M&A Outlook: Australian Financial Services Towards 2030
minterellison.com Introduction
Welcome to the second edition of the MinterEllison M&A outlook series.
The financial services sector is one of Additional drivers are bringing We have asked Australia’s most dynamic and innovative transformational change to the financial members of our industries, and continues to undergo services sector. These drivers include transformational change. Set against changes to prudential standards, shifting cross-disciplinary the backdrop of uncertain economic customer expectations, increased team to share conditions and the wide-ranging, stakeholder management, technological their key insights continuing ramifications of the Financial advancements and new competitive and on the future Services Royal Commission (FSRC), commercial threats. direction of the significant changes in the financial services Victoria Allen industry will continue over the short to However, many of these drivers are moving industry. We would medium term as it addresses a myriad of the sector in different directions and there welcome the Partner issues. These include a need to restructure, will be important trade-offs to be made by opportunity address shortcomings in culture and market participants over time. This report [email protected] explores how M&A may be one of the key to discuss its respond to competition from traditional content with you and non-traditional players. responses to some of these underlying drivers in the next few years. We explore in more detail. M&A activity will be one mechanism open how financial services companies might to institutions in the sector to address the best position themselves for the longer- collective impact of these issues on the term challenges that lie ahead. organisation, its business and its reputation.
The recommendations of the FSRC are a catalyst for simplification, long term change and an opportunity to re- establish community trust. The Federal Budget provided more funding to ASIC and APRA to increase their enforcement activities, and for an increased role for Rahoul Chowdry regulators across the spectrum of financial Partner, Financial Services services businesses. Industry Lead
2 M&A Outlook: Australian Financial Services Towards 2030 Contents
Industry Climate: Financial Services at the cross roads 4 Part D Technology 46 Summary of key drivers of M&A 5 Technology as a competitor in financial services 47 Technology as an enabler, with a focus on the customer 52 Part A Short term M&A context and outlook 6 A key enabler in the drive to acquire and retain customers 54 Short term M&A context and outlook 7 Reducing customer friction 55 Recent M&A developments in financial services 11 Personalised offerings using artificial intelligence Short term predictions 12 and machine learning 56 Divestment of wealth management 17 24/7 capabilities and availability through multichannel delivery and digital payments 58 Recent international trends 18 Financial reporting 63 Regulatory reporting aided by regtech 64 Part B Long term drivers 21 International drivers in technology 65 Long term drivers 22 Coding error and Australia’s largest ever civil penalty 66 Economic and commercial issues 24 Are branch networks now legacy systems? 67 Funds management and investment platforms 32
Part E Conclusions and Key Contacts 68 Part C Governance & culture, and regulatory issues 33 Towards 2030 – M&A will be an important Governance & culture, and regulatory issues 34 mechanism for boards and management 67 The FSRC implementation roadmap 37 The BEAR case on potential talent gaps 40 About Us 71 Regulation and compliance costs 41 Marching towards Basel IV 42 Further regulatory changes likely in superannuation 43 Australian regulatory structure and its impact on M&A 44
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MinterEllison 3 Industry climate: Financial services at the crossroads
The final report of the Financial Services Royal Commission will undoubtedly act as a catalyst for the start of a longer term transformation within the financial services sector. However, it also coincides with the emergence of several other factors that are likely to also drive significant change within the industry. Some of these relate to issues highlighted by the FSRC, including changes to governance, culture, remuneration, simplification and the need to establish trust. Other factors include an increased focus on the customer (assisted by the move to ‘open banking’), technological changes, and increased competitive and commercial threats.
Competitive factors, regulatory costs and Significant regulatory change is upon us. In addition, market dynamics and This report considers the factors driving lack of scale will result in M&A being one of Change is occurring not only from new competitive threats are driving changes in change in the sector, as well as setting the tools that is increasingly considered for regulations, but also from the stronger the sector and providing other reasons for out our M&A outlook. While it is difficult addressing competitive pressures faced by enforcement of existing regulations. The reassessment by decision makers. Overall, to predict what the changes in the sector financial institutions. government’s FSRC recommendation the prospects for profitability and growth, will be in the coming 10 years, ‘business implementation roadmap, the introduction particularly for the larger financial services as usual’ will not look the same as it does While the short term impact from some of the Banking Executive Accountability players in Australia, look to be challenging. today. It will no doubt be a challenging of the changes discussed in this report Regime (BEAR), the impact of Open Data Economic and demographic changes environment for management and boards are more foreseeable than longer term legislation, Productivity Commission including lower inflation, interest rates and to delicately balance responses to the impacts, the long term impacts are likely to enquiries, changes to banking capital economic growth, high levels of household numerous competing issues facing the create the greatest need for M&A. requirements (both in Australia, and debt, growing life expectancy and sector. With many companies slow to Despite solid fundamentals, we anticipate perhaps more acutely, in New Zealand), increasing urban density are all combining recognise the fall in the long term cost of market conditions are shifting which and increasing enforcement by regulators, at the same time. Institutions are facing capital, it’s an opportune time for M&A, and are likely to create additional pressures are providing Australian financial services increasing competition from overseas there are many factors that will influence on financial services institutions. These institutions and investors with new providers and new, nimble and well-funded short term and long term decision making challenges may create triggers for regulatory and compliance challenges technology driven upstarts, which are in the future. institutions and competitors to undertake and questions for their business models. delivering powerful customer experiences strategic reviews. There will be increased onus on boards and and seeking to disrupt the status quo. management to assist in this transformation process in a timely fashion.
4 M&A Outlook: Australian Financial Services Towards 2030 Extent to which Issues Short term impact Long term impact Summary management can influence of key drivers Culture and governance n u u BEAR n u u of M&A Regulation and compliance costs u n n Basel IV n l l Further regulatory change in superannuation n n l Focuses on culture and International experience u n l governance, customers and Increased scrutiny from regulatory bodies n n l business models are among Governance and regulatory the key drivers of M&A which NZ regulatory capital changes l n l management can influence Bigtech l u l (as highlighted in Figure 1). Fintech u u n Neobanks n n n White labelling n u l International Players Growth l n l Competition Open banking l u n Consolidation n n n Legacy IT/ageing infrastructure u n n Branch networks optimisation n n n Customer focus l u u
Technology Digital banking l u n Artificial intelligence/robo advice l u l Figure 1 – Key drivers of M&A, impacts High household debt l n l and extent to which management Lower credit growth can influence them. n u l Subdued yields n u l l Low n Medium u High Overseas funding n n l Source: MinterEllison Economic Weaker asset growth n u l Focused business models l n u
MinterEllison 5 Part A Short term M&A context and outlook 6 M&A Outlook: Australian Financial Services Towards 2030 Short term M&A context and outlook
The market value of banks stocks has recovered by General Life Banking 8% over the year ending Insurance Insurance October 2019 as investor concerns regarding the The large Australian general insurers have Even before the FSRC commenced, the CBA’s divestment of its 20% stake in FSRC abated. This has been seeking to streamline their businesses, Australian life insurance segment had seen Vietnam International Commercial Joint occurred despite weaker simplify management structures and lift strong M&A activity driven by offshore Stock Bank is the only pure banking credit growth and falling profitability. Their M&A activity has focused buyers using their lower cost of capital transaction over the last few years. This house prices, which have on divesting some of their overseas and opportunities to extract synergies follows ANZ making several divestments lowered top line growth, operations, smaller portfolios, investments through scale. In 2017 and 2018 the in Asia several years ago. More recently, in brokers and managing agents, and Commonwealth Bank of Australia (CBA) the major banks have sought to divest while increasing the claims management service providers. divested its life insurance business to themselves of mortgage brokers. There has risks within the existing pan-Asian group AIA, Suncorp sold its life been speculation in the press that Suncorp book of loans. At the insurance business to TAL (a wholly owned will look to divest its banking operations. same time, banks have subsidiary of Dai-ichi Lite Group, Japan) experienced falling margins and AMP agreed to divest AMP Life to Resolution Life (UK)(a deal which presented and profitability due to regulatory challenges to complete). 2019 record low interest rates, also saw the sale of ANZ OnePath Life to increased competition, Zurich (Switzerland). These follow other increased operational costs significant deals such as the acquisitions and rising funding costs. of National Australia Bank's (NAB's) MLC life insurance business by Nippon Life (Japan), Zurich's (Switzerland) acquisition of Macquarie's life business, and Dai-ichi Life Group's (Japan) acquisition of TAL.
