Financial Services Acquisitions: A Primer to Buying Securities Firms, Asset Managers, Insurers and Banks
March 16, 2009
By Timothy Loh, Gavin Cumming and Henri Arslanian
The meltdown in global financial markets has triggered a consolidation of the financial services industry as securities firms, asset managers, insurers and banks alike spin-off assets and restructure their operations to shore up capital. These transactions are often global in nature, involving substantial Hong Kong operations. In this article, we review the basic Hong Kong legal and regulatory framework for these transactions and present some lessons learned.
TIMOTHY LOH | Financial Services & Law Review
Vol. 3 (2009) at p. 15
Acquisitions of financial services firms are
governed in Hong Kong by a patchwork of laws and regulations. Each sector of the industry has its own
governing laws and regulators, each with different requirements. The core regulatory framework comprises
the following:
- Banking and Deposit
Taking. The Hong Kong Monetary
Authority ("HKMA")
regulates commercial banks, private banks and other deposit taking institutions
under the Banking Ordinance ("BO").
- Insurance. The
Insurance Authority ("IA")
regulates insurance companies under the Insurance Companies Ordinance ("ICO").
- Securities and Futures.
The Securities and Commission ("SFC")
regulates merchant and investment
banks, asset managers, brokers and investment advisers under the Securities and
Futures Ordinance ("SFO"). The Hong Kong Exchanges and Clearing,
which operates the Stock Exchange of Hong Kong ("SEHK")
and the Hong Kong Futures Exchange ("HKFE"),
regulates brokers who are exchange participants.
- Provident
and Retirement Schemes. The Mandatory Provident Fund Schemes Authority ("MPFA") regulates trustees
and intermediaries of mandatory provident fund ("MPF")
schemes under the Mandatory Provident Fund Schemes Ordinance ("MPFSO").
These laws create challenges specific to
acquisitions of financial services firms - challenges which differ from sector
to sector not only in respect of requirements arising upon changes in control
and ownership but also in respect of ongoing conduct of business. Thus, whilst acquisitions of financial
services firms share many characteristics with acquisitions of firms in other
industries, an understanding of the legal and regulatory framework applicable
to each sector is essential.
At the same time, the laws create overlapping
regulatory regimes that may increase the complexity of an acquisition of a
financial services firm. For
example, it is not uncommon for an insurance company to be regulated by the IA,
for its asset management operations and its investment linked policies to be
regulated by the SFC and for its retirement scheme operations to be regulated
by the MPFA. Equally, for example,
it is not uncommon for a bank to be regulated by the HKMA but to be subject
ultimately to regulatory oversight by the SFC in respect of its securities and
futures activities. In an
acquisition, this overlap may necessitate approvals from multiple regulators or
due diligence in respect of compliance with multiple regulatory regimes.
ACQUISITION STRUCTURE
As with any other acquisition, a critical initial
step is to decide on the form of the transaction and, more particularly,
whether it will proceed through an acquisition of shares or assets. In the context of financial services
firms, special considerations in this regard include the need to acquire
regulatory licenses, registrations or authorizations, the efficient use of
capital and the ease with which obligations owed to clients may be transferred.
Broadly, an acquirer may prefer a share acquisition
where it does not have the requisite regulatory licenses, registrations or
authorizations required to carry on the business to be acquired or where the
obstacles to transferring obligations owed to clients are too high. However, an acquirer may prefer an
asset acquisition where it wishes to integrate the business (and in particular,
the client base) to be acquired into its existing operations platform.
BANKS
The BO requires the prior consent of the HKMA for
any change in the controllers, any change in the directors and any sale of all
or any part of the business of an authorized institution (i.e. a licensed bank,
restricted licensed bank or deposit-taking company authorized by the HKMA)
incorporated in Hong Kong. For the
purposes of the foregoing, a "controller" includes:
- a person who exercises or controls the exercise of
10 per cent. or more of the voting power of a general meeting of an authorized
institution or any company of which the institution is a subsidiary, and
- any person in accordance with whose directions or
instructions the board of directors of the authorized institution or any
company of which the institution is a subsidiary is accustomed to act.
