1. General aspects regarding foreign direct investments and cross-border M&A at international and European level

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1 CROSS-BORDER MERGERS AND ACQUISITIONS (M&A) IN EUROPEAN UNION BANKING SYSTEM Matei Mirela Petroleum and Gas University, 39, Bd Bucuresti, Ploiesti, Prahova, 0244/575312, The growing foreign direct investments can be observed at international and European level. The main entry modality for foreign investors is mergers and acquisitions. The principal sector, thatattracts the foreign investors, is services. For example, in 2004, the three largest M&A occurred in the financial services. In European Union, the policy makers are aware of importance of these operations and try to improve and harmonize legal system in banking sector. The increasing interest of foreign investors on mergers and acquisitions in banking sector has many effects on host. Key words: cross-border mergers and acquisitions, European Union, financial integration 1. General aspects regarding foreign direct investments and cross-border M&A at international and European level Liberalizations capital movements and expansion of trade induce a dramatic increase of foreign direct investments (FDI) flows. According to World Investment Report 2006, there is an increase of FDI activity on services sector, specially in finance. Table no. 1. World FDI flows, by sector and industry and (mil USD) Sector Developed Developing World Developed Developing South-East Europe and CIS World Primary Manufacturing Services Electricity, gas and water Trade Transport, storage and communications Finance Business activities TOTAL Source: World Investment Report 2006, page 268 The ratio of services increased from 55,34% in period to 64,26% in period, and the ratio of finance in inward flows is relatively constant, being around 19 %. In financial services, the spur of FDI flows can be explain by consolidation and expansion of this industries due to deregulation and liberalization. The foreign direct investors have two ways to entry in a host country: by greenfield investments and by mergers and acquisitions. The determinants for choosing one of these modes of entry are various: industry-specific factors, cultural aspects, transaction costs, attitude towards takeovers, development of capital markets, legal framework, privatization programs, regional integration, the role played by intermediaries like investment bankers (UNCTAD, 2005), existence of better accounting standards and stronger shareholder protection (Stefano Rossi, Paolo Volpin, 2003). Table no. 2. The evolution of FDI and mergers and acquisitions (mil. USD) Foreign direct investments (FDI)

2 Mergers and acquisitions (M&A) Weight of M&A in FDI 53.24% 53.55% 78.18% Source: World Investment Report 2006, page 299, 325 and own calculations According with UNCTAD data, the importance of mergers and acquisitions in foreign direct investments has growing. Regional integration has a great influence on cross border mergers and acquisitions. In European Union, we remark a major rise in 2005, the value of M&A is increased with 140%. Table no. 3. The evolution of mergers and acquisitions on groups of (mil. USD) World Developed Europe European Union Weight of UE in total wold 42% 47% 60% North America Developing South-East Europe Source: World Investment Report 2006, page and own calculations Companies from European Union play a major role on cross-borders takeovers. Weight of mergers and acquisitions in EU is increasing and the rate of growing is bigger than the pace at international level (the rate of growing at EU level was 42% in 2004 and 140% in 2005; at international level, the rate was 28% in 2004 and 88% in 2005). Table no. 4. Cross-border M&A by sector and industry (mil. USD) Total Primary Manufacturing Services Finance Source: World Investment Report 2006, page 325 So, foreign investors have used specially mergers and acquisitions in services sector in order to gain new market, new clients or to have access to strategic assets. 438

3 2. Cross-border M&A in European Union The influence of the level of development of host and the importance of regional integration are demonstrated by the figures of M&A for from EU. The most active nations are United Kingdom, Germany, France, Italy and Netherlands. Table no. 5. The evolution of mergers and acquisitions in European Union (mil USD) European Union France Germany Italy Netherlands Great Britain Source: World Investment Report 2006, page According to World Investment Report 2006, services are the main sector where M&A take place. The ration of this sector in total cross border M&A is around 55%, with fluctuations from year to year (55,53% in 2003, 63,17% in 2004 and 55,44% in 2005). In financial field, foreign investors have an inclination to mergers and acquisition. For example, in 2004, the three largest M&A occurred in the financial services: Abbey National (United Kingdom) was purchased by the Santander Group (Spain) for $15.8 billion, John Hancock (United States) was acquired by Manulife (Canada) and Charter One (United States) was purchased by Citizen Financial (United States). 3. Determinants and obstacles for cross-border M&A in European Union banking system The banks have different ways to extended their activities beyond the national market: alliances, joint venture, direct sales, establishment of branches and subsidiaries, but the principal way is cross-border mergers and acquisitions. The phenomenon of mergers and acquisitions is visible in European Union banking system, because the private initiative is double by authorities initiative in order to increase the financial integration in this region. In general, national banks extend their activities abroad from different motives like: market limitation and desire to acquire new markets, strategy of following the clients, strategy to follow the market leader, access to strategic assets available through privatization programs. In European Union, the existence of single market, the First and the Second Banking Directives (1977, 1988), the Financial Services Action Plan (1999) 1, the Green Paper on Financial Services Policy (2005) and the introduction of euro are facts that contribute to the faster financial integration. In EU banking system, the most recent mergers and acquisitions are between Unicredito (Italy) and the German Bayerische Hypo Bank in 2005 and between the Netherlands ABN Amro and Italian Antonveneta in For European authorities, the M&A appear to be an attractive mode for advancing financial integration. So, it is important for policy makers to identify the main obstacles and restriction that inhibiting the normal market process. After this identification, it is necessary to improve European legislation, to clarify some legal aspect and to reduce the volume of legislation in this field. These obstacles are divided in two categories: obstacles that influence the feasibility of M&A transactions, and obstacles that affect the efficiency after the transactions took place. (FBE 2005). In the first category are: banking supervision and legal market structure. The articles of the Second Banking Directive (2000/12/EC) can raise some difficulties in cross-border M&A activity in EU. The main problems are the absence of application/interpretation criteria and the lack of transparency in the process of making decisions. In addition, at the preliminary stage, supervisors from host could reject the acquiring bank that makes informal enquiries. According with national laws, some credit institutions are only public ownership. Because of that, many national institutions from local banking systems cannot be takeover. So, the number of entities available for cross-border M&A is reducing. Barriers, that can affect the efficiency of M&A, are banking supervision, taxes and the lack of adequate harmonization of laws in certain areas. The bank with international activities could have some problems arising from the duplication of supervision: from home and host 1 FSAP was established in order to create a single market for financial services. It is comprises 42 rules for the harmonization of the member states` rule on securities, banking, insurance and other forms of financial activities. By the end of 2004, almost these measures were adopted. 439

