Firms across the industry have used consolidation to drive growth, promote innovation or take advantage of cost synergies. Scale and diversification are key drivers in wealth management, and acquisitions can help to expand access to specific asset classes, geographical locations, and the expertise of key managers, as well as growing assets under management and the client base.
In this series of articles, we look at a variety of aspects in M&A transactions which can affect value, for buyer or seller, and propose ways of addressing these in the commercial terms to enhance value.
Our earlier articles looked at ways to structure a transaction around value and other key issues to consider when structuring a transaction. Subsequent articles will look at the retention and incentivisation of key personnel and business integration.
In this third article in our series, we look at some of the key regulatory considerations in wealth management M&A.
Change in control approval and regulatory notifications
Often, the main regulatory consideration on a share sale (especially for a buyer) is whether change in control approval is required in order to acquire the relevant business, not least because approval can take upwards of four months to obtain.
An entity or individual is required to obtain change in control approval from the PRA and the FCA, or just the FCA (depending on how the target firm is regulated) where it acquires “control” of a UK-regulated entity (Target) and hence would be considered a “controller”.
What constitutes “control” varies depending on the regulatory classification of the Target. Where the Target is a private bank or wealth manager, usually a person will be deemed to acquire control (and hence be a controller) when acquiring:
10 per cent or more of the shares or voting power in the Target or its parent, or
Shares or voting power in the Target or its parent which gives one “significant influence” over the management of the Target.
This can encompass a large number of entities and individuals in the ownership chain. Change in control approval will be needed for each entity acquiring control, which can result in a large number of controller forms being filed with the relevant regulator(s). This is in addition to a number of supplementary documents such as financial statements, CVs and, where an entity is becoming a parent undertaking, a business plan.
In a Share Purchase Agreement, change in control approval is a condition to completion, meaning that a split exchange and completion is required. As noted above, this can significantly impact the deal timetable as well as (from a buyer’s perspective) necessitate the imposition of gap controls on the seller and the underlying business.
The regulators have 60 working days to assess a change in control application from the date of receipt of a complete application which can be interrupted by a period of up to 30 working days. The clock starts ticking from the date of receipt of a complete application. If the regulator deems the application to be incomplete, this assessment period will not commence, pushing the timeline out even further.
For asset sales, as the buyer is not acquiring shares or voting power in the Target, change in control approval is not typically needed. However, on an asset sale:
UK-regulated buyers and Targets typically notify the regulators in advance that the transaction will occur under the PRA’s Fundamental Rule 7 and / or the FCA’s Principle 11, as such a sale is generally considered to be something of which the regulators would expect notice, and
The Target must ensure that it has in place valid client agreements with those clients who transfer. The transfer mechanism followed will depend on a variety of factors, including the presence and drafting of transfer provisions in the seller’s standard terms, whether client money and / or assets are being transferred (and if this is permitted in the seller’s standard terms) and the buyer’s preferred approach.
Regulatory due diligence
As noted in the first article in this series, thorough but targeted regulatory due diligence is vital given the potentially significant financial impact of needing to fix regulatory issues post-acquisition, and the potential financial and reputational impact of a regulatory penalty or other sanction. Warranty and indemnity (W&I) insurers will also typically require that a thorough due diligence exercise is undertaken on a Target.
Buyers should (among other things) look to flush out any conduct of business issues with particular attention to retail client business, for example suitability failings, mis-selling or defined benefit pensions issues as well as any failures to implement, or implement on time, new regulatory requirements. If a Target acts as a UCITS management company or as an AIFM, buyers will want to check that the fund documentation is compliant and up to date.
Where the Target is a private bank carrying on regulated lending, buyers should assess the Target’s historic compliance with the complex regulated lending regime. If the Target carries on regulated consumer credit lending, failure to comply with the information and agreement requirements can impact the enforceability of the credit agreements and hence the value of a Target to a buyer.
Other important areas include compliance with AML and other financial crime requirements.
Other considerations will be relevant to the scope of regulatory due diligence dependant on the factual circumstances.
Regulatory capital and prudential consolidation
Private banks and wealth managers are subject to extensive prudential requirements. Whilst an exhaustive consideration of the regulatory capital issues associated with regulated M&A is beyond the scope of this briefing, important issues include:
- Prudential consolidation: Where a buyer is looking to purchase a Target, that buyer, the Target and other subsidiaries can become “prudentially consolidated”. This effectively means that the buyer, the Target and other subsidiaries are treated as a single regulated entity, with regulatory capital requirements applied to this theoretical (but potentially very large) regulated entity. This can result in a notable increase in the regulatory capital which needs to be held, potentially affecting the profitability of the Target and a combined group post-completion.
- Cash and gap controls: In some transactions, the buyer will permit the seller to distribute excess cash from the Target or the Target’s group instead of paying for such cash on a pound for pound basis. Both parties need to be careful that such a provision does not inadvertently cause the Target to breach its regulatory capital requirements.
- Structuring and timing: More generally, if a Target (or an entity with which it is prudentially consolidated) is to issue shares or takes on debt, this needs to be done in a way that does not inadvertently cause a breach of regulatory capital requirements. In addition, for certain Targets, prior permission is required if the Target intends to issue financial instruments which it wishes to classify as regulatory capital, which will need to be factored into the deal timetable.
Remuneration Codes and financial incentivisation
This will be covered in more detail in a future article in the series but, by way of summary, private banks and the majority of wealth managers are subject to one or more “Remuneration Codes”. These Codes govern the award of remuneration by UK regulated firms, including any guaranteed variable remuneration and retention bonuses.
In a transactional context, therefore, and depending on the regulatory classification of a Target, the Codes can restrict how much and in what form, say, retention bonuses can be paid to key employees. They can also require a Target to have arrangements to exercise malus and clawback in respect of such awards. Buyers and their advisers should therefore be aware of these Codes and how they may restrict the retention of key employees going forward.
If you require further information about anything covered in this briefing, please contact Anthony Turner, Andy Peterkin, Charlie Court, Edward Twigger or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, April 2023