to the transaction.
What are the key challenges in completing Regulatory Due Diligence and how are they overcome?
The complexity of the RDD process creates considerable challenges for teams working to achieve a robust, thorough, and exhaustive outcome.
Dealing with limited access to and/or potentially inaccurate information, either due to incomplete, inaccurate or lack of documentation provided by the client, or a lack of public communication or clarity from regulators and policymakers, or both.
Our solutions:
We leverage the sector knowledge across the firm to identify key policy and regulatory instruments, validate available information, and detect major gaps or limitations.
Where necessary, we engage directly with regulators, policymakers, and industry experts, and may issue detailed information requests to the Target.
Anticipating the future policy and regulatory landscape, which requires extensive knowledge of, and the ability to interpret, long-term trends in the regulatory reform landscape for the Target’s jurisdiction, and finely tuned consideration of the unpredictability of policy change.
Our solutions:
We develop an understanding of the broader policy and regulatory context in which the Target operates, to determine the likely direction of future reforms and identify any areas of uncertainty.
We seek to understand the long-term implications of trends and changes by considering like-for-like jurisdictions or similar industries beyond the Target’s operations.
Quantifying the impact of regulatory changes that have yet to take effect, change processes that are not yet finalised, and potential changes that may occur in the future, and accounting for uncertainties in when and how new reforms will be implemented.
Our solutions:
We draw on strong quantitative analysis and modelling capabilities to develop robust assumptions that consider the likely end state and implementation timelines of incoming reforms.
We may use proxy data, where relevant, to illustrate potential impacts.
Adhering to a clear, defined scope while ensuring the inquiry remains comprehensive and balancing a wide range of potential queries, interdependencies, and knock-on effects.
Our solutions:
Our discussions with Client stakeholders at the outset of the RDD process agrees a clear scope of work.
We use tailored hypothesis issues trees to ensure our analysis provides exhaustive coverage of the Target’s policy and regulatory landscape.
Keeping track of progress and findings in a coordinated workstream, which, may involve coordinating effort across several sub-workstreams in parallel.
Our solutions:
We employ an array of internal tools and measures to monitor the progress of our research program, record findings and escalate challenges. These include customised research databooks, assigning clear roles and responsibilities for team members (including a designated Information Manager), and employing a rigorous internal quality assurance process in the preparation of all deliverables.
Delivering quality outcomes to tight timelines
Our solutions:
We undertake extensive project planning at the outset of RDD engagements to ensure that we conduct our investigation with maximum efficiency and address client priorities.
We draw on our large and versatile team and work collaboratively to respond to the demands of the RDD process within the agreed timelines.
The foundation of quality RDD lies in deep sector expertise, collaborative planning and prioritisation, and diligent research and analysis. More than understanding the current scope of policy and regulatory obligations, it is about knowing what questions to ask about the future and how the answers will impact the bottom line.
Are you preparing for your next transaction? Message or email us to find out more about how Rennie can support you.
References
[1] ANSARADA, “Regulatory Due Diligence: Definition & Importance,” [Online]. [Accessed 4 December 2024].
[2] R. Hernandez, “Regulatory Due Diligence: Definition, Use, And Best Practices,” Data Room, 8 November 2023. [Online]. [Accessed 5 December 2024].
