Financial Services Point of View - PwC · Financial Services Point of View Uncovering hidden costs and opportunities in financial services acquisitions 2 10 25 30 Competitive intelligence

Financial Services Point of View

Uncovering hidden costs and opportunities in financial services acquisitions

2 10 25 30

Competitive intelligence

AppendixHow PwC can help

Point of view

12

A framework for response

February 2015

What acquiring minds should know about full-scope diligence

Point of view

What acquiring minds should know about full-scope diligence

2

Point of view3

1 J.Bourgeois, Lipi Patel, “Note on Post-merger Integration,” Harvard Business Review, February 19, 2009.2 PwC, “Findings from PwC’s 2014 M&A Integration Survey,” June 2014, www.pwc.com.

,

Overall deal value hinges on proper due diligence

Determining whether or not to acquire an entity is among the most strategically important and complex decisions that an institution can make. This decision is typically supported by a due diligence effort focused on the independent financial modeling of the entity being acquired (financial due diligence). This traditional approach to due diligence is critical—both for verifying the general integrity of the target’s financials and for generating the most accurate bid price.

That said, since this traditional due diligence approach is narrow in scope, it carries a significant risk for the buyer—the probability of overlooking crucial components of the target’s business that should be subject to specialized due diligence. Material deal value is often embedded in business support functions such as IT, operations, regulatory and compliance, HR and risk management. Historically, these functions have either been omitted altogether or examined only at a surface level during traditional due diligence reviews.

Buyers that rely on a narrow-scope due diligence approach - including financial due diligence -leave themselves vulnerable to risk on several levels:

• They may not have enough information to understand the business and operating risks, strategic sources of competitive advantage, or other non-financial critical success factors such as cultural fit.

• Synergy targets may be over- or under-estimated.

• The discovery period required for post-merger integration can be delayed, which in turn may impede the ability to execute contractually required transition services in a timely manner (and without penalties) as well as realize post-close synergies.

Without a full-scope due diligence effort, it is highly likely that mergers and acquisitions (M&A) deals may not meet buyers' objectives and fail to deliver their originally expected value and also may expose buyers to unanticipated risks.

Strategic and financial goals are easier to reach than operational targets, with operational success being almost twice as hard to realize.2

Between 65 percent and 85 percent of mergers and acquisitions fail to create the value expected at the time the deals were announced.1 In our view, a more thorough full-scope approach to due diligence could have more appropriately estimated potential risks, costs, and synergies.

Percentage reporting “significant” strategic, financial, and operational deal success:

38%

44%

64%

30%

38%

62%

35%

49%

65%

2013

2010

2008

Source: “Findings from PwC’s 2014 M&A Integration Survey,” June 2014, in

which 12 percent of survey respondents were financial services institutions.

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Point of view4

Based on the local overview of the French financial services market several development areas arise

A resilient model with some exceptions

• The French banking market has proved to be rather resilient to the economic and financial turmoil except for some financial institutions (Dexia, CIF)

• Main banks benefited from Government’s subsidies in 2008 and 2009 for a total amount of around € 21bn and have all reimbursed them in 2010 by launching capital increases

Increasing regulation

• French regulatory frame is currently evolving under the impulse of both the changes of the international banking regulation and the national political stream (Basel III, higher tier 1 capital ratio, Fatca in the US, new banking regulation in 2012 ...)

Concentrated market

• Highly concentrated and mature market with some significant M&A operations over the past 10 years

• Currently, only seven banks capture most of the market with a very small presence of international banks (HSBC)

New entrants on the market

• A very few new entrants on the market. Some banks are growing (State owned bank like La Banque Postale)

• Internet Banks but these players are subsidiaries of French Group

• Bank insurance model is no more an option for the Banks

Consolidation and

rationalisation

M&A operations such as the creation of BPCE, the acquisition of Fortis by BNP Paribas, or the creation of Amundishow clear objectives of costs synergies in terms of marketing, distribution, regional footprints, or IT, as well as growth of market share. Moreover, further disposals to refocus on core business are expected especially for foreign entities (Greece, non core entities ...).

Restructuring and new

operating model

Following the financial crisis, some banks benefited from State Aid (Dexia, Crédit Immobilierde France (CIF), Banque PSA Finance (the banking subsidiary of Peugeot)). Restructuring plans have been implemented and these banks have to implement a new operating model in order to adapt to new regulatory standards, to improve risk management and to adapt the structure of the bank to the new size of the activities.

Disposal of non core

assets and deleveraging

Banks are redefining their core activities with a particular focus on retail and corporate banking activities. Geographical areas have been redefined and disposal of non core assets (loan portfolios, NPL, non core activities) is key especially for some foreign entities.

Multichannel distribution

Banks are redefining the role of their retail networks, tending to more advisory services and commercial efforts realized in their branches. Activities with lower value-added such as transactions management or accounts opening are shifting toward the Internet, call centers or outsourced.

Main development areas

Banking in France: zoom on some clients

BNP Paribas (BNPP)

BNP Paribas is the first European bank in terms of depositsafter the acquisition of Fortis in 2009. Universal bankingmodel with more than 50% of its business in retail bankingand financial services. Net banking income (“NBI”)breakdown by activities: retail (61%), CIB (24%),investment solutions (15%). NBI breakdown by regions:France (30%), other EU countries (43%), Americas (15%)and other countries (12%).

Recent challenges: BNP Paribas recently acquired amajority stake in DAB Bank AG in Germany (Dec.2014),Bank BGZ in Poland for EUR 1bn (Sept. 2014), andCommerzbank “Depotbank” business in Germany (Nov.2013). The Group also entered the Chinese insurancemarket through the acquisition of ING Group’ stake in itslife insurance joint venture with Bank of Beijing.

Crédit Agricole SA - LCL (CASA)

Formed in 2003 after the merger of Crédit Agricole and LCL(Crédit Lyonnais). Subsidiaries include an assetmanagement company: Amundi (75% owned, andmanaging AuM of EUR 750bn) and life and P&C insurancecompanies (Gross Written Premium “GWP”: EUR 23,2bn).NBI breakdown by activities: retail (41%), specialisedbusiness lines (15%), corporate and investment banking(24%).

