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M&A bankers can’t catch a break at the moment. Higher interest rates and market volatility were already making it harder to get large deals done, and now some are concerned that the European Central Bank has thrown a spanner into one of the few remaining opportunities to generate fees.
The so-called Danish Compromise is a once-niche bit of EU regulation designed to reduce the capital burden on banks that own insurance businesses. But it came with a loophole — christened the “Danish Compromise squared” — that encouraged banks to acquire other types of business, such as fund managers, through insurance subsidiaries.
BNP Paribas was the most high-profile bank to take advantage, announcing a €5.1bn deal for Axa Investment Management last August, while Italy’s Banco BPM launched a full takeover of Anima, a local asset manager in which it already held a minority stake.
Normally, buying a fund manager involves a hefty hit to capital ratios. Whatever premium the buyer pays over the fair value of the target’s net assets must be deducted from its regulatory capital, in effect reducing its capacity to lend and invest. If the fund manager sits inside an insurer, however, it is treated as a risk-weighted asset that consumes only a fraction of the capital.
The ECB doesn’t think this behaviour is within the spirit of the rules. The central bank may not have the last word — the European Banking Authority does — but it is nonetheless hard to ignore. Shares in BNP Paribas briefly tumbled when news broke that it may not receive the expected capital benefits, though they quickly rebounded.
Investors should hold their nerve. The shift in approach certainly raises the bar for potential combinations but good deals can still work, and anything that relied solely on capital wizardry to make sense was probably not worth doing in the first place.
BNP now estimates that the Axa acquisition will generate a return on invested capital of above 14 per cent in the third year, rising above 20 per cent by year four. Clearly, that is less positive than before, when it thought returns would hit 18 per cent by year three. But the more important question is, is it still better than the alternatives?
The bank could invest more in organic growth, but it is already doing that and has previously warned that after a certain point, diminishing returns are a concern.
The other obvious option would be to give the excess cash to investors through a share buyback. Taking its average share price and price-to-earnings ratio over the past 12 months, a €5.1bn share buyback would give a theoretical return on investment of about 14 per cent. Against that, an acquisition still seems like decent business over the long-term.
The only group that really suffers from higher standards is those poor M&A bankers, who might have to work a bit harder to make sure the sums add up in their pitch decks for further deals. But it’s not like they’ve got much else to do at the moment.
nicholas.megaw@ft.com
