Asian markets remain attractive to the growth strategies of many global banks. The Asian deal market has seen a vigorous uptick this year and we anticipate that the trend is likely to continue into 2015.
Yet the financial landscape is looking more complex. In the Asia-Pacific region, as elsewhere, the banking sector is reshaping itself dramatically to operate in a new post-financial crisis environment, and this will require both domestic and international banks to adopt a fresh approach to deal making.
Growing confidence about future deals
The good news is that banking and capital markets executives are increasingly confident about the prospects for deals. In fact, according to EY’s Capital Confidence Barometer (CCB), a regular survey of senior executives from major global companies in 62 countries, they are more optimistic than are executives from other industries about the future of global mergers and acquisitions (M&A). Sixty percent of all respondents to the latest CCB – released in October – believe the global M&A market will improve in the next 12 months; by contrast, 73% of respondents from the banking and capital markets sectors are confident this will occur.
Although 12% of executives say large deals (US$1b and higher) are back on the agenda, 76% expect smaller transactions – at values below US$250m – to grow. The deal pipeline is robust, with a large increase in the number of companies planning to pursue acquisitions: 40%, compared with just 23% in October 2013. In April of this year, less than a third of banking executives expected their deal pipeline to increase in the next 12 months; now, that number has nearly doubled.
The Asian deal market reflects this optimism. Asia-Pacific transactions are up in both value and volume, with several deals topping US$1b, and the majority of bank acquirers are existing regional players from Asia. Year-to-date deal value in the Asia-Pacific region (including Japan) has risen 38% over YTD 2013 and volume has surged 42% in the same period.
Regulatory changes are the biggest challenge
Despite this bright outlook for M&A, new challenges colour the landscape. Besides adapting to changing regulatory regimes, banks must cope with other fundamental shifts in the industry such as changing consumer behaviour, digital transformation, lower economic growth rates and regional economic integration. In some countries, policies such as protectionism and restrictions on foreign ownership also have implications for M&A transactions. These forces are in play against a backdrop of profound global change, including political instability, shifting demographics and slowing growth among the Western developed nations and China.
For the financial services sector, the changing regulatory environment is the largest challenge to M&A. Not surprisingly, EY’s CCB survey results show that banking and capital markets executives find regulation more of an issue than do executives from other sectors (22% vs 12%).
Regulatory regimes vary widely globally and are at various levels of maturity across Asia: some developed Asian markets, for example, are closely following the lead of the US and Europe and adopting similar rules, such as subsidiarization and higher capital levels.
By contrast, some of the emerging markets, such as many of those in Southeast Asia, lag far behind and have very different regulatory agendas. Global banks that are caught in the complex web of both US and European regulations are likely to continue looking at what is the right model for the future when these rules are enforced, as the economic and strategic rationale for holding certain businesses will change fundamentally.
In this environment, flexibility, agility and vigilance will improve the odds of deal-making success. M&A strategists will need to focus on the following four pieces of EY advice:
1. Review their Asia portfolios for who is the “best owner of the asset.” The regulatory change agenda will lead to banks changing the shape of their businesses. Many banks will need to consider who would be the best logical owner of the asset in the new regulatory environment given the impact of cost and return-on-capital hurdles. A current example of this is the trend toward local or regional Asian banks or niche players being seen as better placed than global banks to own consumer lending businesses across Asia. For global banks that want to remain the region, we predict that the conversation may move from “best owner of the asset” to “whom is it best to partner with to grow this asset.”
2. Understand local dynamics and put them into a regional context. The Asian banking M&A environment has many nuances in each market. This is due to a variety of local factors such as the political and economic climate, the regulatory and government agenda and tax issues, and other specific market risks. There will be markets where the regulator wants to encourage rapid banking-sector consolidation, such as the Philippines, where capital ratios are increasing dramatically. Other, more developed markets are keen to see the creation of regional champions that are capable of competing to capture regional synergies such as trade flows. These banks will build scale through transactions that create scale and fill in the gaps in their product and customer base.
3. Have flexibility through access to available capital pools. In terms of cross-border banking M&A, banks with high levels of capital will be the ones able to pursue the bigger transformational transactions. Banks from China and Japan, among others, will be the likely consolidators or partners for those who are capital-constrained. There will be an ongoing opportunity for sovereign wealth funds to act as partners in the supply of capital.
4. Explore a variety of deal structures. Increasingly, international banks will look at capability- and capital-light deal structures, although these have been less common in Southeast Asia to date. Such deals may be smaller and more tactical, such as acquiring a small financial institution with a specific skill set or customer base. The banking sector is also likely to see more alliances and joint-venture or distribution agreements, but the effort required to execute and control these deals will be high. As a result, many of the Western international banks are unlikely to be in the top-20 list of M&A deals (in terms of size) from the buy side in the Asia-Pacific region.
Under the circumstances, dealmakers must weigh opportunities and risks carefully. One of the key findings of EY’s CCB survey is that although confidence has improved and companies are actively seeking growth, they are not doing so without a sharp focus on regulator perception and ensuring capital efficiencies. They also have more deals in the pipeline than before, allowing them flexibility in determining the best strategic growth opportunities and indicating that an increasingly rigorous approach to M&A will be necessary.
Charlie Alexander is Managing Partner, Asia-Pacific Financial Services, Transaction Advisory Services, EY.
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