Recent challenges: Crédit Agricole sold its 50% stake inthe Newedge Group to Société Générale and acquiredSociété Générale’stake in Amundi which has recentlyacquired Bawag PSK Invest in Austria (Oct.2014). CréditAgricole Assurances recently sold some retail and consumerfinance businesses in Europe.

Note: Crédit Agricole Group consists of Crédit Agricole S.A., LCL, Local

Banks and the Regional Banks and their subsidiaries.

Société Générale (SG)

Société Générale operates two retail networks in France(Société Générale and Credit du Nord) and an internationalnetwork. Main subsidiaries include 25% in Amundi (assetmanagement). NBI breakdown by activities: retail (48%),CIB (30%), investment solutions and insurance (13%),asset management, private banking and brokerage (13%).NBI breakdown by regions: France (43%), other EUcountries (39%), Americas (7%), Africa (7%), Asia (4%).

Recent challenges: Société Générale recently acquiredCredit Agricole’s 50% stake in Newedge (May 2014) andsold 5% of the capital of Amundi to Credit Agricole. TheGroup also sold its Asian Private banking business to DBS(March 2014) and its stake in TCW to Carlyle Group (Feb.2013).

Banque Populaire Caisse d’Epargne(BPCE)

BPCE group was established in 2009 from the merger ofBanque Populaire and Caisses d’Epargne and is the 4thbanking group in France. NBI breakdown by activities:retail and insurance (65%), CIB and investment solutions(27%), other (8%). NBI breakdown by regions: France(58%), other EU countries (13%), North America (19%) andother countries (10%). Subsidiaries include Natixis (CIB),Crédit Foncier and Banque Palatine.

Recent challenges: BPCE recently completed thedisposal of 4 % of Nexity’s share capital (Dec.2014) and theacquisition of NexGen through Natixis Global AM inCanada. The group also made some acquisitions in Africa.

Consolidation of the banking sector continues after several mergers occurred during the last 10 years (creation of BPCE and Amundi Group in 2009, Natixis in 2006, Groupe CréditAgricole in 2003). Following the financial crisis in Europe, several banks decided to sell some non-core activities both in France and abroad. This restructuring is now ending and some banks are looking for new acquisitions. Today, seven major banks share the retail banking market.

Number of regulated entities operating in theFS industry in France

• Credit institutions authorised in France (asat 2012): 634 of which

BNP Parisbas 2013

Total assets (€ in billion) 1,800

Loans & receivables (due from customers) (€ in billion) 617

Net Banking Income (€ in billion) 39

Number of employees 185,000

Crédit Agricole Group 2013





Société Générale 2013





BPCE 2013





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Insurance in France: zoom on some clients

AXA

Axa is the largest insurance Group in France and 2nd inEurope (after Allianz). Strong position in life and healthinsurance (61% of total revenues, 3rd in France) and P&C(31% of revenues). Asset management and otherbusinesses account for 4% and 4% of revenues,respectively. Breakdown of GWP by regions: France(25%), other EU (30%), North America (20%), Asia (15%)and Mediterranean and Latin America (9%). Subsidiariesinclude AXA Investment Managers (AuM of EUR 536bn).

Recent challenges: strategic review and disposal of theless profitable businesses (Canada in 2011 and Romania2013) and of selected businesses (AXA PE in 2013).Expansion in growing markets (Columbia 2013, China2012 and the Middle East).

CNP (Caisse Nationale de Prévoyance)

CNP is the 1rst insurance company in France in terms ofGWP and 7th in Europe. Main business is life and healthinsurance (88% of GWP). France accounts for 81% ofGWP, Italy for 5%, Brazil for 11% and other countries for3%.

Recent challenges: despite the financial crisis, CNPmaintained stable capital adequacy ratios (limitedexposure to PIIGS sovereign debt). The group is nowfacing a reduction in GWP and a decrease in life insurancemargins. The group is in the process of renegotiating itspartnership with BPCE.

Groupama

1rst mutual insurance company in France and 8th French insurer. Geographical breakdown of GWP: France (66%), Greece and Turkey (16%), Spain, Portugal and Tunisia (9%), UK (4%) and other EU (4%). Subsidiaries include Groupama Banque and Groupama Asset management (EUR 90 b AuM).

Recent challenges: managing exposures to Greek,Spanish and Italian subsidiaries and sovereign debt,managing solvency requirements (recent capital infusionfrom the shareholders and from CDC, a French publicbank), threat of downgrade below investment grade,strategic review and disposal of selected assets (GanEurocourtage, PE business, etc.).

COVEA

Covéa was founded from an alliance between 3 largemutual groups: MMA, MAAF and Azur-GMF. 1st insurerin responsibility and good.

Recent challenges: need for critical mass in a contextof increasing competition and enhanced regulatoryrequirements. Some recent acquisitions in the UK.

While there are 985 insurance companies, a few big players dominate the sector. The top 4 French insurers (listed below) share Life insurance and P&C markets with international Groups operating significant divisions in France (Allianz, Generali and Aviva) and bancassurance (BNP Paribas, Crédit Agricole and SociétéGénérale). Consolidation has been particularly significant in the mutual insurance industry where the number of companies reduced from around 7,000 in the 80’s to 630 in 2012.

Number of regulated entities operating in theFS industry in France

• Insurance organisations (as at 2012): 985of which:

AXA 2013

Insurance reserves (€ in billion) 573

Gross written premiums (€ in billion) 86

Net Income (€ in billion) 4


Groupama 2013





CNP 2013





COVEA 2013





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Point of view7

These days, the core competencies and competitive strengths of many institutions are defined by excellence that spans IT, operations, risk management, HR and other key functions.

The traditional due diligence process does not recognize the extent to which financial institutions business models have become driven by multiple functional competencies. Further, the typical time constraints of the due diligence process too often

drive a ruthless prioritization of analysis — resulting in these functional components being treated as if they were less material to the commercial prospects of the target, overall financial analysis —and, ultimately, the bid.

Leading institutions are now adopting a full-scope due diligence process that more closely reflects today’s broad business models. As we see it, the resulting benefits more than justify the marginal investment.

We are seeing today’s leading financial services institutions going beyond financial reviews of acquisition targets -adopting full-scope diligence - in an effort to realize the expected value from their M&A transactions.