4 supervision authorities. In order to reduce these obstacles, the European authorities proposed a Capital Requirements Directive and tried to create colleges of supervisions. The activities of Committee of European Banking Supervisions and the set up of Consulting Paper no 9 on the cooperation between home and host supervisors are very important in order to promote feasibility of European takeovers in banking sector. Regarding the taxes, there are some problems with VAT on financial services 2, tax cost for transfer profits between branches and parent companies and tax on dividends. Other problems are the inadequate harmonizations of laws of European states in some areas like consumer protection. The existence of national laws in consumer protection field compels the banks to tailor their products to domestic market; so, the banks cannot promote pan-european products. In conclusion, in spite of efforts of harmonization legislations and of setting-up the European institutions, the European policy makers have to take supplementary actions in order to improve the capacity of European banks of make mergers and acquisitions in European Union. According with Annual Report of European Banking Federation for 2006, 2006 was a busy year because the European Commission tries to amend the legal framework for the supervisory approval process with implications on mergers and acquisitions and to improve the 6th VAT Directive. 4. Effects of cross-border M&A in European Union banking system Technological changes and competitive pressures have a contribution to the creation of financial conglomerate that provide many services like: banking services, mortgage, brokerage services, insurance, and asset management and advisory services. In 1989, transnational corporations from banking sector were not ranked among the top 50 of the world bigger corporations (UNCTAD, 2005). The rise of financial conglomerates is attributed to mergers and acquisitions at national and international level. The size of banks has increase, and from 2003, UNCTAD has elaborated a top for 50 financial transnational corporations ranked by spread index 3 and internationalization index. In this top, 28 transnational corporations are from European Union (UNCTAD, 2006). The first financial group from EU is Allianz Group from Germany. It is on rank 4 and has 58,6 for spread index (the first bank in world having 64,7) and 73,1 for internationalization index (the first bank in world having 76,1). Other transnational banks are from France (BNP Paris, Societe Generale, Credit Agricole), Italy (Unicredito, Banca Intesa), Netherlands (ABN AMRO, ING, Rabobank Nederland, Aegon, Fortis Group), United Kingdom (HSBC Bank, Barclays bank, Prudential Group, The Royal Bank of Scotland Group). The removal of the entry of the barriers entry in banking sector has led to entry of new banks, improvement in the quality of banking activity, better allocation of funds to borrowers, but also increase the number of the bank failures and the exposure of banks to insolvency risk (Leo Kaas, 2004). In case of mergers and acquisitions of local banks, there are modifications regarding liquidity management and loan market competition ( Carletti E., Hartmann P, Spagnolo G. 2003). A takeover creates an internal money market where liquidity could be reshuffled. 5. Conclusions Many in EU like France, Belgium, and Nederland, Sweden have highly concentrated banking sector. In these, a few banks constitute more than two thirds of national banking system. The growing of banks is due to the cross border mergers and acquisitions. The investors prefer this entry mode because of the implantation speed and the rapid acces to strategic assets. The main reasons to invest in foreign `banking system are market limitation and desire to acquire new markets, strategy of following the clients, strategy to follow the market leader, access to strategic assets available through privatization programs. The consequence is the appearance and development of financial groups. In order to sustain this phenomenon, European policy makers have to take additional measures to harmonize the legal system and to improve the supervisions activity. 6. References 1. Carletti E., Hartmann Pg, Spagnolo G., Bank mergers, competition ad liquidity, European Central Bank, Working Paper Series 292/2003, page 6 2. Kaas L., Financial market integration and loan competition. When is entry deregulation socially beneficial?, European Central Bank, Working Paper Series, 403/2004, pag 7 3. Rossi St., Volpin P., Cross-country determinants of mergers and acquisitions, European Corporate Governance Institute, Working Papers 25/200, page 3 4. *** - Barriers to cross border mergers and acquisitions in EU banking: the EU commercial bankers view, FBE Letter, 18/2005, European Banking Federation, page 2 5. *** - Annual Report of European Banking Federation, 2006, page 12 2 The VAT system of financial services is characterized by fiscal non-neutrality that penalizes the EU banks against banks from other. 3 The spread index is calculated as the square root of the internalization index multiplied by the number of host. The internalization index is calculated as the number of foreign affiliates divides by the number of all affiliates. 440

5 6. *** - World Investment Report 2005, Transnational Corporations and the internationalization of R&D, UNCTAD, New York and Geneva, 2005, page *** - World Investment Report 2006, FDI from developing and transition economies: implications for development, UNCTAD, New York and Geneva, 2006, page