Despite the global economic turbulence and financial volatility that has clouded the turn of the year, merger and acquisition (M&A) activity has prospered. However, challenges exist for financial institutions’ post-merger integration (PMI). Merging treasury units is a particularly intriguing case given that their function has broadened over time. Overcoming these challenges requires that a strategic plan is laid out early on: moving with speed is critical as is ensuring that responsibility is clearly allocated to individuals. Successful PMI plans ultimately allow for companies to enjoy the benefits of the synergies that come with integrating businesses.
M&A Activity on the Up
The onset of a potential sovereign debt crisis, continued funding difficulties for European banks and weak macroeconomic data pouring out of China and the US would lead one to believe appetite for M&As is at a minimum, but the evidence is to the contrary. Accounting for the strongest opening quarter since 2008, the value of worldwide M&As totalled US$573.3bn during 1Q10, an increase of 21% from 1Q09 according to Thomson Reuters. Eighteen percent of the total value came from the financial services sector alone. Potential gains from synergies are identified as the most cited justification for engaging in such activity. But given that M&As are widely accredited for destroying value rather than creating it, the crux of the battle for financial institutions lies in how well they execute their PMI programme.
Laying the Groundwork
Integrating the treasury unit presents an intriguing challenge particularly given the function’s evolution over time. Departing from typical capital management duties, working with additional complexities of risk and relationship management makes PMI an exercise fraught with difficulty. Pre-merger activities are often not given the required level of attention from a tactical perspective, but its importance in building a solid foundation cannot be dismissed so lightly. A clear strategic rationale laid out early on will dictate post merger behaviour.
Detailed objectives have to be identified and prioritised with measurable synergies, such as potential cost savings from lower operating costs, long before the transaction closes. These need to have the executive team’s buy-in. Securing implementation budgets, the resources that will be required and the timeframes to complete the integration are all pivotal factors. If the integration time is not judged adequately then an adverse change in market conditions will severely hamper the benefits motivating the deal. For example, hedging foreign exchange (FX) and interest rate exposures across the extended pools of cash and running duplicated nostro accounts longer than necessary will be costly.
Project teams can be assimilated and mobilised to start carrying out preliminary studies on the compatibility of existing (acquirer) technology platforms to handle integration and growth of the combined entity at least in the short term. Due diligence should go much deeper than assessing the target company’s cash flow and financial stability. During this phase there will be limitations, but there should be a comprehensive analysis of target’s entire business. Other considerations that project teams look at should include examining how to tackle tougher cash management practices imposed by regulators in various markets the acquirer may not be located in.
Speed and Clear Responsibility
Once the merger is complete, an appreciation to move with speed is critical. Heads of desks should be selected from both firms and appointed to start heading up each of the sub-functional divisions: cash/liquidity, risk and relationship management. Assigning ownership of data within each section will help reduce any uncertainty created and provide the leadership needed to make critical early-stage decisions around revised credit lines, increased market risk on the balance sheet and new daily controls of settlements and confirmations that are required. Put succinctly, acting quickly will ensure the new, combined entity is readily positioned to meet short-term funding and long-term financing needs. As part of the leadership appointments, retention strategies will need to be deployed for other key personnel in the acquired company.
The functionality, scalability and cost of the target company’s core systems will need to be evaluated, but while this is in motion, the transfer of risk through individual trades and client data (from the target company) should be migrated onto the acquirers systems. Client consent will need to be requested and in doing so the appropriate methodology will have to be adopted. Bank-issued guarantees and loans can be transferred by way of novation. Instructing the relevant counterparty can move across bond holdings in the form of a global note.
Where the counterparty withholds consent, transfer of ownership may have to be conjectured using alternative structures whereby the acquirer maintains legal ownership but the economic liability or benefit passes to a third-party. Intricacies may arise where interest rate swaps are used to hedge loans but consent is only given by one of the counterparties.
In rapidly appointing the business leaders, the acquirer is maintaining that the day-to-day management of the business is not jeopardised while the integration programme runs in parallel. It is at this point that the full force of change gathers momentum:
- Determine the number and types of IT systems and architectures embedded inside the target company, which includes identifying systems that can be retired and third-party vendor contracts that may need to be renegotiated. There will be several enterprise resource planning (ERP) systems. Focus will be to migrate to a common business services model requiring only the one application.
- Determine the various markets and jurisdictions in which it operates and the multiple entities incorporated. It is likely that there will be more than one nostro in each currency. Accounts will need to be closed to avoid duplication and save costs.
- Understand the structural composition of the organisation, including any shared services employed. Centralised cash management units can be strategically placed in low-cost centres.
- Determine potential data segregation issues and how this will affect the manner in which information is shared. Staff in one entity may not be able to see client information booked in another entity.
The short-term focus of the change programme will naturally be on integrating the front office. Sales and trading platforms, product and service offerings and the re-alignment of risk and control will top the initial change agenda. In the medium term, attention will shift towards having a fully consolidated front-to-back system, eliminating system elements that cannot support cross-functional processes. A single source of reference data should be in place, eradicating multiple entries of the same information.
Taking Advantage of Synergies
Longer-term emphasis will be heavy on realising the maximum array of synergies identified before the transaction took place. Re-engineering processes can create optimal flows, so that redundant activities are fleshed out and manual processes can be automated resulting in streamlined operations. Potential opportunities exist to reduce business line and support costs by way of headcount reductions and outsourcing opportunities. There is also a significant degree of potential to yield synergies from working closely with other functional divisions such as finance who will report on factors such as interest charges, FX exposures and derivative instruments for planning and budgeting purposes. There is an overlap waiting to be exploited.
While the probability of a renewed recession remains low, some of the deals that could take place over the next 18 months could prove to be highly lucrative. But the prospects of completing a successful post merger integration programme remain challenging to say the least. The globalisation of banking means activity from a legal, regulatory and financial standpoint will only get more complex and hence the role of corporate treasuries as a function of asset and liability management will become all the more pivotal.
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