Financial institutions reassess divestment strategy following regulatory overhaul, finds Ernst & Young Transaction Advisory Services
New York, 2 November 2010 – Financial institutions are pausing to reassess their operations and the impact of regulatory reform before attempting to raise cash or dispose of non-performing assets, according to a new report released by Ernst & Young LLP’s Transaction Advisory Services practice. The report, Transaction trends: Divestitures and tax free spins: focus on divestiture, finds that following the US’s recent overhaul of its financial regulatory regime, the industry is going through a transformation and financial services companies are rethinking how they plan for and execute divestitures.
“Regulatory uncertainty will likely continue to affect M&A activity in the near term as financial companies continue to reassess and refocus their businesses while attempting to build capital positions,” said Nadine Mirchandani, Partner at Ernst & Young LLP Transaction Advisory Services. “Carve-outs and other transactions in the financial services sector may increase and be much more targeted.”
The sweeping overhaul of US financial regulation that went into effect on 21 July 2010 will have an impact on financial institutions, as divestitures become increasingly complex and time-consuming. Many firms, including hedge and private equity funds, will face new and enhanced regulatory reporting, capital leverage and liquidity requirements – all of which can have affect divestiture planning. In light of today’s uncertain business climate and stringent regulation, companies that need to divest by a specific deadline are setting aside considerably more time and resources up front to do so.
The new regulations call for a “living will” describing an orderly recovery and resolution plan that won’t shock the financial system. Accordingly, firms are showing interest in drawing up hypothetical divestiture plans to examine various possible outcomes. The law also creates a process allowing the FDIC, at the direction of the Treasury Secretary, to liquidate non-bank financial firms on the verge of collapse in an orderly fashion. This means that financial institutions must renew their focus on legal entity-level financial and operational concerns – key issues when planning divestments.
Another provision that will affect financial services firms’ divestment strategies is the Volcker Rule, which limits private equity and hedge fund investments. Bank investments in hedge funds and private equity funds can amount to no more than 3% of their Tier 1 capital in all such funds combined, and no more than 3% of any one fund’s total ownership interest, according to this new rule.
Increased due diligence
“Sellers have an opportunity to increase the likelihood of closing a deal by performing their own due diligence before putting an asset up for sale,” said Paul Hammes, Americas Divestiture Advisory Services, Ernst & Young LLP. “Who’s buying also needs to be considered, as private equity firms continue to join corporates in looking for growth opportunities in the financial
Tax-free spin-offs may deliver many of the advantages of a divestiture, especially in a tight credit environment where outright buyers may be scarce. The basic premise of a tax-free spin-off is that one company’s assets, liabilities and operations are redistributed between two or more distinct, stand-alone entities – in a transaction non-taxable to both the company and its shareholders. However, such deals can be quite challenging. Given the already complex regulatory conditions under which financial firms operate, the time required, and regulatory approvals, it remains to be seen whether successful spin-offs will become a trend.
Ernst & Young LLP professionals discuss the evolving financial services transaction landscape in the first of a quarterly webcast series called Transaction trends. To view the archived webcast
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