Full-scope due diligence adds four additional components to the traditional approach:

Finance

Tax

Operations

Regulatory and Compliance

Risk Management

Narrow

scope

Full

scope

“We have to think broader than just the financials, as both risks and opportunities are present in a material magnitude across many business functions”

Deal Team Leader, Leading US Private Equity firm

IT

Commercial

HR

Point of view8

Full-scope diligence involves assessing the impact of key functional areas on the new business entity and its clients — and, ultimately, on the deal itself.

Financial • The goal of all businesses involved in acquisitions, whether buyers or sellers, is to help ensure that the financial information they hold is as accurate as possible. This is critical not only to prevent paying too much (buyers) or receiving too little (sellers), but also to meet governance and risk-management objectives.

• Financial due diligence can help buyers identify and focus on the factors in the business that will be critical to its future success.

Tax • Looking for hidden deal value by assessing alternative tax strategies and assessing the target’s current tax positions and status with the IRS and local tax authority.

• Reviewing federal, state, local and foreign tax returns and assessing potential tax exposures and advising on potential alternative tax strategies.

• Considering the viability and limitations of any tax net operating loss carryforwards (NOLs) and assessing other tax compliance matters.

Human Resources

• Alignment of compensation models and practices with acquirer and the industry.

• Understanding of compensation obligations including current levels, deferred compensation, employment contracts, retention payments, etc.

• Understanding of required skills, specific competencies and “key person “risks.

Information Technology

• Today, heavy reliance on IT for business operations, management information, and financial reporting makes it a priority item in deals. Since IT is often among the largest capital and operational expenditures, business owners are seeking ways to derive more value and leverage from their IT assets.

• Buyers should only be confident when they are sure that the IT assets supporting the business are up to the task.

• Savvy buyers gain a clear understanding of the IT investment required to maintain the earnings before interest and taxes of their acquisition targets, and factor these costs into their calculations and negotiations.

• Identifying and mitigating relevant IT issues reduces the buyer’s risk and helps the seller to secure the best possible sale price.

Commercial • Understanding the target’s commercial viability from multiple perspectives including industry/competitor, product, service, and client.

Operations • Efficient operations enable the acquired organization to maintain “business as usual” during the transition.

• Improvements in operational efficiency are likely to result in enhanced enterprise value, while underperforming operations typically hinder future growth and lead to costly post-acquisition improvement initiatives.

• Buyers and sellers share the same objective: to help minimize the impact of the sale and transition process on business operations.

Regulatory and Compliance

• Regulatory and compliance demands on complex businesses are many and varied.

• Accounting and tax records must comply with a multitude of rules and regulations applied in different jurisdictions by different authorities, placing significant pressure on limited management resources.

Risk Management

• Since risk avoidance is the driver of all pre-deal due diligence efforts, a risk-management mindset should be embedded throughout the organization.

• To achieve — and maintain — a healthy organizational profile and outlook, it is critical to detect weaknesses in the organization's ability to identify and mitigate against foreseeable risk, and to take immediate action to resolve any risk that has evolved into an issue before it can escalate.

Common functional objectives of full-scope diligence

The risk of not realizing expected deal value is common, even in the best of times for some of the best-run firms. Some examples of where a narrow scope due diligence led to reduced deal value and increased risk include:• The acquirer did not understand or

estimate the extent of operational risk inherent in the target’s manual business processes.

• The acquirer did not identify the obsolescence of the target’s product line-up given current investors trends.

• The acquirer did not understand the extent to which fee discounting and bundling were used in practice by the target.

Point of view9

Understanding the need to execute a full-scope diligence process is only the first step. This approach is more complex and requires proportionally more up-front planning and greater subsequent integration of findings.

1 2 3 4 5 6

Buyers need to understand the level and expertise of required resources, as well as the potential return on investment that can be expected from their participation in any given transaction.

Inadequate budget and lack of resources

with the required skills and knowledge

to perform the diligence work

Incorporating diligence findings

into the deal’s financial model and

bid price

Limited accessibility of target resources.

Incomplete information in the

early stage of integration

Executing diligence in a compressed time

frame

Program management

organization’s (PMO) limited M&A tools and experience

The deal team must attempt to assess quantitative exposures and impacts wherever possible for each of the key areas undergoing diligence.

A prioritization of information gaps is necessary for an understanding of how and into what extent the bid may vary, and ultimately how competitive it might be in and early around of bidding.

Successfully meeting tight deadlines requires a team of deeply experienced resources who are knowledgeable in their respective fields.

Every deal should benefit from an organized process and leverage of proven processes and techniques. Deal PMO’s and other members of the acquirer’s deal team should leverage tools for collaboration, process management and planning.

When access to personnel is not possible, the bidder must be supported by an experienced team of seasoned deal specialsts—either internal or external—that can “fill in” the blanks, leveraging their industry and deal knowledge.

Common challenges and examples of solutions

7

Deal PMO’s and other members of the acquirer’s deal team should leverage tools for collaboration, process management and planning. These tools may be commercially available and easy to obtain.

Limited M&A tools. The acquirer might

not use tools that would enable

efficient collaboration.

Competitive intelligence

Our observations ofindustry practices

10

Competitive Intelligence11

Following are examplesof M&A practices we have observed among financial and strategic buyers.

Frequent Occasional Rare

Industry-observed practices

Industry-leading practice Financial Buyers Strategic Buyers

Implement full-scope diligence

Gain an understanding of the acquired companies’ platforms and processes that will be leveraged going forward.

Have the capability to quantify the financial impacts of non-financial items reviewed in the course of due diligence.

Establish cost-saving operational strategies for IT, the tax function, finance, and sourcing. Consider such options to leverage the acquisition .

Do less strategic diligence, as often the buyers’ platforms and processes will be used going forward.

Have the capability to quantify synergies and associated savings as well as potential new market opportunities.

Apply learning from previous deals and transactions in which they have participated, and compare cost drivers and associated risks.

Quantify risk management aspects of deals using methods such as historical probability of loss

Apply risk models using historical knowledge to quantify financial risks and determine if they are within acceptable parameters for the particular portfolio.

Perform sensitivity testing of budget projections for new launches, customers, and/or markets, taking into account market conditions and management assumptions.

Apply sector knowledge to ascertain the fit of the targets within the buyer parent and determine whether potential strategic opportunities outweigh potential risks of failure or loss.

Through analysis of synergy and margin improvementopportunities, identify new opportunities that coincide with portfolio companies’ strategies, and identify the most efficient way to grow (organic vs. acquisitions).

