Consolidation in the European Financial Industry

In recent years the European financial system has been characterized by large scale, deep, irreversible changes in its structure, due to deregulation and concentration processes. The growing competitive pressures have forced financial intermediaries to rethink strategic and organizational choices in order to achieve better performance. Globalization and the financial crisis emphasize the problems caused by worldwide banking structures and require a reassessment of groups’ development strategies.Given the importance and centrality of the consolidation processes for the European financial industry , the goals of this book are:- to analyze the concentration process in the European financial system and its implications for the strategic evolution of the banking industry, the corporate governance of intermediaries and regulation and financial supervision ;- to investigate the consolidation processes both in the banking industry and in the financial markets (Stock Exchange industry);- to focus on cross-border concentration processes in the European context.This book is the outcome of research undertaken by three groups of academics, from the Universities of Modena and Reggio Emilia, Udine and Verona, as part of a National Research Project (PRIN) financed by the Universities themselves and the Italian Ministry of Education, entitled ‘Financial intermediaries cross-border and cross-sector concentration processes in Europe: regulatory, strategic and management issues and value creation’.The central theme is the general process of consolidation, and the M&A operations in particular, widespread in the financial sector since the early Nineties of the last century, and responsible for a radical transformation of the structural characteristics of the banking and financial systems in both Europe and the United States. The main drivers of this process have been the liberalisation and integration of the European market and, in more general terms, the IT revolution and the globalisation of financial markets worldwide.The subject of consolidation in the financial sector, focus of attention for large numbers of academics and operators in many countries over a considerable time, has recently acquired even greater significance in the aftermath of the financial crisis. For a long time, favourable macroeconomic conditions meant that the positive aspects of these processes were most in evidence, especially the new availability of financial services to the mass market, the expansion of the range of services benefiting more or less all categories of clientele and, probably, a tendency to an increase in the efficiency of both markets and systems. However, the resulting formation of very large banking and financial groups, operating at the cross-border level and subject only to constraints and controls which all proved to be more or less ineffectual and inefficient, generated huge concentrations of risks and levels of correlation responsible for the spread of the recent financial crisis across almost the entire globe. On the one hand, the crisis revealed the obstacles to the success of banks’ M&A-based growth strategies, while on the other it highlighted the pitfalls of the creation of very large, complex groups, certainly capable of achieving synergies and competitive advantages, but also generating negative effects with regard to operating efficiency, groups’ governance and control, and the rationality of the structures themselves. Banking consolidation processes, and the body of M&A operations through which they have taken place, are thus being reviewed today in the light of utterly new facts and processes, which on the operational level have led to the largest mobilisation of public resources ever seen, and on the intellectual scene are catalysing the attention of vast numbers of analysts and academics all over the world.This book focuses on the consolidation process that has taken place within the financial system of the European Union. One distinctive feature of this process in the case of Europe is the growing number of cross-border and cross-sector M&As, a key factor in the integration of the credit and financial markets. Unfortunately, this process has not been accompanied by the introduction of effective regulation and supervision for the groups formed, an asymmetry made all too clear at the peak of the financial crisis, by the implosion of two of Europe's largest cross-border, cross-sector groups, Fortis and Dexia, and the subsequent rescue operations. The book consists of 12 chapters, which together cover the subject of consolidation in the banking, insurance and stock exchange sectors, with some specific discussions of topics relating to regulation and supervision. The strong focus on the banking sector reflects its central role in all Europe’s financial systems. The first two chapters provide a general description of the phenomenon. Chapter 1 sets out to provide a general definition of the consolidation process in the banking-financial industry by outlining the course of events in both the European Union and the USA. It defines the types of operations carried out (cross-border and cross-sector) and then discusses their aims, motivations and drivers. This is followed by a survey of the main negative consequences of the banking consolidation process, and the body of M&A operations through which it has taken place, overlooked in the literature but made starkly obvious by the crisis. It is thus clear that the subject of consolidation is destined to remain at the centre of the debate on banking and finance for a long time to come. Chapter 2 offers a broad survey of the vast literature of theoretical and empirical studies on financial sector consolidation that has appeared since the mid Nineties, discussing findings for the USA, European and international markets.The two chapters which follow analyse the implications and consequences of financial sector M&As. Chapter 3 considers the measurement of a number of effects of consolidation operations in the financial industry, concentrating in particular on the