No similar statutory requirements for prior consent
apply to authorized institutions incorporated outside of Hong Kong. However, it is advisable to verify
whether the institution is subject to any conditions of authorization that may
affect any acquisition.
Change in Management
The BO also requires the prior consent of the HKMA
for any change in the chief executive of an authorized institution, whether
incorporated in Hong Kong or not.
In the case of an authorized institution incorporated outside of Hong
Kong, the "chief executive" is the chief executive of the institution's
business in Hong Kong.
Mergers
The BO expressly provides for the transfer of
authorization from one institution to another with the consent of the HKMA and
upon such consent, for the transferee to have the same privileges, and to be
subject to the same liabilities and penalties, under the BO as if the
authorization had been originally granted to the transferee. However, it appears that these
statutory provisions do not provide for the transfer of liabilities otherwise
than under the BO and, more broadly, do not establish a statutory scheme for
the merger of banks.
In practice, the transfer of authorization
provisions may be appropriate for mergers of authorized institutions
incorporated outside of Hong Kong where one of the merged institutions has more
limited operations in Hong Kong through a Hong Kong branch and a statutory
scheme of merger or amalgamation is available under foreign law.
However, where Hong Kong incorporated authorized
institutions merge, in light of the absence of generic statutory provisions for
mergers of authorized institutions, it may be easier to effect a statutory
merger through specially enacted legislation. Equally, where a merger involves an authorized institution
incorporated outside of Hong Kong but with substantial operations in Hong Kong,
it may be more appropriate to effect the merger through specially enacted
legislation. Where legislation is specifically enacted, the transferee bank will need to ensure separately that
it has been authorized to carry on the business which it will assume under the
merger.
It is significant to note that where banks merge
and the transferor bank is dissolved or wound-up or has its authorization with
the HKMA revoked, no person who was the chief executive, a director or a
manager of the transferor bank may become an employee of any authorized
institution, including the transferee bank, without the consent of the HKMA.
Equally, it is significant to note that where the
transferor bank has local branches in Hong Kong which are to be taken over by
the transferee bank, the approval of the HKMA is required for the transferee
bank to maintain those branches.
Acquisitions by Local Hong
Kong Banks
Acquisitions by local Hong Kong banks of overseas
financial institutions will generally require prior approval of the HKMA. In particular, the BO requires
authorized institutions incorporated in Hong Kong which seek to establish or
acquire overseas banking corporations or which seek to establish or maintain
any overseas branch of overseas representative office to obtain the prior
approval of the HKMA.
More generally, an authorized institution
incorporated in Hong Kong may not acquire (except as security or as a result of
enforcement of security) all or part of the share capital of a company to a
value of 5 per cent. or more of its capital base without the prior approval of
the HKMA. In the case where such
an institution acquires or holds any part of the share capital of any another
companies to a value in excess of 25 per cent. of its capital base, the HKMA
may not grant approval except in prescribed circumstances, including where the
company whose shares are to be acquired carries out nominee, executor or
trustee functions or other functions related to banking business, the business
of taking deposits, insurance business, investments or other financial
services.
INSURANCE COMPANIES
In a similar way to the BO, under the ICO, no
person may become a shareholder controller of an authorized insurer (i.e. an insurance company
authorized by the IA to carry on a class of insurance business) incorporated in
Hong Kong unless the IA confirms that it has no objection to the person
becoming a controller or the IA does not, following notice of the proposal for
the person to become a controller, object within prescribed statutory period. For this purpose, a "shareholder
controller" means a person who, either alone or with any associate or through a
nominee, is entitled to exercise, or control the exercise of, 15 per cent. or
more of the voting power at any general meeting of the insurer. As an "associate" includes a subsidiary
of a body corporate, a change in a shareholder controller may occur, for
example, where there is a change in the shareholding of the ultimate holding
company of the authorized insurer.
No similar express statutory requirement applies to
changes in shareholder controllers of authorized insurers incorporated outside
of Hong Kong. However:
- such insurers may be subject to a condition of
authorization requiring consent of the IA for a change in shareholder
controller, and
- following a change in shareholder controller, even
for an authorized insurer incorporated outside of Hong Kong, the IA takes the
view that it may object to the "appointment" of the shareholder controller if
the shareholder controller is not, in its view, fit and proper to hold that
"position".
