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M&A in banking: change of control regime
Practical Law UK Articles 9-584-9125 (Approx. 5 pages)
M&A in banking: change of control regime
by Gordon Low, Steven Francis and Nina Moffatt, Baker & McKenzie LLP
| Published on 23 Oct 2014 • United Kingdom |
This article, the third of a three-part series on mergers and acquisitions in banking, considers the change of control regime under Part 12 of the Financial Services and Markets Act 2000. It is essential to identify early on whether an acquisition or internal restructuring affects an authorised financial services firm as this may trigger change of control requirements, which could delay or completely derail a transaction.
For firms making acquisitions and disposals in the financial services sector, the need to obtain the relevant financial regulator's approval for the transaction is a hurdle that, at best, may delay completion and, at worst, can derail a transaction completely if consent to the change of ownership is withheld. Therefore, it is essential to identify early on whether an acquisition or internal restructuring affects an authorised financial services firm, as this may trigger change of control requirements in the UK and elsewhere.
This article, the third of a three-part series on M&A in the banking sector, considers the change of control regime under Part 12 of the Financial Services and Markets Act 2000 (FSMA) (the FSMA regime).
The FSMA regime
FSMA implements the requirements of the Acquisitions Directive (2007/44/EC), which came into force in March 2009. Under the FSMA regime, obligations arise for the:
- Buyer; that is, any person or entity that intends to increase its control over the target firm or become a controller of the target firm.
- Seller; that is, any person or entity that decides to reduce or cease control over the target firm.
- Target firm.
Chapter 11 of the Supervision Manual, which forms part of the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) Handbooks, sets out additional rules for authorised firms along with guidance on the interpretation of the FSMA regime.
Applicable firms
Broadly speaking, the FSMA regime applies to UK-incorporated financial institutions in the banking, insurance and investment sectors. However, non-UK incorporated persons that are controllers or potential controllers of a UK-incorporated authorised firm are also subject to it. So wherever the potential controller is based or incorporated, it must obtain the consent of the appropriate UK regulator before it acquires control.
Notifications and applications for consent to change of control will be handled by the regulator with responsibility for the target firm. As firms authorised by the PRA, such as banks, will be dual-regulated by the PRA and the FCA, the PRA must liaise with the FCA on the change of control submissions it receives.
It is important at an early stage of any transaction to determine whether the target is subject to the FSMA regime and, if so, by whom it is regulated as this will affect the drafting of the transaction documents and the process adopted. This can be done by searching the Financial Services Register (www.fsa.gov.uk/register/home.do).
Meaning of control
The concept of control is broad and can raise complexities for buyers as well as existing controllers whose holding(s) may be affected by the acquisition. Therefore, potential incoming controllers should consider carefully which persons or entities within the group will need to submit change of control notification forms.
FSMA does not specifically define the term "control" but it sets out the scenarios in which a person is considered to acquire, increase, reduce or have control over a firm, and so trigger the notification and approval requirements. Generally, an approval or notification obligation is required where a person decides to become, or ceases to be, a controller. For certain types of firms, it is also required where a proposed change in a person's shares or voting rights would mean that they cross certain thresholds of control over a firm.
These thresholds depend on the type of target firm. The normal control bands are: 10% or more but less than 20%; 20% or more but less than 30%; 30% or more but less than 50%; and 50% or more. If an existing controller increases its control within its control band, it does not need to notify the appropriate regulator unless the increase would result in it becoming a new parent of the target. The normal control bands apply to firms authorised under the following Directives:
- A credit institution defined in the CRD IV Directive (2013/36/EU); for example, a UK authorised bank.
- A Markets in Financial Instruments Directive (2004/39/EC) (MiFID) investment firm; for example, a UK authorised investment firm.
- An insurance firm under the Solvency II Directive (2009/138/EC).
- A firm carrying on reinsurance under the Reinsurance Directive (2005/68/EC).
There are different requirements for firms that are not authorised under the above Directives (non-Directive firms), such as authorised general insurance intermediaries, which are beyond the scope of this article.
Process for buyers
Each proposed controller needs to seek approval from the appropriate regulator before undertaking the acquisition. Once the regulator has granted approval, the new controller(s) must notify the appropriate regulator when the change of control takes place. Failure to comply with this regime is a criminal offence (see box "Failure to comply").