MinterEllison 7 Wealth Private Management Equity
Wealth management is an important Both history and theory tell us that area of change for the major banks, with mixing private equity with banking can most looking to make divestments in this be problematic at times. Both sectors are area over time. However, these changes highly leveraged, and hence boosting one are not being mandated by legislation. with the other creates potential alarms for Changing market dynamics have led regulators. Despite that, there are pockets in banks to reassess their ownership of the non-bank financial services sector where investment platforms and financial planning private equity is currently present, including services, with some deciding to divest shareholdings in ClearView, Pepper, Latrobe these businesses. AMP’s portfolio review Financial and Latitude Financial. included the decision to divest its New Zealand wealth management operations Private equity could foreseeably be as conditions permit. Westpac has decided attracted to other non-bank institutions, to continue manufacturing its own with press reports suggesting that Mortgage investment products. Choice, Steadfast Group and AUB Group are potential targets. Furthermore, the We anticipate that banks that retained parts wealth management operations within of their wealth management businesses banking groups could be equally attractive. may find future compliance costs will These capital light businesses generate outweigh revenue. This could see those relatively predictable cash flows and are businesses come to market as part of a therefore ideal for private equity. Currently divestment strategy at a later stage. we are seeing the potential for such a tie- up with global private equity majors being linked to the potential purchase of NAB’s MLC business.
8 M&A Outlook: Australian Financial Services Towards 2030 MinterEllison 9 Short term M&A context and outlook (cont.)
The deceleration of credit growth and the Banks have also supplemented their deposit While the fundamental drivers of credit subsequent fall in property prices has been base by raising wholesale funding (both long quality remain currently unchanged, Despite solid partially influenced by regulators, with the term and short term debt) and securitising high household debt, combined with fundamentals, Australian Prudential Regulation Authority existing loans, such as residential mortgages, the potential of rising unemployment, (APRA) introducing a 10% benchmark on into Residential Mortgage Backed Securities remain as the largest risks going forward. we anticipate that investor loan growth and a 30% cap on (RMBS), to make additional loans and take Despite solid fundamentals, we anticipate interest only loans. Although both have advantage of profitable demand. Much of that shifting market conditions are likely shifting market now been lifted, it is expected that loan the wholesale funding has been raised and to put additional pressures on financial growth will remain subdued, at least in securitised loans sold overseas. This leads services institutions. The credit cycle may conditions are the short term, before recovering. Moves to Australian banks’ funding costs being have started to turn, with lenders seeing to strengthen underwriting have had an partly driven by what is happening to the an uptick in arrears and losses. While likely to put even greater and ongoing effect. Added cost of funding overseas. This reliance on doomsday scenarios are unlikely, these to this, APRA is now focusing more on overseas funding may bring its own set challenges may trigger institutions and additional pressures minimising debt to income ratios and of risks, particularly if the cost of overseas competitors to undertake strategic reviews keeping low-deposit lending to a minimum. funding rises while the Australian cost of that lead to selected portfolio divestment on financial The net effect could be a further tightening funding falls. or runoff. in housing credit, which will continue to services institutions." constrict some housing market activity and In this climate, it is easier to focus on the reduce the prospects for price appreciation. short term challenges rather than the long term opportunities arising from the The brunt of this low credit growth is current operating environment and the seemingly being borne by the larger market new ways of doing business being created participants (and perhaps already reflected by technological advancements. Most in the fall in the market capitalisations of the importantly, notwithstanding the now major banks). Smaller players are benefiting long prevailing benign credit environment, from this environment, with some non- banks are being proactive in managing bank lenders or ‘shadow-banks’ showing their credit exposures to minimise credit accelerated loan growth. Major banks now losses. Notably, the majority of employees need to be best in class in relation to each in these financial institutions may not have product and market segment. A portfolio seen a recession (which has not occurred approach will no longer work as some in Australia in 28 years). Therefore, they smaller lenders target niches. may consequently lack some experience in managing a downturn.
10 M&A Outlook: Australian Financial Services Towards 2030 Recent M&A developments in financial services
A number of high profile Recent strategic reviews and M&A and complex M&A processes have been predominantly driven by institutions seeking to pre-empt transactions have been and mitigate any additional compliance completed in recent years requirements and fallout from the FSRC. In in the Australian financial some respects, the sheer size, complexity services sector. This trend and poor quality of legacy systems within has continued, if not been our larger financial services institutions contributed significantly to the issues accelerated by the major highlighted in the FSRC. Hence, solving banks with a number of these inherent problems is not easy and transactions, some of which will require significant spending and are yet to be completed. management time. These transactions are Weaker equity markets and an increase part of a broader trend to in credit spreads over 1H19 (triggers that creating simpler businesses. increase the cost of capital for acquirers They also establish a strong and potentially decrease the transaction valuation multiples that buyers are willing base for buoyant M&A to pay) led some to believe that the peak of trends to continue. M&A in this cycle may have already passed. However, aided by the market rebound in 2H19, and according to Merger Market, M&A volumes have been robust. There has been a 7% increase in deal value in FY19 in Australia compared with FY18. However, there has been a slowdown in 1H20.