degrees of internationalisation of systems and strategic diversification, and the measurement of value creation. Chapter 4 is an empirical analysis of the effects of banking consolidation operations in terms of shareholder value and risk, with in-depth discussion of the role of the phenomenon’s cross-border and cross-sector dimensions. The survey is conducted on a large, comprehensive and original list of M&A operations concluded from 1997 to 2007 by banks and insurance companies from EMU countries, with a focus on a sample of listed firms from this group.The three chapters which follow basically cover consolidation amongst the large groups which form the top tier of banking systems. Chapter 5 reports on the dynamics of the consolidation of major European banking groups during the period 2000-8, and provides an overview of the expansion policies pursued by these groups in recent years. It also considers the impact of the sub-prime mortgage crisis. The study includes the top fifteen European banking groups by stock market capitalisation and total assets, with two Spanish, three French, three British, two Swiss, one Dutch, two Italian and two German banks. Chapter 6 studies a fairly recent aspect which is however of major of importance for the future evolution of the largest banking and financial groups in both European and North America, partly in the light of the crisis: the changes in their ownership structure, concentrating in particular in the role of the Sovereign Wealth Funds, most of them from non-European states. This is done by analyzing the 44 most important global banking groups in terms of capitalization and total assets. Twenty-three groups are based in Europe, 18 in the United States and Canada, and three in Japan. One smaller bank, Standard Chartered, is also included following the massive recapitalization of the group by SWFs.Chapter 7 focuses on an equally specific topic which is also extremely important, especially for large banking groups: the possible links between growth, bank size and operational risk. The aim is to examine the dynamics of operational risk during consolidation by seeking to identify changes in the quality and quantity of operational risk in the newly merged group compared to the pre-merger situation. A case study is presented, dealing with the two largest Italian banking groups: Unicredit Group and Intesa SanPaolo.The next two chapters are on the subject of regulation and supervision, an urgent priority given the events of the financial crisis. Chapter 8 considers the insurance sector, and especially the outcomes of the geographical diversification of insurance companies and the implications of the capital regime to be introduced by the Solvency 2 framework, now being asked to bridge the gap between regulation and business operations. Europe’s legislators are currently hard at work on this framework, which although scheduled for implementation in 2012 is still struggling to achieve a standard approach for the financial requirements, supervisory review process and market conduct of European insurers and reinsurers. Chapter 9 discusses the regulation and supervision of cross-border groups operating in the EU in the light of the crisis. It outlines the existing regulatory and supervisory framework and highlights the imbalance between it and the development of cross-border groups and the inadequacies that have come to light, before discussing the cases of Dexia and Fortis, the two most dramatic European banking group collapses. It then moves on to a critical examination of the main reforms on the drawing board, especially those put forward by the de Larosière Report, with its proposals for the establishment of two pillars: micro-prudential supervision and macro-prudential supervision.The two chapters which follow cover consolidation in the stock exchange sector. Chapter 10 studies the ongoing moves to merge the main markets, investigating their drivers and implications. The focus is on the European stock exchange consolidation process fostered by the new regulatory framework introduced by the Markets in Financial Instruments Directive (MiFID). The evidence is twofold: even though there is a continuous process of consolidation in the stock exchange industry, barriers to entry continue to fall and new competitors obtain authorization to operate as Multilateral Trading Facilities (MTFs). However the crisis has hit banks, the main shareholders of MTFs, hard, thus slowing down the rate of start-ups. Chapter 11 concentrates on the effects on the market consolidation process in terms of the governance and value both of the markets themselves and of the companies which operate them. An empirical analysis is carried out on the valuation criteria adopted in the most recent stock exchange mergers (mainly NYSE Group and Euronext; London Stock Exchange and Borsa Italiana). Value drivers are examined, in particular the relationship between operational exchange volumes and economic-financial dynamics. Moreover, stock exchange pricing is related to the specific governance structure resulting from exchange mergers. Chapter 12 discusses the integration of systems and markets, with particular attention to the problems arising from the widespread obstacles to the regulation of international operations, and the possible solutions. The analysis reveals that the existing regulatory framework on matters affecting the regulation of cross-border transactions appears to be not only incomplete, but also incapable of provide a satisfactory level of certainty. At the European level, the problems posed by the crises hitting intermediaries working in a multiplicity of legal contexts require the adoption of the necessary reforms by member states, thus opening the way to truly international standards, complete solutions for the regulation of cross-border settlements.The research findings were presented at a workshop at the University of Verona. The comments received and the subsequent discussions provided useful input for the final drafting of the various articles. Thanks in particular to Roberto Tedeschi and Prof. Francesco Vella.