As a result, in practice, it may be prudent to
discuss the fitness and properness of the shareholder controller in advance of
a change of shareholder controller.
Changes in Management
Under the ICO, no authorized insurer may appoint a
management controller unless the IA confirms that it has no objection to the
appointment or the IA does not object to the appointment within the prescribed
statutory period. For this
purpose, a "management controller" means a managing director or the chief
executive of the authorized insurer as well as the chief executive of any
insurance company that is a holding company of the authorized insurer.
In the case of an authorized insurer incorporated
outside of Hong Kong, a managing director includes a managing director in
respect of so much of its insurance business as is carried on within Hong Kong
and a chief executive includes an employee of the insurer who is responsible for
the conduct of the whole of the insurance business carried on by the insurer
solely within Hong Kong elsewhere.
Mergers
The IO expressly establishes statutory schemes for
the transfer of both long-term and general insurance business from one insurer
to another. Under both provisions,
a pre-requisite is that the transferee insurer be authorized to carry on the
class of insurance business to be transferred.
In the case of long-term insurance business, the
transfer is effective upon court sanction. In this regard, the IO requires the court to ensure that the
IA has been consulted (and in practice, does not object), policy holders have
been notified and an actuary has reached the opinion that the scheme will not
have any adverse effect on the reasonable benefit expectations of policy
holders of both the transferor and transferee. The court will generally sanction the scheme unless it
considers that the scheme as a whole is unfair as between the interests of the
different classes of persons who are affected.
As part of the court order sanctioning a scheme of
transfer for long-term insurance business, the court may order the transfer of
the whole or any part of the undertaking and of the property or liabilities of
the transferor company and such incidental, consequential and supplementary
matters as are necessary to secure that the scheme shall be fully and
effectively carried out.
In the case of general insurance business, the
transfer is effective upon the approval of the IA. In this regard, the IO requires public notice of the
transfer and allows policy holders to make representations to the IA in respect
of the transfer. The approval of
the IA operates only to transfer the rights and obligations under the policies
to be transferred and may, if the transfer documentation so provides, secure
the continuation by or against the transferee of any legal proceedings by or
against the transferor which relate to those rights and obligations. It does not operate as a general
transfer of all assets and liabilities.
SECURITIES AND FUTURES
The SFO distinguishes between licensed corporations
and registered institutions.
Registered institutions are authorized institutions regulated by the
HKMA but which are registered with the SFC to carry on a business in a
regulated activity in the securities or futures markets, including dealing in
securities or futures, advising on securities, futures or corporate finance and
asset management. Licensed
corporations are non-bank securities firms which are licensed by the SFC to
carry on a business in a regulated activity in the securities or futures
markets.
The SFO requires prior approval of the SFC for a
person to become a substantial shareholder of a licensed corporation. For this purpose, a "substantial
shareholder" includes a person who has an interest in shares in the
corporation:
- the nominal value of which shares is equal to more
than the nominal value of 10 per cent. of the issued share capital of the
corporation, or
- which entitles the person, either alone or with any
of his associates and, either directly or indirectly, to exercise or control
the exercise of more than 10 per cent. of the voting power at general meetings
of the corporation.
A chain principle applies to the definition so that
a person who holds shares in a holding company of a licensed corporation which
entitles him to exercise or control the exercise of 35 per cent or more of the
voting power at general meetings of the holding company may be regarded as a
substantial shareholder of the licensed corporation.
The prior approval of the SFC is not required under
the SFO in the case of a person becoming a substantial shareholder of a
registered institution. However,
as set out above, approval of the HKMA may be required.
Change in Management
The SFO also requires the prior approval of the SFC
for a person to become a responsible officer of a licensed corporation. A "responsible officer" is a person
responsible for supervising a regulated activity of a licensed corporation. Every person who is a member of the board
of directors of the licensed corporation and who actively participates in or
directly supervises any regulated activity of a licensed corporation must be
approved by the SFC as a responsible officer.