MinterEllison 11 Short term M&A predictions predictions in banking
The sector’s ongoing The bancassurance model may be in trouble The outlook for credit cards is difficult for Australia may spread to New Zealand under response to the FSRC The bancassurance model appears to be smaller providers the current structure. APRA is now also facing significant challenges. With growing Credit card operations are businesses of looking to change the capital requirements Final Report, new capital demands and reduced capital scale. There are only a limited number of for holding banks' NZ businesses. This could regulation and compliance synergies, banks may look to further divest providers with such scale in Australia. Many lead the NZ subsidiaries to modify their regimes are likely to bring remaining insurance businesses, particularly store cards, smaller banks, and some regional lending appetite, depending on the final further scrutiny, and those dealing in general insurance. For institutions provide their customers with capital requirements. The RBNZ had also example, CBA will carve out its general white-labelled credit cards from one of these initially rejected AMP’s sale of AMP Life to behavioural and structural insurance business. providers. Banks are increasingly focused Resolution Life. change to the sector in the on the profitability of their loan portfolios. Basel IV looks at total loss-absorbing capital A fifth major bank In addition, recent changes to card lending short term. We envisage (TLAC) for banks and puts floors in internal Long speculated is the idea of a tie-up of standards aimed at restricting the growth in that a number of changes models for the calculation of risk weighted regional institutions to form a fifth ‘major card credit limits and outstanding balances, assets (RWAs). In other countries, regulators will occur across segments. bank’. A merger of regional banks, servicing and greater competition from buy-now pay- have looked to Tier 2 and Tier 3 (unsecured different geographic areas would provide later providers, might lead some providers to subordinated debt) to boost TLAC. In greater scale and geographical scope. divest their credit card operations in favour of Australia, APRA plans to use Tier 2 capital to Additional acquisitions of smaller banks, white labelling. This will allow them to reinvest boost TLAC held by Australian banks. or mutual or credit unions, could address the proceeds into more profitable parts of any additional servicing gaps. This is similar their business. The proposed RBNZ requirements, which to the process the major Australian banks propose Tier 1 equity capital rather than Tier It is more expensive to do banking in NZ have undertaken over at least the past 35 2 or Tier 3 subordinated debt, would be now given increased capital requirements years. Clearly the Australian Competition tougher than Basel IV proposals. This scenario and Consumer Commission (ACCC) would The Reserve Bank of New Zealand’s (RBNZ's) could create depressing returns and strategic scrutinise any such proposal. proposal to significantly increase the capital challenges for Australian financial services requirement proposals for banks could lead institutions operating in NZ. Should the RBNZ The outlook for auto loan books is to Australian banks strategically reviewing embrace a more stringent standard, Australian very uncertain their ownership of New Zealand banks banks with subsidiaries in New Zealand and potentially moving down a path of ASIC’s ban of ‘flex commissions’ in the car might consider undertaking strategic reviews divestment. According to a RBNZ discussion finance market, coupled with a desire to and consider all their options for their New paper on capital standards, released in April focus on core operations, may lead some Zealand businesses. These changes have 2019, the regulatory authorities in NZ are of the major banks to review their auto already caused Australian banks to review their concerned that systematic banking risks in loan portfolios.
12 M&A Outlook: Australian Financial Services Towards 2030 overall strategy in New Zealand. However, ATMs are potentially going the way of divestment (other than potentially for first phone boxes mover advantage) or withdrawal is unlikely. With falling demand for ATM services The size, nature and pricing of the loan books associated with the increase in card payments and other activities will inevitably be put under and tools like Apple Pay, the major banks have the microscope. already removed their ATM fees. We may see major banks and ATM owners look to Fintechs are unlikely to take market share rationalise their ATMs into one or more ‘utility’ from the major banks in the short term ATM networks (subject to ACCC approval It is very likely that some existing institutions or authorisation). will strategically invest in fintechs. Smaller Despite media reports, the Australian specialist lending portfolios, based around a banking market is still attractive to particular asset class, may see greater volumes foreign banks of M&A. This will be partly driven by shadow banking fintechs operating in niches such as While the Australian banking sector continues lending to small and medium-sized enterprises, to experience significant problems and inventory finance, and asset/vehicle finance. the value of banking businesses de-rate Banks may also reconsider their portfolios in materially, foreign banks may look to increase these areas given the high capital demands their presence in Australia. One way of and margin compression driven by increased doing this is to simply acquire Australian competition. Alternatively, the fintechs in these institutions as a way of cheaply acquiring segments may be acquired by other fintechs customer relationships and economies of looking to expand or scale up their offerings, scale. Japanese and Chinese institutions, or by opportunistic banks that can get niche as well as those from other countries that providers out of difficulty. For example, have a significant savings surplus and limited CBA plans to invest more than $5 billion in domestic or existing long term growth technology over the next five years to maintain opportunities, may identify Australia as an its leadership position in digital banking. In attractive market. August it announced a $100 million investment in Klarna which is a buy now pay later fintech.
MinterEllison 13 M&A predictions in mortgage broking
Seeming casualties of the FSRC, The recommendation that consumers pay mortgage brokers continue to mortgage brokers, replacing the current lobby against a recommendation on commission structure, was aggressively commission structure fought by the mortgage broking industry on the basis that it diminishes competition. Historically, mortgage brokers have been These Liberal/National and Labor political used by banks as a cost efficient way parties have expressed caution or of sourcing new business, with banks abandoned this recommendation. We paying trail commissions in the form of a expect that significant political debate on deferred spotter’s fee. Criticisms of bank any major reforms in this area will continue, ownership of mortgage brokers had been given that there are over 7,000 mortgage long building. A Productivity Commission broking businesses in Australia employing report concluded that many brokers had more than 18,000 people (IBISWorld), with started acting in the best interests of the many being small businesses. banks that own them, as opposed to providing competition to the major banks as they did in the 1990s. Two of the major banks noticeably hold mortgage broking businesses, with CBA already announcing plans to divest its Aussie Home Loans business (although now delayed).
14 M&A Outlook: Australian Financial Services Towards 2030 M&A predictions in insurance
The insurance sector may see further Some business units of large insurers There is an unwinding of vertical Now that the FSRC is over, there is heightened M&A activity in the short term now have increased pressure following integration to claims fulfilment potential for some deals to reappear the FSRC’s recommendations to prevent The insurance sector was severely insurance sales alongside the sale of other The general insurance industry has moved The FSRC has resulted in a few M&A disrupted by the FSRC recommendation to products. towards the vertical integration of claims transactions being delayed or falling remove grandfathering on both financial fulfilment, through vehicle and property through, such as the terminated divestment advice and life insurance commissions, plus Insurance brokers and managing agents repairs. This appears to be moving in of St Andrew’s insurance from Bank of the recommendation to review general are likely to consolidate, but it may not be phases, with insurers acting as the catalyst Queensland to (the now defunct) Freedom insurance commissions. This, combined a structural change for an increase in scale. This is partly driven Insurance Group. A number of other recent with growing capital demands and reduced by changes in technology and to drive M&A deals are at risk of being, or have capital synergies, may see banks further The insurance sector tends to go through efficiencies. As the market responds to been, blocked. Suncorp’s bid to buy Tower divest their remaining insurance businesses. periods of acquiring brokers and managing match this increase in scale, some general Insurance in New Zealand was blocked by agents. This is in order to grow its insurers are now looking to divest and the New Zealand Commerce Commission. The third party insurance sales model is intermediated business and is followed by reduce vertical integration. For example, In a more certain post-FSRC environment, certainly threatened. Restricting the ability periods of selling these businesses as they Capital SMART Repairs was sold by Suncorp we could see other interested buyers bid to instigate life insurance sales over the become less critical for business growth. to AMA Group at the end of October 2019. for these assets. phone will prevent some insurers from This process is likely to continue. using third party call centres to sell direct to customer life insurance products.
