Cross-border bank mergers in Europe (II): The unique peculiar features of the law in each country
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Keeping our legal sight on the obstacles or difficulties for cross-border mergers which we started looking at in the previous article in this series, we cannot overlook that the laws of every state retain their own peculiar characteristics, a few of which are deep rooted although little known beyond their borders, which may place boulders in the path that are hard or impossible to move round.
We are going to describe two examples, although we have no doubt that in a few other European countries we would find legal elements with the makings of varying degrees of fearful challenges. A few will tend to disappear or be reduced in step with the relentless advance of the harmonization of laws in Europe whereas others will tend to ossify. We have one case of each in the two examples we are providing.
Co-determination in Germany: potential deal breaker
Large companies in Germany are governed by co-determination rules (mitbestimmung). Under these rules, their supervisory boards, a body belonging to their dual corporate governance system, equivalent to a board of directors in countries with similar systems to the United Kingdom or Spain, have to have equal numbers of workers’ representatives and directors chosen by shareholders. The chairperson belongs to this second category and has the casting vote.
The system is very deeply rooted among employers and workers and their representatives and according to some it has been one of the explanations for the German “miracle” and the strength of its industry since the mechanism was adopted in the fifties in the twentieth century. We have heard good and not so good things about co-determination from our German friends and colleagues; some say that chairpersons rarely using their casting vote whereas according to others they do so often. The truth is we have seen that a few acquisitions in Germany by foreign acquirers have been prevented by, or had to be made conditional on, co-determination having to be retained.
We also know from experience in other sectors that this arrangement can ruin the chances of concentration transactions between equals by German and non-German companies.
This means in our case that any German credit institution will probably come up against resistance from its supervisory board and its workers in general to any transaction design that, by reason of including a cross-border change of headquarters or for any reason, makes it impossible to retain co-determination at the new group.
And the trouble is that European cross-border merger legislation was written with this German idiosyncrasy in mind and with the goal of protecting it. So there can be no hope of any harmonization or convergence process for laws across the European Union removing this obstacle in the short or medium term. It is unlikely that any mergers of equals with German banks will go ahead unless the new bank chooses Germany and German law.
This perhaps partly explains why a merger between Deutsche Bank and Commerzbank is still being talked about instead of each German bank looking for a partner outside its borders.
Any solutions? From a very careful study of German and European laws and those of other member states we were able to make out a solution involving taking the headquarters to a certain European country whose legislation appeared to be designed specifically to provide a suitable location even for German companies, by offering a compatible co-determination system. The format does not appear to have been tested in the banking industry and there is no guarantee either that it will work in many cases, though it is worth exploring.
Spain and Spanish bonds: covered bond or under the cover of bonds
Moving to Spain, we find an important unique characteristic. Spanish credit institutions issue cédulas hipotecarias or mortgage bonds; covered bonds, in other words, secured by the mortgage loans of the issuing bank. Every EU country is familiar with covered bonds. They give investors a very high quality instrument because, aside from the issuer’s unlimited liability, the bond subscriber has a special priority right over the bank’s mortgage loans that have been expressly put up as collateral for the issue.
In Spain they have a unique feature: in addition to unlimited liability against the bank’s balance sheet’s other assets, and the special priority over the mortgage loans listed on a special register that the bank is required to keep (mortgages meeting certain loan to value and other requirements), the special priority is valid in relation to any other mortgage loans provided from time to time by the bank, including any not appearing on that register.
The consequence of this is that, in the case of a cross-border merger, this priority over the other mortgage loans may become a source of legal uncertainty: will the priority apply over the mortgage loans of the new bank as a whole, including the mortgages of the other merged bank?
This has not been a problem for any of the domestic mergers carried out to date in Spain because this extended right is accepted and is reciprocal in actual fact because both merged banks have usually issued covered bonds. In fact, the Spanish residential mortgage is the same across the country and does not pose any problems with identifying and valuing the new underlying collateral.
It would be a different matter if the merger took place with a bank from another country: then the priority, if it applies, would do so not just over the Spanish mortgages specified on the special register but additionally over all the other mortgage loans of the foreign bank. This would be a huge problem! Bear in mind also that there may be legal and financial differences between how a mortgage is defined in one country and in another, plus the disputes that may arise with the creditors of the other non-Spanish bank.
The best opinion, based on Spanish private international law, is that the Spanish idiosyncrasy should not have extraterritorial effect (the collateral cannot include mortgages in the foreign country). However, this opinion has not been tested in practice so far.
Here, in contrast, the solution will be provided very soon by European law: there is a recent regulation and directive on European covered bonds that is applicable to Spanish mortgage bonds and seeks to harmonize the legal treatment of these instruments thereby creating a discernible European covered bond for investors. This legislation and its forthcoming implementation in Spain will find a solution to the identified problem, probably consisting of making the priority not apply across borders (at the time of writing the preliminary adaptation bill has just been published and we will have to follow the process until the final wording is passed).
This brings us to the end of the second chapter in our series. In the next, we will look at the complex approvals system for cross-border bank mergers; we will see how the movement appears to come close in any event and how any entities that sit on their hands will come out worse off. And we finish by suggesting a way to clear the path to a future merger.