Acquisitions – don’t make it a costly mistake  

With so much activity in the mergers and acquisitions market, the impact of an acquisition on a firm’s regulatory capital can get overlooked in the rush to get the deal done.

Goodwill and regulatory capital

If you are an acquiring firm, you need to think about how the acquisition could affect your own regulatory capital. Acquirers tend to pay a premium to acquire the intangible assets of a target firm, such as their client list or good reputation, so ‘goodwill’ will almost always be created as an asset. Under accounting guidelines, firms are allowed to amortise this asset over a number of years to spread out the impact on profit and loss. Despite this, the FCA expect investment firms to deduct any goodwill asset in its entirety from regulatory capital. This will deplete a firm’s regulatory capital resources, so you’ll need to model to see if you still have sufficient capital after the acquisition.

Prudential M&A considerations

If you are acquiring another FCA regulated firm, you’ll need to consider a number of prudential issues, such as whether this creates a consolidation group and the additional reporting burden resulting from this. You will also need to make sure the firm you’re looking to buy holds “adequate financial resources”. As it suggests, an element of this assessment will be subjective as firms need to self-assess their risks and controls, and make sure they hold sufficient capital against any residual risks. You need to be comfortable that the firm you are buying has carried out this assessment satisfactorily, as when you do your assessment you might arrive at a different figure for the capital needed for the residual risks identified.

Another element of whether the firm holds adequate financial resources is what firms report to the FCA in their financial regulatory returns. The FCA has recently pointed out that the quality of the returns is often poor, so the capital firms think they need to hold may be different to the actual amount that must be held. For this reason, it’s important to review these calculations.

These types of prudential challenges may not naturally be flagged by advisers as part of the transaction as they are caused by risk and accounting issues, but they are an important consideration which shouldn’t be missed.

We can help

We help firms with regulatory challenges throughout the M&A lifecycle including with regulatory due diligence, back book remediation, target operating model design, change in control applications and integration support. When it comes to identifying and fixing potential prudential challenges, our dedicated prudential consultants are specialists when it comes to risk and accounting, as well as regulatory compliance.