The FSRC resulted in a few M&A transactions being delayed or falling through. In a more certain post-FSRC environment, we could see other interested buyers bid for those assets.”
MinterEllison 15 M&A predictions in wealth management
Structural separation from the banks is their customers with the options they commissions). Press reports suggest Productivity Commission reports, APRA likely to occur over time need. However, Westpac has exited from these businesses are pricing at between may become far more aggressive in financial planning. 3–3.5 times recurring revenues, or seeking the closure of underperforming CBA has already sold Colonial First State 6–7 times normalised EBITDA. superannuation funds or their merger into Global Asset Management to Japanese ANZ sought to sell its OnePath wealth other, more successful funds. giant Mitsubishi UFJ Trust and Banking, management operations to IOOF, Potential liabilities associated with some and its financial planners to CountPlus. completing the sale of its financial planning financial groups may limit M&A activity, Similarly, funds management is an area It is separating its remaining wealth business. However, APRA’s concerns with but there are solutions where scale will remain ever more management (less the already divested IOOF have delayed regulatory approvals. important as investors continue to demand funds management and financial planning APRA’s sanctions against IOOF may see the Given the potential professional indemnity lower management fees. In areas such operations) and mortgage broking transaction further delayed. liabilities associated with inappropriate as exchange traded funds (ETFs) or active business into a separate business dubbed financial advice and fees for no service, management, we expect that funds ‘NewCo’. CBA has confirmed that its There are opportunities for M&A in it is possible that some smaller financial failing to reach acceptable scale may be Financial Wisdom licensee will be closed financial planning given the turmoil planning organisations might look to divest increasingly shut down or merged into and no longer offer licensing services by caused by the major banks the back book of their operations. These other funds. June 2020. ‘run-off liability companies’ could then be At the smaller end of the market, financial rolled up in a series of M&A transactions, An example of the recent changing activity NAB has stated that multiple options for planning businesses looking to grow similar to the process used by the insurance in this space is the signing of a non- its wealth management business remain will have many opportunities to acquire industry to transfer run-off liabilities from binding memorandum of understanding by under consideration, including an initial businesses that are being divested by the closed insurance books. VicSuper and First State Super to explore public offering, sale or demerger. majors. There appears to be particularly the benefits of a merger. This would make strong buyer interest in advisor groups Increased consolidation is likely in super the resulting fund the nation’s second Westpac has made the decision to where the clients are well engaged and and funds management largest behind AustralianSuper. continue manufacturing its own investment pay good ongoing fees (as opposed to products, believing that this path gives those businesses that rely on conflicted As a result of the FSRC recommendations, the group greater control in providing remuneration models and trailing the APRA Capability Review and
16 M&A Outlook: Australian Financial Services Towards 2030 Divestment of wealth management
There is no greater example of the (c) Conflicts of interest between Figure 2 – Market share of wealth management/financial planning in Australia (2018) changes happening in the market than customers' best interests and staff the efforts by Australia’s major banks incentives; 20% to divest their wealth management (d) the airing and scrutiny of high-profile activities. The days where the big four case studies of internal misconduct by 15% banks and AMP controlled 80% of the financial planners and the management Australian wealth management industry impost to fix such misconduct; have gone. Figure 2 and Figure 3 highlight 10% the current market share positions in (e) increased competition from the not- wealth management but this market for-profit industry super funds; concentration will change rapidly. (f) increased regulatory pressures 5% such as the MySuper legislation, The FSRC did not directly address the which forced institutions to offer 0% future of the vertically integrated business simple, low-fee accounts for new AMP ANZ CBA NAB WBC IOOF model. However, this model is now under superannuation customers; and the source: Money Management Magazine. severe pressure and most of the larger Freedom of Financial Advice (FOFA) players in the sector have, through actual legislation, which banned commissions Figure 3 – Market share of retail funds under management in Australia (2018) or planned divestments of their wealth on financial products (apart from management and/or insurance businesses, insurance); 20% signalled their intentions to simplify their business models. Contributing factors (g) anticipated enhanced regulation and associated cost to professionalise have included: 15% services and conduct, and improve the (a) the banks, in particular, becoming products available to end consumers; progressively more circumspect with 10% the wealth management business and (h) greater management time and seeing more effective use of capital; responsibilities (under BEAR) for a small proportion of its overall business; and 5% (b) lack of customer demand to using their local bank branch as a ‘one-stop-shop’ (i) the need to overcome negative for their investment, superannuation reputational and share price impacts. 0% AMP WBC/BT CBA/ NAB/ ANZ Macquarie IOOF and insurance products; Colonial MLC Wealth
source: Plan for Life.
MinterEllison 17 Recent international trends
International M&A activity International trends by sector in the financial services sector has shown some interesting contrasts Banks Asset managers over the last 12 months. Deal making between banks continues to be Deal making in the banking sector has been subdued for the A record was set in 2018 for deal making in the asset management sluggish, while transactions last decade. This is due in large part to the stricter regulatory segment. Acquirers have been attracted to the discounted involving asset managers regimes that have been put in place since the Global Financial valuations through the segment, which dropped to their lowest Crisis. In addition, regulators and governments have in many level in seven years through 2018. The median valuation for and insurers have instances effectively barred mega bank deals amongst the largest publicly traded asset management companies – measured as increased. international and national banks. the enterprise value multiple to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) – was about 6.2 However, since US President Trump has come into office, US times last year, well below the peak of 11 times registered in 2011. bank rules have loosened considerably, leading some to predict a Interestingly, valuations of privately owned asset managers have pickup in deals, particularly as smaller banks look to consolidate. maintained valuations of about 10 times over the last five years.
In February 2019, US regional lender BB&T Corp acquired another With the trend towards low cost industry funds appearing to US regional lender SunTrust Bank for $US28.2 billion, creating be a secular shift, traditional active managers have used cost the sixth largest US retail bank and making it the largest US bank cutting measures to try to stay profitable. This combination of low merger since JPMorgan’s acquisition of Bank One in 2004. valuations and cost out opportunities has also seen significant Technology has been mentioned by the bank’s executives as the private equity interest, which in turn may be an attractive option for main impetus for the deal. The pooling of resources will allow the asset managers as it provides them with an escape from the glare companies to develop better digital offerings. of seasonal earning cycles. In Europe, Deutsche Bank was unable to reach a deal with prospective partner Commerzbank and has since embarked on an aggressive restructure of its operations, shedding its Asian equities businesses and downsizing its investment bank.
18 M&A Outlook: Australian Financial Services Towards 2030 Insurance
The pace of global insurance M&A was robust through 2018, up 9% from 2017, with 382 completed deals. This included 18 $US1 billion+ mega deals, such as AIG’s $US5.5 billion acquisition of Validus, and Axa’s €12.4 billion acquisition of XL Group. Despite these numbers, mega deals are still difficult to complete, as evidenced by the collapse of SoftBank’s proposed acquisition of a stake in Swiss Re.
