Russia Ukraine war: potential impact on UK SITS sector
By Lloyd Evans,
Russia’s invasion of Ukraine and subsequent escalation of events, including sanctions and other measures imposed by major economies including the UK, EU and US , have led to a critical geopolitical inflection point.
As restrictions eased, the UK economy appeared poised for recovery, with sectors rebounding, the workforce tightening, prices soaring and the Bank of England set to begin to untie the fiscal policy and monetary support it initiated during Covid-19. The Russian invasion of Ukraine will significantly hamper the UK’s economic recovery, presenting new hurdles to overcome and increasing pressure on the UK economy.
The macro impact of the military conflict will be felt through multiple channels. Commodity price shocks will exacerbate inflationary pressures as supply constraints remain tight. The financial repercussions of the new sweeping sanctions could lead to financial market volatility and a decline in market confidence. Potential security issues can arise in an escalating military conflict scenario or via cyber attacks.
Russian aggression is likely to lead to increased inflationary pressure and a moderate impact on GDP growth in future periods. While the prospect of further rises in commodity and energy prices heightens the dilemma facing the Bank of England’s Monetary Policy Committee. The Committee needs to assess the short-term impact of rising commodity prices on domestic inflation against the corresponding risks to demand.
Potential impact on UK SITS companies
In this extremely fluid environment, the changing geopolitical scenario will undoubtedly affect the UK SITS market, given the elevated cybersecurity threats, migration of tech talent and strict sanctions implemented by the government. .
Aging IT infrastructure and growing service demands, coupled with cloud adoption and changing market dynamics, have caused cybersecurity to quickly rise to the corporate agenda. Combined with recent events, businesses are now rapidly assessing their exposure to the crisis, as military conflict increases the risk, frequency and complexity of cyberattacks. Given the digitalization and interconnectedness of global markets, cyberattacks can have unintended and damaging consequences for a wide range of industries across large geographies. Following Russia’s unprovoked and premeditated attack on Ukraine, the National Cybersecurity Center called on organizations to strengthen their online defenses, citing the use of HermeticWiper and WhisperGate malware against Ukrainian organizations as a particular concern. Additionally, the demand for effective AML/KYC software is expected to see a significant increase due to increased due diligence and audit trail processes as the government seeks to increase transparency with the new Foreign Entity Registry. . The ongoing acts of aggression against Ukraine will provide industry tailwinds for cybersecurity firms as organizations work to mitigate cybersecurity risks. In terms of M&A, increased demand should fuel continued appreciation in deal volumes and values as strategic acquirers look to integration and consolidation capabilities while financial acquirers look to raise awareness in the industry, providing a window of opportunity for shareholders to crystallize value at high levels.
The crisis will likely fuel a migration of tech talent, as Ukraine, before the invasion, was a favorite destination for global tech companies. The abundant availability of skilled talent resources and low cost of living has attracted many leading technology companies to offshore and near-shore third-party capabilities like EPAM, Softserve, GlobalLocic and Luxoft – alone providing over 30,000 senior computer engineers to global organizations and it is expected that 170,000 Russian computer scientists could migrate from the region by April. Therefore, the war and disruption in the services market is occurring at the same time as a broader global talent shortage. It is expected that with the pressure already exerted by the global talent shortage coupled with the additional strain of war on skilled IT resources, the cost of IT talent will rise further, adding to the strong inflationary pressure. The brain drain is expected to lead UK companies to migrate their outsourcing and proximity capabilities to alternative hubs such as India and Argentina, however, the migration creates uncertainty regarding quality, costs and longitudinal dispersion increased.
Overall, while process timelines may be lengthened due to changing due diligence scopes and increased scrutiny, the effects of the crisis in the UK M&A market SITS are expected to stay minimal and potentially act as a growth driver for domestic trading volumes and market valuations. due to high cybersecurity requirements.
Potential impact on SITS mergers and acquisitions
The crisis can alter the trading environment, as market sentiment and volatility can fluctuate. Macroeconomic pressures and geopolitical developments that continue to unfold will inevitably weigh on near-term deal-making as acquirers re-evaluate their acquisition pipeline and risk appetite. Demonstrated by Spectris PLC ending their talks of a possible acquisition of Oxford Instruments PLC for £1.8 billion due to economic uncertainty resulting from Russia’s invasion of Ukraine.
The sweeping sanctions imposed by the UK on Russia mean that increased due diligence is required for any Russia-related transaction to ensure compliance with UK regulations. Companies conducting international transactions should be aware of sanctions and regulations imposed by other countries linked to Russia. For example, Citigroup’s sale of its Russian business to Russian state bank VTB is set to hit a roadblock, and Roman Abramovich’s high-profile exit from Chelsea FC is set to come under scrutiny in the light of current and evolving sanctions.
To address due diligence challenges, acquirers and targets should consider extending due diligence timelines and ensure that due diligence is conducted in a careful manner and within a prudent scope. Newly defined scope of due diligence expected to extend to business and operations continuity, insurance, supply chain risk, solvency risk, risk of perpetuating material contracts and applicable changes to national laws and international. Governmental considerations must be taken into account, as volatile geopolitical conditions and evolving international sanctions will lead to an increased number of regulatory considerations when conducting M&A transactions, which will lead to extended transaction times given the the newly defined scope and increased monitoring.
The invasion of Russia will clearly have profound effects on the ESG framework from a social and governance perspective. ESG research houses MSCI and Fitch have downgraded Russia from an ESG perspective and assigned the toughest ESG governance rating to the Russian Federation. ESG downgrades extended to the MSCI Russian IMI index and major private companies. Given the current sanctions, volatile geopolitical conditions and the fact that Russia will be excluded from political benchmarks, this will lead to dire economic conditions for Russian businesses and make the region uninvestable. In light of the sanctions, leading companies have also started to divest themselves of their Russian businesses, with BP pulling out of its position in Rosnet, Shell pulling out of its joint venture with Gazprom and TJX divesting of its stake in Familia. Although it is currently difficult to predict the exact consequences for UK companies, companies should review their exposure to Russia and the ESG framework more carefully as ESG benchmarks are increasingly scrutinized as part of the ESG framework. due diligence exercises and investment valuations, providing a method to unlock improved shareholder value.
Since the beginning of the conflict and the subsequent imposition of strict sanctions by major economies, the macroeconomic and credit implications have impacted the capital markets of many countries. However, UK financial intermediaries appear to have low exposure to Russia and therefore remain well insulated from significant financial ramifications arising from the imposed sanctions. Nonetheless, given the BoE’s pre-war rhetoric, gloomy consumers, heightened market volatility and rising commodity prices will fuel upward inflationary pressures and the possibility of further interest rate hikes. in the short term as the crisis exacerbates the tightening of the political environment. To show how pervasive the pressures are likely to be, economists are upping their inflation forecasts for major global economies, including forecasts that UK inflation will hit 8% this spring. Upward inflationary pressure could cause UK businesses to ramp up fundraising activities in an attempt to capitalize on the relatively low cost of capital, before further rate hikes are applied and the cost of capital rises . However, the long-term implications are expected to remain relatively limited as capital markets are expected to evolve with geopolitical conditions and inflation is expected to return to the BoE’s 2% target within 2-3 years.
While the crisis will present short-term headwinds for UK SITS businesses, the net effect of Russia’s invasion remains to be seen, as the fluid geopolitical environment remains unstable. The migration of technology talent and increased cybersecurity risk are expected to cause the most significant disruptions for the industry.
If you would like to arrange a call to discuss current market trends and/or available opportunities to create, increase or realize shareholder value, please contact a member of the Software and IT Services industry team.