Increase pre-closing remediation requirements for the sellers

Focus on accelerating speed to closing, without conducting the due diligence required to help ensure that divestiture prices reflect the full value of the businesses.

Determine potential impact of various issues (e.g., new technologies or changes in regulations) on the current and future value of the target companies. Provide qualitative insight into key deal issues and opportunities; even if limited access and/or quantitative information is available.

Evaluate targets in light of current market sentiment, competitors, and new developments, as well as relevant geopolitical factors that could have an impact on the targets’ valuations.

Identify performance gaps and potential levers for rapidimprovement (e.g., through cost reduction, operationalrestructuring, and off-shoring) and evaluate the targets in relation to market environment.

Move too quickly and not carefully enough to close deals and integrate the acquired companies, in an attempt to realize the strategic advantages and new opportunities related to the acquisitions as soon as possible.

Framework for response

Our recommended approachto the due diligence related work

12

Framework for response13

We recommend applying a framework that identifies key M&A drivers appropriate to the type of transaction and mapping a full-scope diligence effort back to these drivers to ensure that they are comprehensively addressed and thereby positioning the acquirer to realize greater value from the deal.

Type of dealFull-scope diligence

PwC’s deals framework serves as a means to:

• Identify applicable M&A drivers. Drivers can include flexibility, integration cost/time, cost-reduction synergies, and/or strategic opportunity.

• Align key M&A drivers with the deal type. Common deal types include consolidation, transformation, combination, and preservation.

• Map full-scope diligence to these drivers. A critical first step is to link diligence tasks to the key drivers.

“Getting involved in integration efforts earlier - and staying involved longer - seem to improve deal success”

PwC’s 2011 M&A Integration Survey

Identify key M&A drivers


A framework for response A critical first step: establishing M&A drivers

PwC’s approach to deals is designed to first identify key M&A drivers in the context of the type of transaction contemplated. Thereafter, full-scope diligence activities can be mapped to these drivers for maximum effectiveness. Such a full-scope diligence commonly addresses eight key areas of the business (below) — thereby positioning the buyer to more comprehensively identify and estimate issues, risks and potential financial impacts.

*These traditional due-diligence practices are in common usage by financial institutions.

**These due diligence practices are starting to be used more frequently by financial institutions.

*** These due diligence practices are rarely used by financial institutions.

M&A drivers 1

Deals framework

Common deal types

Consolidation

Transformation

Combination

Preservation

Full-scope diligence

Financial*

Tax**

Commer-cial***

Opera-tions***

Regula-tory & complian-ce***

Risk Manage-ment***

Informa-tionTechno-logy**

Human Resources

**

Synergies & economies of scale

Gain access to new markets, customers and products

Diversification of risks

Access to new technology and knowledge

Ability to limit competition / gain market share

1 PwC, Value Creation Through Mergers & Acquisitions


A framework for response Map key M&A drivers to common deal types.

M&A drivers1 Common deal types and examples

ConsolidationClose subsidiary A and move operations to subsidiary B. Keep back-office functions for B.

Combination

Integrate several capabilities into one site, with best-of-breed functionality from both merged entities.

Transformation

Merge functions from multiple subsidiaries, e.g., combine product offerings and create new territories and a new compensation structure.

PreservationKeep company A and company B largely unchanged—other than streamlining the organization and improving communications.

1 PwC, Value Creation Through Mergers & Acquisitions

Synergies & Economies of Scale: Value of the merged entity is more than the individual values of the entities before merger and has the ability to generate higher shareholders wealth than the standalone entities. It can take the form of revenue enhancement and cost savings, use of common resources & distribution network, improved production and procurement efficiencies and avoidance of duplication and waste

Gain access to new markets, customers and products:• Companies look at the M&A route to:

Reach new markets Gain access to newer products & services or diversification thereof

• Helps entities leverage on the expertise of understanding market dynamics where they have a strong presence to create a value preposition.

• M&A involving forward & backward integration enables companies gain ‘Direct’ access to key source in the value chain

Diversification of Risks:• Risks can arise out of various factors such as - Socio-Economic, Political / Technology / Customer / Competition.• M&A is the fastest and an effective tool to diversify risks by gaining access to:

New markets & customers New product & service segments New technology

New Technology and Knowledge• Technology obsolescence is the key risk in today’s world; the challenge is to innovate quickly and remain

competitive• Walk down the M&A path, which offers Companies:

Access to better technology Cut down expenditure on R&D Complement its existing product profile Strengthening capabilities in niche areas

Limit competition / gain market share:• M& A as a tool to limit competition :

Companies in a mature stage (and deep pockets!) of their business lifecycle look to eliminate potential competition from fast growing emerging Companies (who need funding, expertise & economies of scale)

Companies in the same segment (catering to different category of customers) can diversify & gain market share.

Firms typically start the acquisition process with certain key drivers in mind and need to realize these objectives irrespective of the particular deal type


A framework for response Financial due diligence focuses on analyzing and validating all the financial assumptions being made using past experience to form a view of the future and confirm that there are no 'black holes'

.Objectives Examples of key diligence topics

General Develop an understanding of the company’s overall business trends, legal and organizational structure, competitive environment and recent developments through discussions with management with the purpose of identifying key risks.

• Business trends• Accounting policies and judgmental

areas• Key competitors and clients• Portfolios / revenues breakdown• Presentation of the branches’ network

• Overview of the client base structure and evolution

• Related party transactions

• Historical M&A and divestitures

• Other key accounting and finance matters

Income statement

Analyze the significant components of the income statement to understand historical revenue and expense trends and key drivers and to assess the target’s quality of historical earnings and understand run rate changes to the earnings.

• Key performance indicators

• Net Banking Income detailed analysis

• Assets performance assessment

• Exceptional results and cost of risk analysis

• Quality of earnings and run rate analysis

• Management fees and carried interest

• Impact of changes in AUM vs. fee rate

• Current year trading analysis and comparison with budget

• Standalone costs (for carve outs)

• Scalability of existing cost structure

• Compensation structure and headcount

• Revenue sharing agreements

Balance sheet Analyze the significant components of the balance sheet to understand the target’s assets and liabilities structure and historical working capital needs (for asset management activity), existence of debt-like items which may impact the purchase price.