MinterEllison 19 Recent international trends (cont.)
International regulation driving change
Easing up on Europe’s banks Canada strengthens midsized US Banks face new rules standards
In November 2018, the US Federal Reserve Ten years after the financial crisis, the The new rules also required large foreign In 2018, the Canadian Office of the said that it wanted to ease regulations for regulatory revolution continues for banks to set up intermediate parent Superintendent of Financial Institutions US lenders with less than $US700 billion European banks. The past year has seen undertakings that would bring their (OSFI), implemented changes to mortgage in assets, as a way to lessen the burden reforms passed which will open up EU operations under a single holding underwriting standards, creating a stress on big commercial lenders that do not European banking to more competition, company. The move effectively mirrors US test for borrowers making a down payment have volatile Wall Street businesses. Under tighten rules on trading, dent reported rules and is seen as crucial to protecting exceeding 20%. This will require banks to the proposal, midsized lenders would profits and boost capital requirements. the bloc’s financial stability against risks increase their loan-to-value ratios, which face lower liquidity and compliance Taken together, these changes should also posed by major banks. will be strictly enforced by OSFI. requirements, while smaller banks would make Europe’s financial system healthier. get even easier treatment. Concerns are still held that the ‘Too Canada’s banking regulator also increased European Union (EU) finance ministers Big to Fail’ problem persists in Europe. the amount of capital that its biggest The proposal stems from a law the were able to reach agreement on Since 2008, the five largest banks in the lenders must carry, to protect them against US Congress passed in May that reforming bank capital rules, a major step Eurozone have increased their share of the risks at home. Regulators pointed out that ordered the Federal Reserve to reduce towards boosting the bloc’s financial total assets of the entire banking industry despite positive credit performance and regulatory burdens on community and stability and a stepping stone towards a from 44% to 48%. Critics argue that implicit generally stable economic conditions, regional lenders. deal on a backstop for its bank rescue subsidies for ‘Too Big to Fail’ banks remain now is a prudent time for banks to build fund. The accord came after 18 months in place as well. Since creditors continue to resilience against future risks to the of heated debate among the 28 EU believe that those banks would get bailed Canadian financial system. governments on how to apply new global out in a crisis, they can borrow at lower bank capital rules. interest rates than smaller banks.
Under the accord, European banks will have to abide by a new set of requirements aimed at keeping their lending in check and ensuring they have stable funding sources.
20 M&A Outlook: Australian Financial Services Towards 2030 Part B Long term drivers
MinterEllison 21 Long term drivers
The financial services sector has and will Regulatory & Competition Technology continue to be a key stakeholder pillar of the Australian economy, and an enabler Ongoing changes to international and local We're likely to see new competition from We're seeing greater customer expectation of productivity, jobs regulatory and compliance conditions are nimble, agile and sophisticated companies, for customised, agile and on-demand and economic growth. inevitable, including to banking capital especially those with smart technology systems, coupled with ongoing However, we anticipate requirements, banking executive offerings. This would result in shifts in advancements in technology solutions, that a number of longer accountability, open banking, tightening of market share and power, and the formation especially in quantum computing. This will term changes will see the social responsibility, culture, reputational of more strategic alliances among result in further outlays to upgrade ageing and shareholder priorities. The impact may traditional players wanting to stay relevant. infrastructure and systems just to 'remain in sector look fundamentally be further regulatory and remediation cost the game'. Part D provides further insights different by 2030. It is here cutting into profit margins and potentially about this driver. that we see the greatest market value. Non-core business units opportunities and need might be divested and we might see for M&A. fundamental institutional shifts towards simplified operations, and possible consolidation and market concentration by astute buyers. We’re seeing a number of other interrelated and coordinated forces that will drive longer term change in the sector.”
22 M&A Outlook: Australian Financial Services Towards 2030 Economic
Shifting economic conditions, especially from the current and expected prolonged low interest rate environment, and also leverage risks, will result in different credit and operating conditions.
MinterEllison 23 Economic and commercial issues
Taking a long term view, Fall in financial services market value despite a solid base, market conditions are shifting. In 2018 and early 2019 there was a (a) the FSRC; (e) market uncertainty and volatility due to When combined, they are significant reduction in the collective (b) actions by regulators to slow international market and concerns; market value of Australian financial likely to create additional investment and interest-only (f) moves by APRA to slightly ease new services institutions, which has since partly lending growth; mortgage stress test requirements; pressures on financial recovered. This is highlighted in Figure 4. services institutions. While (c) weaker credit growth and falling (g) APRA’s timetable for revisions to the A confluence of factors have led to this house prices; capital framework for authorised doomsday scenarios are reduction and then recovery in market deposit-taking institutions (ADIs); and unlikely to eventuate, these (d) falling margins and profitability value. These include: ratios due to competition, increased (h) interest rate cuts by the RBA. challenges may create operational costs, and rising triggers for institutions and funding costs; competitors to undertake strategic reviews.
Figure 4 – The reduction in market value of ASX200 financial service sector (January 2018–November 2019).
Banks (Big 4 plus BEN, BOQ, CYG & GMA) Insurance (SUN, AM, IAG, QBE, MPL, NHF, SDF)
440 75 FSRC Final Report FSRC Final Report
420 428 425 71
423 70 421 419 70 413 411 68 68
400 408 405 67 402 400 399 408 66 65 66 395 393 65 65 65 394 65 $Billions $Billions 64 64 387
380 64 64 385 383 63 63 62 373 372 61 371 60
360 60 364 59 359 58 340 55 Jul-19 Jul-18 Jul-19 Jul-18 Apr-19 Apr-18 Jan-19 Jan-18 Feb-19 Apr-19 Feb-18 Apr-18 Sep-19 Sep-18 Jun-19 Jun-18 Oct-19 Oct-18 Mar-19 Aug-19 Mar-18 Jan-19 Jan-18 Feb-19 Feb-18 Aug-18 Sep-19 Sep-18 Jun-19 Jun-18 Oct-19 Oct-18 Mar-19 Aug-19 Mar-18 Nov-19 Nov-18 May-19 Dec-18 May-18 Aug-18 Nov-19 Nov-18 May-19 Dec-18 May-18
source: Start of month market capitalisations, ASX200List.com, accessed 20 November 2019.
24 M&A Outlook: Australian Financial Services Towards 2030 – The market value of bank stocks has fallen 16% in the last year or ~$70 billion – The market value of insurance stocks has fallen 17% in the last year or ~$14 billion – The market value of diversified financials has fallen 7% in the last year or ~$5 billion – The total decline in market value for larger Australian listed financial services stocks is approximately $90 billion or ~15%.
