In 2020 there has been an increasing M&A activity amongst Finnish financial technology sector, generally referred to as the fintech sector. In this article, we elaborate our thinking around the factors that are expected to drive the fintech and financial sector M&A market forward and the key focus areas that should be considered when contemplating a transaction in this field.
Digitalisation and data. Amid the extraordinary times we currently live in, the fintech industry has shown resilience and fintechs have not been amongst those suffering the most, as more and more services and transactions are conducted digitally. At the same time, the incumbent market players are seeing tech giants entering the financial services sector, starting from the payments industry.
Scalability and consolidation. Fintech solutions are typically scalable and may be introduced in international markets with limited alterations to the operating model presenting a lucrative upside value proposition. While the COVID-19 pandemic does not necessarily cause dramatic movements in the markets in the form of distressed situations, we expect the pressure for profitability, scaling up and following-up on digital strategies to support consolidation in the financial sector.
ESG. Investors have become very aware of ESG matters. They generally require certain level of implementation of ESG framework in the company they are contemplating to invest. Sustainability in the financial sector has moved from “nice to have” to “must have”. Pursuing sustainability has moved from “why” to “how” following the introduction of the EU’s sustainable finance framework and also reflecting risk-based approach to climate change acknowledging the threats of global warming to financial stability. At the same time, the fintech scene is leading the way in finding new financial solutions towards a sustainable society. Actions taken to anchor sustainability in companies’ core business are no longer considered as mere items of expenditure in order to fulfil regulatory compliance obligations or as PR costs to improve one’s image but as truly value adding activities instead.
After being recently involved in a number of fintech and financial services -related transactions, we have identified focus areas, to which special attention should be paid from a legal perspective when contemplating a transaction within the financial sector. These areas should generally be considered in detail in addition to certain more general key areas in an M&A transaction, such as the purchase price mechanisms.
Where to focus in a transaction in the financial sector?
Intra-group relations and structuring
Where the target is part of a group, the intra-group dependencies between group members may be extensive. Sophisticated due diligence is often required to paint a clear picture of the existing intragroup dependencies. Transitional arrangements are typically key in ensuring uninterrupted business following the transaction. In addition, business transfers may be required as a (pre-)transaction step if the target business is not operated within a subsidiary company. Tax analysis is key both in the sell-side and the buy-side to ensure the most efficient transaction structure.
Authorisations and registrations
Financial sector companies are typically subject to one or more financial regulatory frameworks. In such case, a self-evident key focus area is if the business has all required authorisations and/or registrations to conduct its business on a standalone basis after the transaction. Further, it is important to verify that the target fulfils all conditions for its regulatory licenses also post-closing. Typically, a permission is required from the supervisory authorities for an acquisition of a minority holding or control in a company with a regulatory licence as well as for any changes in the board of directors and senior management of the target.
In addition to sector-specific regulatory requirements, companies operating in the financial sector are generally subject to anti-money laundering and counter terrorist financing requirements. Due to the high potential financial impact of severe noncompliance, such adverse impact typically materialising in the form of administrative sanctions and/or reputational damages, compliance with regulatory requirements is often one of the most critical areas of interest for both parties to a transaction. In addition, data security and compliance with the GDPR are also key and even more in focus in connection with data and technology intensive transactions.
It is also important for the purchaser to understand how the target has arranged its compliance functions and how the target ensures compliance at the operational level. The mere review of the target’s organisational chart, code of conduct, regulatory policies and guidance is not yet sufficient to verify that the target has been in compliance with applicable laws in its operations. It is important to verify that sufficient regulatory trainings have been arranged to employees on a regular basis, that the target’s internal controls and supervision is sufficient and effective and that proper actions have been taken, if misconducts, breaches or deficiencies have been identified by internal control functions. Often, most important sources of information are internal and third party analyses conducted on the target’s compliance as well as correspondence and reports of supervisory measures and inspections conducted by supervisory authorities.
Often one of the key investment parameters for the potential purchaser is to be able to retain the existing management and other personnel required to ensure the execution of the business plan.
Overall, a carefully conducted legal due diligence provides the potential purchaser with a comprehensive picture on the level of the target’s compliance as well as any compliance-related financial and reputational risks that the target may bear. Thinking ahead is, however, equally as important in ensuring a successful transaction. In particular, digitalisation and scaling up are expected to drive the transactions in the financial sector