• Deposits and loans portfolio analysis

• Financial assets analysis

• Working capital analysis (for Asset Management)

• Retirement indemnity provision

• Debt and debt-like items

• Off balance sheet liabilities

• Credit files review

• RWA and regulatory ratios calculation

• Financial instruments valuation

• Nostro accounts analysis

• Contingent liabilities

• Potential client complaints and litigations review and related provisions analysis.

• Capital expenditure

Other matters Some of the other key diligence objectives include understanding internal control environment, historical control deficiencies identified by internal and external auditors, understanding complex accounting topics such as consolidations, accounting for carried interest, assessing whether contingent consideration would be treated as compensation expense or earn-outs.

• Read external audit workpapers

• Review of relevant correspondence with the authorities and key contracts;

• Management letter comments

• Internal audit findings

• Accounting memos

• Local GAAP vs. IFRS differences

• Differences in buyer’s and target’s accounting policies


A framework for response Tax due diligence can bring to light specific tax situations that can be beneficial or detrimental in a newly-structured firm comprised of the buyer and the target

Objectives Examples of full-scope diligence work areas

Historical federal tax exposures

Initially focus on identifying historic tax exposures that could give rise to cash tax liabilities or reduction of valuable tax attributes

• Filings / Compliance

• Historical tax income returns

• Corporate tax structure

• Income tax returns

• Information Document Request

• Tax organization

• Prior acquisitions and divestitures

• Policies and procedures

• Reserves

Related party transactions

Overview of the target’s related party transactions, including discussion of transfer pricing policies and procedures

• Transfer pricing documentation

• Loans / interests

• Advances

• Management fees

• Royalties

• Withholding

Tax attributes Gain an understanding of available tax attributes, including any historic limitations on the utilization of such attributes and potential future limitations

• Domestic and foreign net operating losses

• Tax credits

• Deferred tax assets and liabilities

• Existence of potential tax goodwill

• Tax implications of loan write-offs

Tax accounting methodologies

Evaluate the company's material tax accounting methodologies

• Revenue recognition / deferred revenue

• Changes in accounting methods

• Hedging transactions

• LIFO/FIFO

• Securities resale / repurchase agreements

Non-income tax Understand company's US and foreign non-income tax posture, policies and procedures.

• Sales and use

• Personal and real property taxes

• Payroll tax compliance

• Historical and projected VAT position

• Import/export taxes

• Transfer taxes


A framework for response HR due diligence can uncover cost savings from potential synergies, as well as reveal significant costs related to underfunding and unpaid benefits


Integration & Carve-Out Considerations

Evaluate appropriateness of compensation and benefit allocations from the parent for the assumed employee population. In addition understand corporate cost allocations associated with shared HR services & functions.

• Potential lost value

• Side-by-side comparisons

• Benefit Integration

• Associated synergies

• Stand-alone analysis

• Payroll/HRIS 3rd party costs

• Demographic review

Compliance Considerations

Review of HR policies and practices to identify potential non-compliance issues and there financial impact.

• Labor contracts

• Trade union agreement

• Work-council

• Outstanding labor disputes

• Severance arrangements

• Overtime management

• Statutory leave

• Casual labors

Transaction-related costs from employee contracts

Understand potential payments/obligations that might exist under executive contracts and summarize potential payments to key executives upon closing of the proposed transaction and there tax implications.

• Severance entitlements

• Transaction-related bonuses

• Retention arrangements

• Golden parachutes

• Transaction-related vesting

• Executive compensation

• Stock options

Employee benefits & compensation plans

Identify and analyze benefit plans provided to employees, assessing the funding status of such plans including reasonable of balance sheet, provide pro-forma estimates of the P&L impact, cash contribution requirements, and potential synergies or costs.

• Pension plan

• Health & Welfare plans

• Equity Compensation

• Post-retirement medical & life obligations

• Vacation plan

• Incentive agreements

• Deferred compensation

Average tenure, turnover, and any broad based severance

Compare average tenure and employee turnover rates (by function) to industry norms to identify potential risks. Also evaluate any broad based severance related programs.

• Turnover rates

• Per Capita severance amounts

• Key employees for continued operation

• Restructuring of workforce

• Employment agreement terminations

Organizational Culture & Employee Outreach

Evaluate the organizational culture of the target company and how it impacts integration.

• Employee communications

• Outreach activities

• Mission

• Vision

• Values

• Policies around adherence


A framework for response IT due diligence addresses all aspects of the IT environment, from finances through applications, operations, networks, security, and data centers


IT finance Investigate target’s spend over the last three-to-five years (such as general ledger, projects, and services) Analyze target’s inventory and the useful life of IT assets. Also view target’s maintenance vs. investment projects and compare with industry standards.

• Ongoing costs

• Capital expenditure

• Historical budget

• Value of the assets

• Projects budget

• Cost of services

IT organization Analyze target’s IT teams and resources around ongoing operating tasks and various project expenditures. Identify target’s key resources and assess the team occupancy and turnover rate.

• Key skill sets

• Staffing

• Team occupancy

• Third-party providers

• Roles and responsibilities

• Management oversight

• Training

• Culture

Applications Study the target’s application architecture, data flows, and audit trail functionalities; assess the functional fit, scalability, and reliability of the main applications (maintenance and support model, including service-level agreements).

• Email

• Front office

• Middle office

• Back office

• Policy administration

• Analytics

• Data warehousing

• Customer relationship management

IT operations Analyze the target’s infrastructure inventory and computing needs (for example, back up and restoration). Confirm the ability of the target’s current environment to support the business.

• Hardware

• Database

• Integration middleware

• Operating system

• Directory services

• Performance management

• File server

• Job scheduling

• Help center

• Desktop print

• Runtime environment

• Storage area network

Network and security

Assess the target’s network architecture and security, including security for the intranet and the segregation of duties. Analyze the target’s business continuity and disaster recovery plans and results of its main tests.

• WAN

• LAN

• Telephony

• Security

Data center Examine the target’s global data-center environment (such as building security, facilities equipment, and compliance with the market standards)

• Electricity

• Cooling

• Facilities

• Real estate

• Building

• Rack space


A framework for response Commercial due diligence analyzes the market positioning of the target, its value proposition and potential ability to exploit opportunities


Addressable market share (current and prospective)

Gain an understanding of how the target views its addressable market and compare this with the view of their competitors.