The regulator has up to 60 working days to assess a change of control, although it can interrupt the assessment period to ask the buyer to provide any further information necessary to complete its assessment. The regulator may only interrupt the assessment period once and it cannot do so after the 50th working day of the assessment period. The 60-working day period will begin on the day that the regulator acknowledges receipt of a complete notice. As the clock will not start to run if the regulator considers the notification incomplete, it is important to ensure that all required information has been provided at the time of submission.
Given these timing requirements, any share purchase agreement (SPA) should include a pre-completion obligation regarding obtaining the relevant change of control approval.
Regulator objections
Regulators can object to a controller of an authorised firm in certain circumstances, including where:
- The person fails to submit a notification to the appropriate regulator relating to the change of control.
- The person has breached a condition imposed by the appropriate regulator when the change of control was approved.
- There are grounds for objecting to control on the basis of specified assessment criteria.
When assessing the application, the regulator must consider the suitability of the incoming controller(s) and the financial soundness of the acquisition in order to ensure the sound and prudent management of the target. It must also consider the likely influence of the buyer(s) on the regulated firm while disregarding the economic needs of the market.
The criteria against which the regulator must assess the application include: the reputation of the buyer(s); the reputation and experience of those who will direct the target's business following the change of control; the financial soundness of the incoming controller; whether the target will be able to comply with applicable prudential requirements; and whether the target will become part of a group that enables the appropriate regulator to exercise effective supervision and exchange information among regulators. The UK regulators will need to liaise with any state agencies that have supervisory responsibilities for the buyer(s).
Sellers should carry out sufficient due diligence on prospective buyers so that they are comfortable that the deal will not collapse due to the buyer's failure to obtain change of control approval. As the regulator may grant consent subject to certain conditions, once the seller has settled on a prospective buyer, the parties should agree the extent to which the buyer is required to go to satisfy those conditions.
Process for sellers
A person who decides to reduce or cease control over an authorised firm must notify the appropriate regulator in writing before proceeding with the step that would lead to the disposition. The notification must provide details of the extent of control that the seller will have following the change of control. Unlike for buyers, there are no specific PRA or FCA forms to complete. Any current controllers should carefully examine how their holdings will be affected by the acquisition, especially given the complex definition of control.
Process for targets
Unless the target is a non-Directive firm, it must notify the appropriate regulator when a person acquires control, an existing controller increases, reduces, or ceases to have, control.
The notification must be made as soon as the target becomes aware that a person has decided to acquire, increase or reduce control. If the change of control goes ahead without the target's knowledge, it must make the notification within 14 days of becoming aware of the change of control. In practice, a target that is involved in the acquisition process will have notice of a potential change of control. However, the target may not be aware of the change of control if, for example, the acquisition occurs further up the chain in the group.
Approved persons
Approved persons are those persons (usually individuals, but corporate bodies can be approved persons) who have been approved by the FCA or the PRA to perform key functions in an authorised firm. Generally, the key activities, known as controlled functions, are dealings with clients, their assets or the control environment in the firm, and any exercise of significant influence over the firm's affairs.
As changes of control often result in changes to the senior management of the authorised firm, it is vital that approved person applications are submitted together with, or shortly after, the change of control notification so that individual approved person approval is received at the same time as the transaction is approved by the appropriate regulator. This allows the relevant approved persons of the buyer to begin exercising influence over the target as soon as possible after the acquisition has completed.
Gordon Low and Steven Francis are partners, and Nina Moffatt is an associate, at Baker & McKenzie LLP.
Failure to comply
It is a criminal offence to acquire or increase control of a target firm without notifying the appropriate regulator and obtaining prior approval for the transaction. Various other offences can be committed by those who do not comply with the change of control regime; for example, a seller with control who fails to notify the appropriate regulator before making a disposition will commit an offence. Criminal sanctions include an unlimited fine and, in certain circumstances, may result in imprisonment for up to two years.
Additionally, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) can impose restrictions on shares in an authorised firm if they have been acquired improperly. If certain conditions are satisfied, the appropriate regulator may issue a restriction notice in writing on the firm. Restrictions might state that no voting power is to be exercisable or that, except in a liquidation, no payment is to be made of any sums due from the firm, whether in respect of capital or otherwise. If the shares or voting power are held in a parent undertaking of the firm, the appropriate regulator will serve the restriction notice on the parent undertaking. The PRA and the FCA can also apply to the court for the order of a sale of shares or the disposition of voting power.