The latest developments in retail
It is difficult to talk about recent developments in the industry without addressing the collapse of Silicon Valley Bank and the ensuing disruption in the financial sector, which particularly impacted e-commerce companies and start-ups. Companies warned of delays in scheduled deposits, paused payments to merchants, and announced deep discounts to fund working capital in the short term. The reverberations of the collapse have been felt throughout the world and come in the larger context of high inflation, geopolitical disruption, labor shortages, high freight costs, and economic uncertainty. As the earnings season begins in the US, retailers have indicated that sales were down at the end of 2022, particularly for those who target lower-income shoppers. But there were also some positive signs: some abatement of freight costs, strong retail sales in January (even when adjusted to take out the effect of automotive sales and restaurants and entertainment), and better-than-expected retail sales in February. Consumer confidence and retail spending are up in the UK, with a strong focus on value retailers such as thrift retailers or discounters. Retail does continue to struggle in the Eurozone, with sales down in January and only slightly up in February. As a contrast, China’s retail market is rebounding again after a tough 2022. The market is reminiscent of what we saw during the pandemic, with sales for true luxury products up twenty-four percent over the last year and non-luxury retailers squeezed as lower income customers cut back spending. Consumer spending is still strong and we’ve seen remarkable resilience in the face of economic jolts such as with Silicon Valley Bank and subsequent related events.
Financing retailers and e-commerce in a distressed financial market
There remains a significant amount of liquidity available to retail businesses and e-commerce companies, but it may not be readily available in the same form as was historically the case. For example, there are many private credit providers in the market today who were almost immediately available and ready to provide liquidity when the Silicon Valley Bank shutdown initially occurred. In 2023, compared to 2008, there is no dearth of liquidity available to businesses. That liquidity just may not be coming from the banks that the retail market has often traditionally utilized for their services. Some of these private credit providers would provide this liquidity on different terms than banks such as Silicon Valley Bank. One thing to note is that Silicon Valley Bank, in its credit agreements, almost always required minimum deposits to be maintained at Silicon Valley Bank, which arguably allowed for Silicon Valley Bank to provide more competitive terms on interest rate, fees and other pricing terms. Private credit providers, which are not banks, would not maintain deposits, so their terms may not be as attractive as an alternative in relation to interest rates, fees, and other premiums from the perspective of a retail or e-commerce borrower. We are also expecting to see more out-of-court solutions with respect to retail businesses, including through liability management transactions in more complex capital structures, as retailers may have an avenue to delay confronting more challenging operational restructuring matters with liquidity still available from a fairly diverse array of sources.
Recent trends and challenges in insolvency
The retail industry in 2023 has not yet seen a large wave of restructurings. The liquidity environment has not fundamentally changed as most debt maturities were set out a number of years, and even if there are liquidity challenges, lenders remain available. We are, however, seeing an environment of increasing challenge, driven by supply chain pressures increasing prices, wage increases, and historically low unemployment, providing inflationary pressure and a high interest rate environment. Interest rates moves, though, are starting to impact on the economy in certain sectors. Employment is also slowing down, as seen with layoffs primarily in the technology industries. These various factors create a recessionary petri dish that we do not yet know when will harvest. Large increases in personal savings during the pandemic are depleting rapidly as inflationary pressures increase prices. So, while we do not expect to see many bankruptcies in the near future given liquidity and credit support to companies, they may be looming. We are seeing a shift in consumer behavior as consumers move away from large brand names in supermarkets to big-box retailers. These types of shifts will continue. And, when we get there, restructurings will be more challenging even with ample liquidity due to interest rate increases and the resulting increases in cost of borrowing and price increases to consumers, which may all lead to a possible (downward) spiraling effect. Investors will require a different level of discipline than they have had in the past few years and decisions will have to be made more carefully in this environment.
Fashion legislation: The FABRIC, Fashion, and Fashion Workers Acts
Sustainability in fashion is when clothing is manufactured with environment measures in mind such as when mitigating the use of excess water and energy or reducing the need for chemicals and fertilizers in producing materials. Lately, shoppers have been focused on sustainability. Historically, the fashion industry has been self-regulated and privately tracked with regards to sustainability efforts, without legal obligation to the federal or state governments to meet social responsibility targets. Now the U.S. federal government and state legislatures are stepping in. On the federal front, the FABRIC Act, and in New York, the Fashion Act and the Fashion Workers Act are potential laws, introduced in the previous year, that could see passing in the coming year. The Fashioning Accountability and Building Real Institutional Change (FABRIC) Act would be the first federal bill aimed at improving labor rights for garment workers by setting hourly pay for workers, enacting penalties for violations, requiring recordkeeping measures, and establishing joint and several liability among all parties employing garment workers for violations of the act. The Fashion Sustainability and Social Accountability Act, or Fashion Act, in New York would make New York the first state to directly hold the world’s largest fashion brands liable for environmental and social impacts. This bill would amend the existing New York business law to require apparel and footwear companies generating over $100 million in revenue to map and disclose their supply chain across all production tiers including labor abuses, greenhouse gas emissions, and energy consumption. Companies would have to publicly publish their social and environmental sustainability reports and establish annual goals to reduce their environmental impact. The New York Fashion Workers Act is aimed at model management agencies, which traditionally have not fallen under employment regulations in New York. The act would provide basic labor protections for models and creative workers in the fashion industry such as requirements to pay models and creative workers within forty-five days of performing services, limiting enforcement of exclusive representation contracts, and creating a ceiling on the amount of commissions that agents could collect. These New York Acts have been reintroduced for consideration until the end of 2024.
Cybersecurity in the retail industry
The retail industry is facing two primary issues in the cybersecurity threat landscape and the evolving legal and regulatory landscape. Many of the risks organizations have to be prepared to face in cyber crisis are often the same, but the retail sector has played an early and prominent role in the last fifteen years. Retail organizations have thus known they are the potential or likely victims of a cyberattack. The stakes have risen significantly over the past three years because of ransomware attacks. These attacks have become increasingly frequent, increasingly sophisticated, and the amounts demanded by perpetrators of attacks have increased. We are now living in what some call a ransomware epidemic. Previously, attacks were relatively simple with hackers using malware and demanding payments with relatively low amounts in the thousands. Today, we often see double extortion attacks where threat actors will compromise a victim’s infrastructure and exfiltrate an organization’s most sensitive information. These two points of pressure allow actors to demand huge sums of money in the millions. Organizations have to be prepared for a variety of cybersecurity threats beyond ransomware attacks. Because of today’s increasingly significant cybersecurity threats, regulators globally have announced a wide variety of laws, regulations, and guidance on what organizations must do before, during, and after experiencing a cybersecurity incident, with continued opportunities to increase regulatory harmonization in this space. Historically, there is a large body of law governing data breaches under privacy law, but not every cybersecurity breach involves data. The focus of recent laws and regulations specifically address cybersecurity incidents. One year ago, President Biden signed a new cybersecurity law calling on the Cybersecurity and Information Security Agency to develop rules to require various critical infrastructure industries to take certain actions after a cybersecurity incident. The Securities and Exchange Commission has also proposed its cybersecurity rule relating to cybersecurity governance and incident reporting. There continue to be several sector specific regulations to apply to organizations as well.
Authored by Kelly Tubman Hardy, Meryl Bernstein, Christopher Donoho, Peter Marta, Matthew Schernecke, Max Cardin, and Nathan Truong.