Assess degree of current market penetration and prospects for the future.

• Verification of target’s markets• Review of market share information• Competitors analysis

Unique value proposition and competitive differentiation

Gain an understanding of how the target perceives that they have differentiated their market offerings and validate that their perception is shared by clients.. This may include a SWOT analysis. Further evaluate whether this differentiation is defendable over the long term

• Value proposition and marketing collateral review

• Review of client’s feedback on value proposition

• Assessment of value proposition versus competitors and their barriers to entry

• SWOT analysis

Positioning relative to key industry trends

Identify which market and/or secular trends are likely to impact the target’s business model and estimate the timing and magnitude of these impacts.

• Market trends analysis

• Pro-forma modeling of the target’s business performance

Ability to exploit new client, product and market opportunities

Assess the target’s strategy (or comparable) business function to ensure that it is routinely analyzing the market for potential opportunities.

Determine the target’s speed, flexibility and scalability in response new business opportunities.

• External market, client and product research

• Review of historical performance when pursuing opportunities including assessment of speed, flexibility and scalability.


A framework for response Operations due diligence analyzes deals in four key areas to assess the target institution’s overall level of function


Organization Analyze the target’s current operations organization (reporting structure, key skill sets, and staffing by key operational function, etc.). Evaluate the target’s policies and commitments regarding its executives and employees.

• Executive compensation plans• Organizational charts and

roles• Resumes• Standing severance plans

Real estate and business services

Assess the ability of the target’s real estate holdings and business services to provide for the target organization’s functions. Due diligence is necessary for the target’s real estate, leases, imaging and printing services, contracts providing services to third-party companies, and operating costs.

• Facilities and offices, including leasing contracts

• Agreements with third-party service providers

• Operating costs

Asset management processes

Examine the target’s front-office investment decision and execution processes—along with the operational functions of the middle and back offices—to gain visibility into the target’s fundamental business viability.

• Portfolio management and trading

• Security operations

• Risk management

• Reporting and analytics

• Investment accounting

• Investment administration

Procurement Analyze target’s sourcing agreements, long-term contracts and their termination clauses, and historical spending on sourcing and vendor selection.

• Sourcing agreements

• Long-term contracts

• Historical spending


A framework for response Thorough regulatory and compliance, due diligence is essential in order to fully realize the potential of the M&A drivers and to achieve the highest value for shareholders


Regulatory & compliance policies and procedures

Gain a thorough understanding of the target’s position in the current regulatory environment, along with any foreseeable changes that may occur. Evaluate the target’s compliance policies and procedures and compare them to market standards. Assess controls around insider trading.

• Policy age, acceptance, training, review practices, investment policy statement

• Investment restrictions and guidelines, regulatory reporting

• Investor status, KYC/AML• Investment policy statement,

performance management• Pre/post-trade compliance• Insider trading and segregation of

duties

• Applicable regulators

• Comprehensiveness, location, and accessibility of policies

• Marketing compliance

• Product suitability

Committees and boards

Assess the target’s structures, functions, and duties of important committees and boards to determine if they fulfill regulatory requirements and reveal potential synergies or conflicts. Also conduct diligence on the individuals comprising these bodies, as well as on governance procedures.

• Investment committee; trust committee

• Fund board

Regulatory capital position and requirements

Examine the target’s regulatory capital requirements and both current and historical balances as well as any correspondence with applicable regulators; and check to see if the target has been cited for any misconduct. Additionally, help ensure that policies and restrictions are in place to prevent rogue trading and to enforce limits.

• Current and three-year historical balances

• Rogue trading statistics and policies

• Limits management

• Insider trading statistics and policies

• Director and officer trading-restriction policies

Functional fit and compliance reporting

Diligence should be performed on the acquirer and target's compliance systems to determine if there is a functional fit between the organizations. Internal audit reports, project lists, and key performance indicators need to be evaluated for this purpose.

• Percent of applications and operational process putinto place retroactively and proactively to address compliance

• Internet control breaks

• Statistics and key performance indicators, especially surrounding broken controls

• Regulatory and compliance team coverage


A framework for response The goal of risk due diligence, including insurance risk, is to identify all possible risks that could keep a deal from fully achieving its expected potential, and to analyze in detail those risks that are most likely to be realized


Structure and organization

Analyze the target’s overall organization, structure, and function of the risk management group—paying special attention to the independence and coverage of material sources of risk to determine the influence of the group on organizational decisions.

• Risk function or organization and its structure

Risk policies and procedures

Assess the target’s completeness, adequacy, and quality of policy documentation and standards. Analyze the activity associated with trade failures, cancellations, corrections, write offs, and other sources of risk.

• Comprehensiveness and location accessibility of policies including frequency of updates to policy

• Training, awareness, and compliance

• Securities pricing policies and limits on activity

• Operation risk management including statistics and key performance indicators

• Risk tolerance

• Remittance policy and authority given to risk officers

Regulatory capital position and requirements

Analyze the target’s current and historical balances and fluctuations in capital to determine whether or not capitalization is adequate. Significant variations may indicate that certain policies are neither adopted nor followed comprehensively.

• Current and historical balances

Commitments and contingencies including financial exposure

Identify commitments and contingencies and discuss potential payout, timing of payout and whether obligations are on or off balance sheet

Investigate the target’s portfolio/cross-portfolio reporting to determine if documents clearly aggregate holdings and convey to clients confidence in the activities and transactions undertaken.

• Vendor and IP commitments review

• Capital commitments Analysis

• Litigation related contingencies

• Portfolio and cross-portfolio level of risk reporting

Securities valuation Investigate the target’s valuations process. Determine the level of pricing transparency (for example, sources, methodology, and models used) and whether or not any independent valuations of the financial assets are being purchased. Examine the governance and oversight of such pricing policies.

• Transparency of pricing (sources, methodology, models used)

• Market, credit, and operational risk practices

• Governance and oversight of pricing policies


A framework for response

Measure the success of the Merger and Acquisition

Category Description

Strategy and business Alignment

Track and report the degree to which integration efforts to date have helped to achieve desired business strategies and objectives.

Business and IT performance

Monitor and report on a continuing basis the impact on business performance from the integration of acquired technology with existing platforms. Highlight realized synergies and areas for continued improvement. Modify previous key performance indicators and develop new ones to measure the business performance of the combined entity.