Diversified financials (ASX, CCP, CBG, ECX, IFL, JHG, MFG, MOG, PDL, PPT & PTM)
100
FSRC Final Report 99
95 97 96 96 95 94 94 94 93 93 92 90 92 91 91 90 90 89 89
85 87 $Billions 83
80 82 80
75 78
70 Jul-19 Jul-18 Apr-19 Apr-18 Jan-19 Jan-18 Feb-19 Feb-18 Sep-19 Sep-18 Jun-19 Jun-18 Oct-19 Oct-18 Mar-19 Aug-19 Mar-18 Aug-18 Nov-19 Nov-18 May-19 Dec-18 May-18 source: Start of month market capitalisations, ASX200List.com, accessed 20 November 2019.
MinterEllison 25 Economic and commercial issues (cont.)
Challenges to credit growth
Currently in Australia, banks are facing The deceleration of credit growth has Although the 10% benchmark was lifted The net effect could be further tightening an undeniably challenging credit growth also been influenced by regulators. In late from 1 July 2018, and the 30% cap was in housing credit, which will continue outlook, which is largely being driven by 2014, APRA introduced a 10% benchmark lifted from 1 January 2019, the likelihood to constrict housing market activity and the slowdown in the home loan market on investor loan growth. Investment of a quick rebound in housing credit reduce prospects for price rises. (represented in Figure 5 by housing finance lending volumes as a proportion of total remains low. The 30% cap on interest-only commitments and investments), especially lending volumes for household finance lending had a much more broad-based in the last 12 months. This weakening in peaked at 44.4% in May 2015, just after dampening effect on investor activity. housing credit is a product of economic APRA’s imposition of investment lending Moves to strengthen underwriting have and market fundamentals, namely slower 'speed limits'. In March 2017, APRA also had an even greater and ongoing effect. economic growth, low inflation and implemented a cap on interest-only lending Added to this, APRA is focusing more on overextended property prices. at 30% of all new mortgages, which has minimising debt to income ratios higher led to a substantial drop in demand for this than six times and maintaining a focus on product (largely used by investors). keeping low-deposit lending to a minimum.
This weakening in housing credit is a product of economic and market fundamentals, namely slower economic growth, low inflation and overextended property prices."
26 M&A Outlook: Australian Financial Services Towards 2030 Figure 5 – Housing finance commitments (1985 to now)
45 Housing finance commitments 45% Banks are facing a 40 40% challenging credit growth outlook, 35 35% which is largely 30 30% being driven by the
s slowdown in the n 25 25% o l i
i home loan market." b
20 20% $
15 15%
10 10%
5 5%
0 0%
Owner occupied (LHS) Investment housing (LHS) Investment % dwelllings (RHS)
source: ABS 5671.0 Table 8, Seasonally adjusted data, aggregated into owner occupied and investment categories, http://bit.ly/2OkMu9r, accessed 22 January 2019.
MinterEllison 27 Economic and commercial issues (cont.)
As Figure 6 highlights, system-wide housing Figure 6 – Shifts in non-bank lending credit growth in Australia has slowed Housing credit growth in Australia (year on year) Non-bank market share of financial commitments over the last year due to the restrictions imposed on APRA regulated banks. In this 20% 30% environment, the non-bank lenders or 15% ‘shadow banks’ have stepped in and are 25% now showing accelerated loan growth. 10%
Furthermore, as overall credit growth has 5% 20% slowed, some banks have been more 0% affected than others, most notably ANZ. 15% Recently released APRA stats for June 2019 -5% show that ANZ’s owner-occupied home -10% 10% loan market has declined dramatically, by 0.75%, in the past year to 15.65%. This -15% is the largest one‑year fall recorded by 5% -20% APRA in relation to the big four banks. In February 2019, ANZ Chief Executive Officer, -25% 0% Shayne Elliott, conceded that the bank had 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 become too conservative in its home loan Non-bank Bank approval process. sources: APRA, RBA. source: ABS.
28 M&A Outlook: Australian Financial Services Towards 2030 Figure 7 highlights that growth rates in Figure 7 – Credit growth in Australia (year on year) Figure 8 – Median house price changes 2018 other forms of credit, such as business and personal credit, have also been slowing alongside housing. 25% 10% 8.8% Figure 8 also highlights that tighter credit 20% assessment and availability has led to 5% declining housing prices, particularly in 15% 1.7% Australia’s largest cities. There has been less 0.0% of an impact in other smaller capital city 10% 0% markets (where the Household Expenditure -0.1% Measure may not be as distorted as it is in 5% -3.3% the Sydney and Melbourne markets). -5% 0% -6.5%
-10% -8.7% -8.4% -5% -9.9%
-10% -15% 2005 2008 2011 2014 2017 2020
Housing Personal Business
source: RBA. source: Domain Group.
Tighter credit assessment and availability has led to declining housing prices, particularly in Australia’s largest cities.”
MinterEllison 29 Economic and commercial issues (cont.)
Asset and liability mix/ funding mix Figure 9 – Funding composition of Australian banks through time
70% One driver of rising funding costs is the funding composition for Australian banks, 60% which is a function of the deposit to loans ratios (DLRs). These were improved to 50% just above 60% with the implementation of the Basel III standards. Banks have 40% supplemented their deposit base by raising wholesale funding (both long term and 30% short term debt) and securitising existing loans such as residential mortgages into 20% residential mortgage backed securities (RMBS) to make additional loans 10% given profitable demand. This funding composition is highlighted in Figure 9. 0% 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 The majority of wholesale funding has been raised and securitised loans sold Domestic Deposits Short-Term Debt Long-Term Debt Equity Securitisation overseas, which leads to Australian banks’ funding costs being partly driven by what is happening to the cost of funding overseas. Australian banks are likely to have rising sources: APRA, RBA, S&P funding costs, despite interest rate stability in Australia, as the US looks to increase rates and other markets linked or pegged to the US dollar implicitly follow suit.
30 M&A Outlook: Australian Financial Services Towards 2030 Banking in a low interest rate world Figure 10 – Low interest rates in leading developed markets
Central Bank policy rates Over the last decade, low interest rates Low interest rates for long periods bring 8% have become a permanent feature other challenges. For example, low rate 7% throughout the economies of the environments reduce bank profitability, as 6% developed world (as highlighted by net interest margins are compressed. At 5%
Figures 10 and 11). the same time, investors (both retail and 4%
institutional) can be pressured to increase 3% This unprecedented period of loose their risk exposure to start chasing returns. 2% monetary policy has been driven by The dangers of increasing risk exposure 1% the need to nurse economies back to a are often not apparent in a benign 0% path of growth after the Global Financial GFC environment. -1% Crisis. Although we have seen economies 2005 2008 2011 2014 2017 2020 stabilise, and in some cases stage robust Banks are being proactive in managing their Australia US Japan Euro area UK recoveries, the policy experiment of ultra- credit exposures to minimise credit losses, low rates and quantitative easing has not in part prompted by APRA. During a benign source: RBA. been without consequences. Side-effects credit environment, it can be difficult to are now apparent in asset prices, which determine where credit exposures could Figure 11 – Low long term interest rates in Australia in many instances, have been increasingly deteriorate, and, given the economic stretched from underlying fundamentals. uncertainties, it would be brave to predict 18% Australian 10 year yields
This was most visible in the US stock too far out. However, the fundamental 16% market, but also extends to other corners, drivers of credit quality remain unchanged, 14% such as private equity. In Australia, the with high household debt combined 12% impacts of the global debt binge seem with rising unemployment (resulting in 10% most apparent in residential property. households being unable to service their debt) producing the largest risks. 8% 6%
4%
2%
0% 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014 2019
source: RBA.
