Special purpose acquisition companies or SPACs offer a clear example of the Baader–Meinhof phenomenon – you hear about them once and suddenly they’re everywhere. For Christopher Unwin, senior development underwriter at Travelers UK, the space, as it explodes in popularity, must be carefully and constantly monitored.
Read more: Find out more about Travelers
Explaining for the unversed exactly what a SPAC is, Unwin stated that they are publicly traded shell companies established to acquire existing operating private companies and take them public. SPAC investors are invited to invest in a shell company that pulls in cash and has no operations, which then looks to find a private company to purchase within a two-year period. SPACs do not initially have a target company in mind and any guidance it offers investors on that subject is not binding.
“The SPAC is set up by a sponsor, who assembles a management team with prior experience in private equity deals and M&A transactions,” he said. “The investor funds (the proceeds from the initial IPO) are held in a separate trust account until the acquisition is complete. There’s usually a two-year time frame for this to happen. And if a target isn’t found in time, the funds are then liquidated and returned back to the investors.”
The Travelers financial lines team has seen a lot of inquiries regarding SPACs this year, Unwin said, and several factors are driving this upsurge. From the simplicity that this route offers in contrast to a traditional IPO - which is a more time and resource-consuming process - to the increased encouragement of retail investors by success stories in the media, it is no surprise that more investors are considering the option.
Read more: Former Allianz veteran plans major SPAC
This is all occurring against a backdrop of a changing regulatory environment, he said, as plans are in place to amend the current rules governing these transactions. While current regulation means these transactions are not as viable in the UK as they are in the US, where they are very popular, the UK government is looking to open up the stock market more to SPACs following Brexit.
With so much happening in the space, Travelers is keeping a close watch on any market developments and Unwin noted that this overview has highlighted the key challenges.
“One of the biggest difficulties that insurers will face is that you can never be 100% sure what company the SPAC will eventually acquire,” he said. “When an insurer is presented with a SPAC risk, they may have a general guide as to the target industries being focused on, but they don’t have the ability to underwrite the ultimate target company.”
“Underwriters who want as much information as possible in order to assess the risks that they’re being asked to cover will find it really difficult to examine the potential exposures, as you have no idea what type of company you’ll be insuring. And that’s one of the first questions that any underwriter would ask - what activities is this entity undertaking?”
Another major concern is the potential for litigation, he said, and recent events have shown that this can amount to serious costs. Unwin highlighted a recent high-profile SPAC-related litigation that partially settled for $35 million, plus additional costs, and the possible intention to seek recoveries under the D&O insurance policy applicable. Other challenges include the very real possibility that some retail investors are putting their money into SPACs without fully understanding the risk that they are taking on.
“And we’ve also seen that the FCA has warned that returns from SPACs remain highly varied, and they can often result in losses despite a degree of hype around the room,” he said. “The FCA advises investors to carefully consider terms before supporting a SPAC and the Wall Street Journal has reported that in 2021, an average of five new SPACs are being launched every day.
“A major concern I think, for insurers regarding the explosion in capital in this space is that we have so many SPACs seeking out private firms to take public that it may become increasingly difficult to source high-quality acquisition targets. SPACs may end up overpaying to source a target company, or may source riskier or lower quality targets in order to complete a deal within the two-year window or face liquidation.”
Insurers are also careful to consider the disclosures made by the SPACs and whether these are adequate for investors to make an informed decision, he said, with examples such as failures to disclose conflicts of interest or allegations of misleading statements also throwing a spanner in the works.
As an insurance company, Unwin said, Travelers is closely monitoring the claims environment around SPACs and expects that the increase in transactions will likely result in a similar increase in litigation and claims activity. The company will watch with interest where these claims will tend to fall – whether it’s with the SPAC, the target company or the new company post-transaction. This is further complicated by the fact that each entity may have different D&O insurance and thus different wordings, terms and conditions.
“I think challenges will arise in determining which policy would respond first in a given claim scenario,” he said, “and this will be even more complex when insurers may participate on different layers for each of the entities. As an insurer, we’re also going to monitor comments and activity from regulators. In the UK, the FCA is looking at changing the rules around SPACs to balance investor protection and harmonise standards with international markets... and we anticipate regulation changes may lead to a rise in popularity on the UK exchange.”
As the situation currently stands, Travelers’ view is that it does not have the appetite for SPACs given the challenges that insurers face across that transaction space. While the insurer is continually evaluating the situation, it does not offer coverage and this is the stance all the way across its financial lines and commercial D&O business.
“We’re looking to exclude [such] operations until the market matures,” he said, “and until we can greater assess this rapidly changing landscape.”
Find out more about the range of products and services available from Travelers here