Financial synergies Report hard and soft revenue gains and/or cost savings resulting from integration and capability rationalization, and review related financial measures frequently. Examine any new areas of potential efficiency that have emerged through integration and rationalization efforts.

Operations and process Track and report on the current status of integration efforts, including risks, issues, successes, opportunities, and deviations from plan and from ongoing daily operations.

Compliance and reputation

Quantify and report on impacts to company or brand reputation, including any material changes in client perception or impact, as well as any regulatory or internal policy compliance issues that may have arisen from the integration.

The metrics that are tracked and emphasized on executive reports vary based on the stage of integration and the approach chosen (for example, extent of assets converted, platforms retired, degree of automation and overall synergies captured).

“Deal success remains all about execution: you do the right things—in the right ways—and you get the right results. If there’s any “mystery,” it’s in knowing where to focus your efforts and how to deliver effectively”

PwC’s 2011 M&A Integration Survey

How PwC can help

Our capabilities andtailored approach

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How PwC can help

PwC serves clients on diligence engagements in multiple ways. We can tailor our services to meet your needs.

Deciding which acquisitions will create shareholder value depends on the rigor and quality of due diligence performed on the transactions. PwC's transaction and advisory services team’s approach to diligence goes above and beyond traditional accounting and financial analysis to assess the key assumptions underlying the deal.

Our experienced teams help clients to:

• Gain a deeper understanding of the total performance of the target business

• Negotiate favorable deal terms

• Uncover real opportunities for capturing post-deal value

• Address key tax and financial reporting implications and the related impact on the communications strategy for the transaction

• Assist with the post-acquisition purchase price adjustment

Our full suite of buy-side (and sell-side) due-diligence services includes:

• Financial due diligence: our financial due diligence teams have deep industry knowledge in many sectors, and we take a unique business approach to each deal by fully understanding our client’s entire business upfront, along with that of the deal counterpart and focusing on the total performance of the merged entity.

• IT/operations due diligence: our solutions focus on the operational aspects of a business, uncovering both the risks and opportunities inherent in a deal. In addition, our teams work with clients involved in carve-outs, helping them gain comfort with stand-alone costs, transition service agreements, or post-deal integration synergy estimates.

• M&A tax due diligence: PwC’s M&A tax specialists can identify tax-saving opportunities and help clients assess and identify potential tax exposures and their impacts on a transaction.

• Human resources due diligence: our human resources professionals can help clients evaluate and address the impacts of human resource issues on their transactions.

• Risk management: our risk management team will help developing a risk management strategy to identify other possible deal issues and risks and our insurance risk management advisors will help clients to focus on the economic impact of insurance risk on the transaction.

• Regulatory diligence: our regulatory team has a first-hand compliance and regulatory knowledge and experience - most of the members of our FS regulatory team have either previously worked for a financial services regulatory agency or have been a compliance professional at a major financial institution.

• Commercial due diligence: our commercial due-diligence specialists perform impartial assessments and help clients to evaluate target management forecasts in the commercial environment; analyze risks and opportunities in the target market; and determine the strength of the target’s competitive positioning.

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How PwC can help

PwC offers flexible, strategic support to clients, based on our in-depth knowledge of M&A activity across the financial services sector.

How PwC can help27

Among the key distinguishing characteristics of PwC Advisory in France is the depth and reach of the firm’s global network of professionals.

Experience • We have significant, relevant, and recent experience in providing actionablerecommendations to leading financial institutions on improving customer-centric capabilities spanning business and technology.

• Our clients include leaders in capital markets and wholesale banking, retail, and consumer lending; regional and national universal banking; and insurance. We have advised large commercial banks, investment banks, insurance companies, and hedge funds on IT operating models, technology solutions, and business information.

• Key PwC audit clients in the banking, capital markets, and insurance sectors areconsidered leaders in the customer experience space.

• Our firm’s 40,700 financial services professionals in more than 150 countries have a long history of leveraging lessons learned and experience across borders.

Expertise • PwC Advisory in France can provide you with an in-depth and up-to-date understanding of leading practices in developing customer-centric capabilities.

• We can work with your leadership team to effectively apply these practices to help your business develop actionable recommendations and implementation plans.

• Our work is grounded in our practical application of leading practices atfinancial institutions.

• We leverage our experienced professionals and PwC’s proprietary tools andframeworks, which draw upon the practices of leading peers, industry leadingpractices, and our lessons learned from past programs.

Value • We provide relevant and practical knowledge, insight, and expertise.

• We contribute an independent perspective and act as a neutral third party thatprovides transparency and objectivity.

• We encourage discussion of sensitive and critical issues, and help drive timelydebate, resolution, and action.

• We bridge organizational divides and take an end-to-end view of client issues.

How PwC can help28

PwC Advisory in France We look across the entire organization—focusing on strategy, structure, people, processes, and technology—to help our clients improve business processes, transform organizations, and implement technologies needed to run the business.

Client needs Issues we help clients address

Innovate and grow profitably

• Reshaping the IT function into a source of innovation

• Transforming business information to drive insight and fact-based decision making

• Evaluating acquisition and divestiture strategies to position for the future

Manage risk and regulation

• Building a risk resilient organization

• Managing ERP investment and project execution risk

• Safeguarding the currency of business; keeping sensitive data out of the wrong hands

• Ensuring capital project governance and accountability

Build effective organizations

• Establishing effective strategic sourcing and procurement

• Realizing competitive advantage through effective sales operations inventory planning

• Transforming the close and consolidation process to work for you rather than against you

Reduce costs • Driving efficiency through shared services

• Redesigning finance to realize efficiency and competitive advantage

• Taking control of cost through effective spend management and cash forecasting practices

Leverage talent

• Defining and implementing an effective HR organization

• Rethinking pivotal talent

Clientneeds

Managerisk andregulation

Build effective organi-zations

Reducecosts

Leveragetalent

Innovateand grow profitably

How PwC can help29

What makes PwC’s Financial Services practice distinctive

Integrated global network

With 40,700 industry-dedicated professionals worldwide, PwC has a network that enables the assembly of both cross-border and regional teams. PwC’s large, integrated global network of industry-dedicated resources means that PwC Advisory Services deploys the right personnel with the right background on our clients’ behalf whenever and wherever they need it.