MinterEllison 31 Funds management and investment platforms
As Figure 12 highlights, Australia’s Over the past couple of years, we have Figure 12 – Australia’s projected superannuation assets ($ trillion) superannuation asset pool is expected seen a huge exodus of funds away from to grow from $2 trillion to $9.5 trillion the traditional giants of the Australian 10 by 2035. This significant change in the wealth management sector, and into the landscape will have a long term impact on lower cost industry super funds. A key M&A in the sector. question that looms for 2020 and beyond 8 is whether this switching has been a In Australia, next generation specialist reaction to the negative headlines from platform providers, such as Hub24, the FSRC, or whether other forces are at 6 Netwealth and Praemium offer their play. We believe the broader global theme services to independent financial planners. of lower cost (often passive) investment 4 These specialists have already captured managers winning funds off higher cost significant market share of net funds flows legacy providers, is set to continue playing into investment platforms, and are quickly out with no end in sight. growing assets under management. 2 They are challenging existing platform operators by offering greater functionality, 0 flexibility and accessibility. Their growth has been further aided by the brand 2020 2025 2030 2035 damage large wealth management businesses experienced due to the misconduct revealed by the FSRC. source: Austrade.
32 M&A Outlook: Australian Financial Services Towards 2030 Part C Governance & culture, and regulatory issues
MinterEllison 33 Governance & culture, and regulatory issues
Since the Global Financial Crisis in particular, the Australian financial services sector has seen an increase in global and local M&A due diligence processes will become Increased governance considerations will Remuneration changes are unlikely regulatory scrutiny. While more onerous most likely slow M&A to drive M&A activity, but may be an some significant regulatory important qualitative consideration in and compliance changes Acquirers will undoubtedly increase With the Treasurer required to approve how a deal is structured their due diligence as a direct result of M&A deals in the financial sector, there is will occur in the aftermath the FSRC, and may also seek increased good reason to anticipate that governance If remuneration changes limit incentive of the Financial Services levels of warranties and indemnities from considerations will be relevant to approval. pay or change its structure, it could impact Royal Commission (FSRC), vendors. In addition to financial due Given the recommendations of the FSRC, if how M&A is structured for both boards financial institutions face diligence, companies may wish to consider regulators voiced concerns to the Treasurer and management. Increased emphasis on a number of regulatory undertaking more thorough regulatory and around an organisation's governance, they long term incentives under APRA’s BEAR cultural due diligence to prevent inheriting might be sufficient to affect the course regime, consistent with those discussed pressures as a result of or acquiring any regulatory, legal or of the proposed transaction. Governance in the final round of FSRC hearings with measures designed to make compliance liabilities. concerns appear to be delaying the Macquarie Bank, might actually lincrease them more resilient, and completion of the acquisition of OnePath's M&A if any changes encourage boards and accountable to customers, Pension and Investments business by IOOF. management take more calculated risks. which may drive transformative structural change in the sector.
Part C written by: Mark Standen Partner
34 M&A Outlook: Australian Financial Services Towards 2030 Culture and governance
Weak corporate governance practices are in the spotlight. This follows APRA’s prudential inquiry into CBA, the FSRC, risk governance self-assessments, and the Remuneration Report first strikes for the major banks at their recent annual general meetings.
In his interim report, and reiterated in his final report, FSRC Commissioner Hayne stated six informing principles that reflect the norms of conduct that lie behind compliance which are: (a) obey the law; (b) do not mislead or deceive; (c) act fairly; (d) provide services that are fit for purpose; (e) exercise skill and care; and (f) when acting for another, act in the best interests of the other.
The FSRC Final Report laid blame for misconduct at the feet of directors and senior management. During public hearings, the blurring of lines between board and management was evident.
Many of the governance failures observed during APRA’s prudential inquiry and the FSRC arose because corporate governance practices fell short of these six guiding principles. (For more information, view our report, Delivering sustainable stakeholder value in a post-Hayne Royal Commission world: https://bit.ly/338qWlF)
MinterEllison 35 36 M&A Outlook: Australian Financial Services Towards 2030 The FSRC implementation roadmap
In August 2019, the Commonwealth According to the Government, it has Government published its implementation implemented 15 of the commitments it roadmap for action to be taken in response outlined in response to the FSRC Final to the FSRC. Report. They include eight out of the 54 recommendations directed to the Of the 76 recommendations, 54 were Government and seven of the 18 additional directed to Government, 12 to the commitments the Government made as regulators and 10 to the industry. Of the part of its response. Significant progress 54 recommendations directed to the has also been made on a further five Government, over 40 require legislation. recommendations, with draft legislation In addition to the FSRC’s either introduced to Parliament, or released 76 recommendations, the Government for comment, or detailed consultation announced a further 18 commitments in papers have been issued. its response to address issues raised in the FSRC Final Report.
Of the 76 recommendations, 54 were directed to Government, 12 to the regulators and 10 to the industry.”
MinterEllison 37 Government implementation plans (taken from the Commonwealth Government's Restoring Trust in Australia's Financial System: Financial Services Royal Commision Implementation Roadmap, August 2019 (Government Roadmap))
Legislation to be introduced by the end of 2019 Other measures include: Measures to improve consumer protection include: 1.11 – A national farm debt mediation scheme Recommendations 1.5 – Regulating mortgage brokers as financial advisers – This 1.2 – Mortgage broker best interests duty recommendation will be progressed following the review of 1.3 – Mortgage broker remuneration financial advice reforms (recommendation 2.3), given that 2.4 – Ending grandfathered commissions for financial review may recommend changes to the regulation of advisers (legislation introduced on 1 August 2019) financial advisers 4.2 – Removing the exemptions for funeral expenses policies 3.5 – One default superannuation account – Implementation of 4.7 – Application of unfair contract terms provisions to this recommendation will be considered in the context of insurance contracts the findings and recommendations of the Productivity 4.8 – Removal of claims handling exemption for insurance Commission’s report Superannuation: Assessing E ciency and Competitiveness
Legislation to be introduced by the end of 2020 Reviews in 2022 Measures to strengthen financial regulators include: Recommendations Recommendations 1.4 – Council of Financial Regulators and the Australian Competition and 3.9 – Extending the Banking Executive Accountability Consumer Commission review of changes to mortgage broker Regime (BEAR) to Registrable Superannuation remuneration and operating of upfront and trail commissions Entities licensees 2.3 – Review of measures to improve the quality of financial advice – 4.12 – Extending the BEAR to APRA-regulated insurers Consistent with the FSRC’s recommendations, the review 6.6 – Joint administration of the BEAR will examine all exemptions including the ban on conflicted 6.7 – Statutory amendments to facilitate co-regulation remuneration, including for general insurance, consumer credit 6.8 – Extending the BEAR to all APRA-regulated financial insurance, timeshare and stockbroking remuneration, and stamping fees services institutions 2.6 – Review of each remaining exemption from the ban on conflicted remuneration. This review will occur as part of the review of measures to improve the quality of financial advice (recommendation 2.3)
38 M&A Outlook: Australian Financial Services Towards 2030 Regulator implementation plans (taken from Government Roadmap)
ASIC approach to enforcement Supervision of culture governance 6.2 – ASIC has established an O ce of Enforcement. 5.7 – Issues of culture and governance are priority Its purpose is to strengthen ASIC’s enforcement areas for APRA. APRA is reviewing its program of work culture and eectiveness, and to implement a single to enhance its regulatory and supervisory approach in enforcement strategy. The o ce will lead the these areas following the Government's ASIC Life Insurance application of ASIC’s ‘why not litigate’ enforcement announcement of additional funding as part of the Commission’s review approach. 2019–20 Budget. APRA intends to publish a statement 2.5 – ASIC will include the of its approach by the end of 2019. factors identified by the FSRC in its post-implementation review of the 2017 life insurance reforms. ASIC’s ASIC will monitor and report on the extent to review will take place in 2021. which product issuers are acting to end the grandfathering of conflicted remuneration in the period 1 July 2019 to 1 January 2021, as directed by Government.
