Mergers and Aquisitions webinar
ComplianceFinanceMarch 24, 2021

M&A: A chance to transform finance, risk and regulatory reporting

The need for smaller or medium-sized entities to seek out deals is acute these days. Interest rates remain at historically low levels, and loan growth is meager, limiting profitability and hindering the ability of firms to expand their businesses organically.

A record number of bank mergers and acquisitions were completed worldwide in 2020, as institutions sought to achieve growth against a forbidding backdrop of chronically low interest rates and anemic economic growth during the Covid-19 pandemic The deals tended to be more moderately sized than in past years with headline-grabbing mega-mergers, however, and that trend is expected to continue through 2021.

The appeal of mergers and acquisitions for regional and super-regional institutions in the United States or Europe, those with assets between $50 billion and $250 billion (or the equivalent amount of euros), is that the right transaction for a firm in that sweet spot could make it big enough to benefit from economies of scale, and enhance its ability to take business away from the behemoths that dominate its marketplace. That means that while the deals being made today are modest – the 1,316 mergers and acquisitions completed worldwide in 2020 had a total value of $101 billion, or just under $77 million each, according to Statista, a provider of market and consumer data – the stakes involved in contemplating and executing them certainly are not. Nor is the work that banks will face after a combination. For once the transaction has been completed, the hard part is just beginning.

A closer look from regulators, but a helping hand, too

One potential outcome of corporate activity is added scrutiny from the authorities; in the new supervisory order, in which the proportionality principle is a central tenet, the bigger they are, the harder they are regulated. A new merged entity, with more assets and a broader range of activities than either of the constituents, could have more complex risk calculations and reporting obligations to deal with.

Looking on the bright side, executives of the combined entity should consider whether they will be able to shift reporting and risk functions to a lower-cost jurisdiction. If that seems likely, the next question is whether their existing risk and reporting systems or processes permit such a shift.

Regulators around the globe play various roles in the merger movement that has gripped the industry. Some may stay on the sidelines until approval is required and others may offer guidance and assistance along the way. Overall, supervisors have sharpened their focus on banks during and after the merger process by performing additional audits and more closely scrutinizing key figures, such as profit and loss, capital and liquidity requirements, and ensuring that the M&A plan is being adhered to.

Regulators in major Asia-Pacific jurisdictions, including the Australian Prudential Regulation Authority (APRA), Monetary Authority of Singapore (MAS) and Hong Kong Monetary Authority (HKMA), call on merged entities to fulfil regulatory requirements commensurate with the impact the combined entity will have on its market, in certain cases asking for additional audits, for instance.

The European Central Bank (ECB) is taking a noticeably hands-on approach, issuing guidance in January 2021 pledging to “make use of its supervisory tools to facilitate sustainable consolidation projects.” When presented with such a project, the ECB will not raise Pillar 2 capital requirements and will provide an idea of the capital levels that the combined institution will need to maintain. The ECB also indicated that it would look favorably upon the temporary use of existing internal risk models, and it encouraged banks to keep it apprised of developments as a merger progresses so that it may offer guidance if needed.

Even if there are no significant changes to a firm’s profile with regulators, or if any needed changes in risk and reporting obligations are manageable, the formidable task of combining the operations of two organizations remains. A single, seamless whole must be assembled from two sets of activities; two work forces, each with its own corporate culture; and two sets of technological assets.

Merging the parts, not just the wholes

None of these issues is distinct from the others. Consider the technology: Each of two merging firms, or one firm acquiring a smaller one or an individual business line or national or regional division, will have to contend with two data systems – at least. Each company’s data management architecture will have a staff that makes it run using a modus operandi developed over years of dealing with a particular client base, competitive landscape and regulatory regimen, and with the support of a particular set of vendor relationships.

And that is the best-case scenario. A firm that is holding on to a siloed organizational structure, in which functions like risk, finance and compliance act independently of one another, is likely to have separate data management capabilities within each department. Joining so many moving parts is no small feat, but it provides no small opportunity. A merger or acquisition allows the constituent institutions – forces them, really – to reassess legacy systems and, when handled correctly, assemble a comprehensive, fully integrated whole from existing and new tech to meet the combined entity’s compliance and commercial needs.

Creating the ideal unified finance, risk and reporting system starts with an honest evaluation of the multiple systems of the merging partners. This should be completed before any operational changes are effected Particular care should be taken to assess whether the equipment and processes of an entity being subsumed into another are better than those of the survivor, or have certain features that should be incorporated into the combined system.

Merger partners also should consider the possibility that “none of the above” is the right answer and accept that both sets of legacy systems are not up to present or future challenges. It could be that the corporate combination provides an opportunity to start over, or nearly so, and build something more suitable from the ground up, although certain elements will need to remain in place to maintain operations in the meantime. Another factor to consider is whether the asset size of the new unified business warrants an independent verification process to supplement the risk and regulatory reporting program.

Understanding what you have and what you need

To get the evaluation process under way for the operational merger – the longer-term strategic consolidation of systems beyond the maintenance of customer-facing and other basic functions – a bank should list and assess its critical systems, not just for their functionality but with respect to licensing or other contractual obligations with suppliers. The costs of breaking agreements and switching to other systems must be determined.

Fine print aside, managers at the combined entity should look for redundancies in the partners’ systems that can be eliminated. Some of these will be obvious; there will be two general ledgers, for instance. Will one feed the other one? Will one be retired? If so, which one? Or will both be retired, and replaced by a single one, perhaps from a new vendor?

A single organization can have a complicated back-end systems architecture, with intricate workarounds and many manual processes. Bringing together multiple organizations of similar complexity can leave the combined entity with infrastructure that is expensive to maintain and lacks needed flexibility. A subledger and controlling functions can simplify this for finance, risk and regulatory reporting functions. They permit multiple charts of accounts and general ledgers to be consolidated, relieving pressure on the general ledgers. Organizations in some cases can choose to migrate general ledgers to a cloud environment while retaining detailed data in a fat subledger.

Whatever choices are made, a finance, risk and reporting system should have the latest technology, preferably based in the cloud to ensure it will be adaptable, flexible and scalable – three qualities that are vital for any institution, but especially one that is consolidating operations after a merger or acquisition, and therefore is bound to experience more change in its business, and in relations with regulators, than usual.

The ability to integrate systems is critical in creating a unified financial institution that operates with optimal productivity in its regulatory compliance and reporting effort, and as a business. It is especially important when the institution is being created by joining two distinct ones. Integrating systems helps to assure standardization of processes and the accuracy, consistency, agility and overall ease of use that result from it.

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