Extensive industry experience

PwC Advisory serves multi-national financial institutions across banking and capital markets, insurance, the asset management/hedge fund/private equity industry, payments, and financial technology. As a result, PwC Advisory has the extensive experience needed to advise on the portfolio of business issues that affect the industry, and we apply that knowledge to our clients’ individual circumstances.

Multi-disciplinary problem solving

The critical issues that financial services companies face today affect their entire business. Addressing these complexities requires both breadth and depth, and PwC Advisory service teams include specialists in strategy, risk management, finance, regulation, and technology. This allows us to provide support to corporate executives as well as key line and staff management. We help address business issues from client impact to product design and from go-to-market strategy to operating practice across all dimensions of the organization. We feel equally comfortable helping the heads of business and the heads of risk, finance, operations, and technology; we have helped clients solve problems that cross all of these areas.

Practical insight into critical issues

In addition to working directly with clients, our practice professionals regularly produce client surveys, white papers, and points of view on the critical issues that face the industry. These publications—as well as the events we stage—provide clients with new intelligence, perspective, and analysis on the trends that affect them.

Focus on relationships

PwC Advisory in France helps organizations and individuals create the value they are looking for. We are a member of the PwC network of firms with 195,000 people in more than 157 countries. We are committed to delivering quality through assurance, tax, and advisory services.

Appendix

Select qualifications

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Appendix – Select qualifications31

Some of our recentcredentials


Issues An asset servicer planned to acquire a hedge fund administrator to enhance its platform capabilities. The company sought an advisor to validate the market opportunity, strategic fit, and overall viability of the target. It engaged PwC to perform a comprehensive market assessment and M&A due diligence on the prospective target.

Approach PwC performed a detailed market assessment and interviewed hedge fund executives to gain perspective on the target's capabilities, strengths, and weaknesses in the marketplace. As part of the assessment, we validated the investment thesis and provided the client with observations on the market opportunity. We also met with the client to discuss the company’s revenue growth strategy, the maturity of the hedge fund administration sector, drivers of growth in the industry, and business and operating model considerations.

The PwC team conducted a detailed technology and operations due-diligence exercise to evaluate the target's operating model (its structure, people, processes, and technology). In addition, we helped the client's external counsel create deal documents, including documents for technology services, a software license, and a transition services agreement.

Benefits As a result of the market assessment and due diligence exercise, the asset servicer:

• Entered into the transaction with full knowledge of important considerations that factored into the negotiations and purchase price.

• Obtained a clear understanding of one-time, post-transaction costs that were expectedto occur.

• Used the market assessment to build consensus among the board of directors.

The client recently announced its acquisition and has expressed an interest in more assistance from PwC going forward.

Market assessment and M&A due diligence―asset servicer


Issues One of the largest custodial banks in the US was determining whether to create an investment manager outsourcing business for the purposes of cost reduction and scalability. The bank sought assistance in developing the business case, design, and operating model for the new business unit.

Approach PwC helped the client develop the operating model, business case, and design approach. We also:

• Helped the client identify, target, and close on potential opportunities in the US market.

• Identified the appropriate resources to provide program leadership and support, while leveraging available M&A opportunities to create a new business.

• Helped develop the metrics of the transactions, identify risk characteristics, and developapproaches to onboard effectively.

• Participated in the initial transactions, including the design, bid, and onboarding of new business.

Our work also included substantial process improvement, people and change management, and rigorous issue tracking and oversight.

Benefits With the help of PwC, the client created an industry-leading business with a robust operating model and the capability to generate profitable long-term revenue. The new business has generated additional opportunities across the firm and has helped the client secure a leadership role in investment manager outsourcing.

Development of operational and performance metrics―leading global custodian and asset servicer


Issues A global, diversified asset manager was exploring middle-office outsourcing opportunities for its institutional and retail businesses. The company needed to conduct rigorous diligence to assess the target providers’ operating models, commercial terms, and strategic fit. Because middle-office operational services are among the newer market offerings from asset servicers, the assessment was a critically important step in the process.

Approach PwC performed this comprehensive analysis and narrowed the possibilities to a short list of credible providers. We performed a multi-dimensional vendor capability assessment using detailed selection criteria developed with the client, and aligned the end-state operating model with best practices for third-party service management.

Simultaneously, we assessed the commercial terms and structuring of the numerous contracts the transaction required (e.g., exclusivity agreement, heads of agreement, transition-services agreement and its detailed schedules, definitive agreement, and preferred provider agreement).

Benefits Using PwC’s analysis, the client was able to identify the benefits and drawbacks of each vendor and understand contractual timelines, including deal closing. As a result, the client’s executive committee members were better educated and able to make a balanced, fact-based decision on outsourcing.

Middle-office operations analysis and vendor selection―global asset management firm


Issues Following rapid expansion of the middle- and back-office areas of a UK investment manager (which included a number of outsourcing deals to third parties), PwC was asked to conduct a review of the controls, policies, and procedures currently in place.

Approach PwC assembled a team of professionals with strong middle- and back-office experience as well as control and risk knowledge. The team:

• Conducted a series of interviews across all areas of the client organization.

• Identified the key control weaknesses.

• Helped the client develop a roadmap to address these and all other control, policy, and procedural weaknesses.

Benefits The client was immediately able to identify its control weaknesses, remediate many of the weaknesses, and create a plan to address those that required longer-term attention. In addition, the client was able to identify the significant overlap of roles and responsibilities between its organization and those of the third-party providers and though save costs as a result of this work.

Review and development of controls, policies, and procedures─major investment manager

www.pwc.fr

© 2015 PwC Advisory. All rights reserved. “PwC Advisory” refers to PricewaterhouseCoopers Advisory, a French legal entity of the PwC network. PwC refers to the network of member firms of f PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. This publication is protected under the copyright laws of France. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

To have a deeper conversation, please contact:

Hervé Demoy

Partner TransactionsBanking & Cap. Markets

[email protected]

+33 6 10 84 38 17

+ 33 1 56 57 70 99

Antoine Grenier

Partner TransactionsInsurance & Brokerage

[email protected]

+33 6 08 90 61 33

+ 33 1 56 57 69 56

Patrick Akiki

Partner Consulting Financial Services

[email protected]

+33 6 48 00 87 74

+ 33 1 56 57 81 61

http://www.pwc.fr/

mailto:[email protected]



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