At the same time, the BO requires the prior consent
of the HKMA for a person to become an executive officer of a registered
institution. An "executive
officer" is a person responsible for directly supervising the conduct of each
business conducted by the institution that constitutes a regulated activity under
the SFO.
It is significant to note that under the SFO, every
licensed corporation is required to have not less than 2 responsible officers
for each of its regulated activities and under the BO, every registered
institution is required to have not less than 2 executive officer for each of
its regulated activities. As the
regulations governing the exercise of discretion for approval of responsible
officers and executive officers requires that such persons have minimum
industry experience and regulatory knowledge, an acquirer must be careful to
ensure that changes in management personnel, whether arising from resignations
of directors at completion, insufficient retention incentives or otherwise, do
not result in a shortage of responsible and executive officers and hence,
unnecessary disruption of the acquired business.
Mergers
The SFO neither provides for the transfer of
licenses and registrations nor for the transfer of assets from a licensed
corporation or registered institution to another. Indeed, regulations under the SFO governing custody of
client assets may create difficulties for an acquirer who wishes to migrate
client portfolios from the acquired business onto its existing operations
platform.
To the extent that operations of a licensed
corporation are to change as a result of a merger, it is necessary to ensure
that the licensed corporation is licensed for the regulated activities which it
will carry on following the merger.
At the same time, it is notable that any significant changes in the business
plan or nature of business of the licensed corporation must be notified to the
SFC. An asset purchase, which
substantially changes the scope or nature of the business of the acquirer, may
therefore oblige the acquirer to notify the SFC of the purchase following
completion of the purchase. Whilst
this does not amount to a pre-approval requirement, if the SFC is not satisfied
that the acquirer remains fit and proper following the completion of the
purchase, it may take action to suspend the activities of the acquirer. As a result, it may be desirable to
discuss the merger with the SFC in advance of completion.
It is advisable, as usual, to check any conditions
of licensing or registration to ascertain whether such conditions may affect
any merger.
Hong Kong Exchanges
In the case of a transferor licensed corporation
which is a holder of a trading right on the SEHK or the HKFE, the rules of the
SEHK or the HKFE may apply to the acquisition.
In the case of the acquisition of the shares of a
licensed corporation which holds a trading right but which is not a participant
of the SEHK or HKFE, a transfer of a trading right will be deemed to occur if
there is a change in control of the licensed corporation (or of any holding
company of such corporation). If a
transfer of a trading right on the SEHK will be deemed to occur, the licensed
corporation will need to apply to the SEHK (i) to become an exchange
participant, or (ii) to relinquish the trading right. Similarly, if a transfer of a trading right on the HKFE will
be deemed to occur, the licensed corporation will need to apply to the HKFE for
approval of the transfer or relinquishment of the trading right.
Trading rights themselves are transferable only
once up to March, 2010. As above,
a trading right on the SEHK may only be transferred if the transferee applies
successfully to the SEHK to become an exchange participant and a trading right
on the HKFE may only be transferred if the transferee applies successfully to
the HKFE for approval of the transfer.
In either case, it is possible for an acquirer to apply directly to the
SEHK or the HKFE for a trading right.
RETIREMENT SCHEMES
Under the MPFSO, a person may not become a
substantial shareholder of an approved trustee of an MPF scheme without the
prior consent of the MPFA. For
this purpose, a "substantial shareholder" includes a person who, together with
any associate, controls at least 15 per cent of the voting shares of the
approved trustee. In light
of the definition of an "associate" under the MPFSO, a change in the
shareholding of a holding company of an approved trustee may require consent of
the MPFA on the basis that the holding company may control, directly or
indirectly, the exercise of that voting power of the approved trustee or
influence substantially the exercise of that voting power.
Approvals of trustees may be subject to conditions
and, consequently, it is advisable to ascertain whether there are any
conditions applicable to a trustee to be acquired which may affect any
acquisition.
Management
An approved trustee of an MPF scheme must not
appoint a person to be its chief executive officer or as one of its directors
without the prior consent of the MPFA.
At the same time, (i) an approved trustee must have at least 5
directors, all of whom are natural persons, (ii) a majority of its directors
must have the skill, knowledge, experience and qualifications that are, in the
opinion of the MPFA, necessary for the successful administration of provident
fund schemes, and (iii) the approved trustee must have sufficient expertise and
management resources in Hong Kong.
Mergers
The MPFSO does not expressly address mergers
involving an approved trustee.
However, approved trustees are required to comply with prescribed
qualifications and capital adequacy requirements and if they do not, the MPFA
may revoke their approval.
Consequential Matters
Where a financial institution is the subject of a
merger or acquisition and that institution is an insurer, investment manager,
custodian of an MPF scheme, the eligibility of that institution to continue in
that role must be assessed in accordance with the MPFSO.
HUMAN RESOURCES
As with many acquisitions, a key concern for an
acquirer may be to retain key personnel of the firm to be acquired. This concern is particularly critical
for many sub-sectors of the financial services industry, including for example,
private banking, which are sometimes heavily relationship based.
News of an acquisition inevitably raises
uncertainty in the minds of personnel of the firm to be acquired. Such individuals may fear for job
security, may be wary of incompatibilities with new management or may consider
that the platform offered by the acquirer is undesirable. These concerns in turn raise the real
possibility that such individuals may seek employment or engagement elsewhere
or that competitors may seek to exploit their fears and entice them away.
Responses
Experience suggests that it is critical for an
acquirer:
- to put in place retention arrangements for key
personnel of the target firm as soon as possible so that these important assets
do not walk out the door, and
- to communicate with clients of the target firm so as
to mitigate the impact of any loss of key salespersons.
An acquirer may counter the possible loss of personnel
at the target firm by offering retention packages under which employees may
receive economic incentives to remain at the target firm. In this regard, an acquirer should aim
to put retention packages in place as soon as possible and ideally, at the time
of the disclosure of the acquisition to pre-empt the loss of key
personnel. However, a vendor is
likely to be reluctant to allow an acquirer the freedom to communicate and
contract with personnel of the target firm and thus, an acquirer should work with
legal counsel to ensure that the transaction documentation can accommodate
this.
As an adjunct to a retention package, an acquirer
may consider a communications program to counter the loss of personnel and
clients ahead of the completion of the acquisition. For personnel, timely and regular communications may counter
fears for the worst and for clients, they may provide a more balanced
perspective on the purchase, a perspective that clients may not get from nervous
salespersons ready to jump to a competitor. However, again, a vendor is likely to be reluctant to allow
an acquirer the freedom to communicate with personnel and clients and thus, an
acquirer should work with its legal counsel to ensure that a communications
program can be accommodated within the transaction documentation.
DUE DILIGENCE
Due diligence is a natural and essential part of
any acquisition, not only to understand the business of the target firm but
also to avoid the unknowing assumption of liabilities. Acquisitions of financial services
firms may raise some special due diligence issues.
The SFO, for example, imposes statutory obligations
of non-disclosure as regards any ongoing regulatory investigation. A target firm could be subject to an
ongoing investigation but, although the details of the investigation may be
material to the acquirer, the statutory secrecy obligations would limit the
extent of disclosure available to the acquirer. Similarly, the acquirer will
naturally be interested in having access not only to the target firm client
list but also to each client's business history with the target firm. This
information may be subject to personal data privacy laws.
Furthermore, given the complex regulatory framework
governing each sub-sector of the financial services industry, due diligence
will generally be required to assess compliance and in this regard, the
potential for major regulatory enforcement action against any acquired firm.
POST-MERGER INTEGRATION
The post-merger integration process should be
carefully planned. A compliance audit should be performed to ensure that there
are no unknown material violations of applicable laws and regulations and that
appropriate notifications in respect of the completion of the acquisition are
sent to the regulators. Capital
efficiency scenarios should also be considered to maximize the benefits of the
consolidation. The merger of front
office or back office operations is not an easy task and should not be
underestimated. The merger of different IT systems may be particularly
complicated given regulatory requirements including record keeping and client
reporting requirements. The potential need for clients to re-sign documentation
may be a cumbersome process.
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