Co-operation memorandum ASIC application of BEAR APRA BEAR product responsibility 6.10 – APRA and ASIC are to regulators 1.17 – On 28 June 2019, APRA released for consultation a proposed reviewing the co-operation and 6.12 – ASIC will implement this heightened product accountability regime, which requires ADIs to co-ordination arrangements recommendation in anticipation identify and register accountable persons to hold end-to-end product between the two agencies, of the Government establishing a responsibility for each product the ADI oers to its customers. In including revising the existing financial regulator oversight November 2019, APRA released an information paper discussing its Memorandum of Understanding. authority. ASIC will develop and approach to transforming governance, culture, remuneration and This review is expected to be publish accountability statements accountability, addressing FSRC recommendations and its capability completed before the end of 2019. before the end of 2019. review recommendations; highlighting draft Prudential standard CPS 511 Remuneration. It plans to respond to feedback in early 2020 and finalise thereafter.
MinterEllison 39 The BEAR case on potential talent gaps
The BEAR has significantly impacted many BEAR requires institutions to defer a portion APRA’s alignment of consistent prudential aspects of governance in big banks since of variable remuneration of accountable standards across the industries it regulates. it was implemented in mid-2018. BEAR persons for at least four years. Based The broader financial services industry applies to small and medium banks since 1 upon similar UK regulations (the 'Senior needs to prepare itself to meet the July 2019. ADIs, their subsidiaries, Australian Managers Regime'), BEAR may also present standards required. branches of foreign ADIs, and those in some unique challenges for the sector. For director and senior executive roles in these example, deferral and increased potential The RBNZ is now also considering the institutions are now being required to meet liability may create indirect challenges in need to strengthen executive accountability heightened accountability obligations in relation to attracting senior global talent in New Zealand as part of its review of its addition to deferred remuneration and into the market. Australian businesses do powers, particularly after recent identified notification obligations. not operate in isolation. They participate in management shortcomings at the New a global market for senior talent and need Zealand subsidiary of one of the major BEAR articulates greater detail and adds to remunerate key hires accordingly or they Australian banks. It is looking at both the transparency to executive responsibilities. will fail to attract the required talent. UK Senior Managers Regime and Australian All accountable persons must be BEAR as it considers similar regulations. registered with APRA, which also has new Going forward, further guidance and strengthened powers. While BEAR on implementation and transitional potentially adds complexity and increases arrangements will be released by APRA. short term cost to some areas, if properly Regardless of size, BEAR will require a implemented, those downsides can be comprehensive review of, and make more than offset by longer term efficiency substantial changes to, policies and gains through better accountability, a procedures relating to governance, reduction in a sales culture and streamlined employment, compliance, risk and training. governance. The key is to treat BEAR as a business rather than compliance issue and Consistent with the recommendation to avoid stultifying decision making with from the FSRC, the Commonwealth ‘tick a box’ requirements for documenting Government has announced it will expand decisions. BEAR to other financial services entities - life and general insurers, superannuation trustees and non‑financially regulated financial entities - in a manner similar to
40 M&A Outlook: Australian Financial Services Towards 2030 Regulation and compliance costs
Increasing regulation and compliance responses are Figure 13 – Estimated remediation and compliance costs on the big having significant impacts on financial institutions’ four banks (2018 - 2020) operations and profitability. Various estimates from management consultancies such as Bain suggest that governance, risk and compliance (GRC) spend Financial impact of banks misconduct accounts for between 15% and 20% of 'run the bank' costs, and 40% of 'change the bank' costs. These percentages are considerably higher than they were 800 a decade ago and will continue to rise.
For example, earlier this year, media reports disclosed 600 that Morgan Stanley had estimated that Australia’s big s four banks, in addition to the various costs directly n o incurred responding to the FSRC, are due to outlay l i 400 m i
an additional $2.4 billion over the next two years in $ remediation and compliance costs (as highlighted in Figure 13). Macquarie has derived a number 200 approximately twice this size to resolve financial planning malpractice issues, based on Westpac’s estimate of $750,000 per adviser, which is over and 0 above what has been already provisioned. 2018 2019 2020 Additional compliance costs Fines & customer remediation It would be safe to assume this level of change is the ‘new normal’ and financial services institutions will adjust how they address this increasing burden. This could be through absorbing the costs, business source: Morgan Stanley. exits, or outsourcing, or through developing better technology systems.
MinterEllison 41 Marching towards Basel IV
The Basel Committee on Banking The BCBS proposes a nine year Figure 14 – Basel capital requirements since 2013 Supervision (BCBS) has designed a series implementation timetable, which allows of agreed minimum requirements with the considerable time for preparation. A five- aim of strengthening regulation, supervision year phase-in period would commence on 10.0% and risk management of banks. As Figure 14 1 January 2022, with full implementation highlights, these requirements have been from 1 January 2027. APRA has signalled increasing since 2013. it intends to introduce these reforms per 8.0% BCBS’s timetable, rather than ahead of The BCBS has proposed reforms that are BCBS’s timetable, to keep Australian banks designed to make banks across the world competitive with overseas players. more resilient and increase confidence 6.0% in the banking system. The most recent APRA has now announced its approach proposals announced in December 2017, to Total Loss Absorbing Capital (TLAC), referred to as ‘Basel IV’, include updates departing from the approach embraced 4.0% to the methods banks use to calculate overseas by having Australian banks their capital requirements, with the aim raise additional Tier 2 capital, rather than of making outcomes more comparable adopting a Tier 3 capital approach. The 2.0% across banks globally. One principal feature RBNZ approach appears to be even is the way banks calculate risk weighted more conservative, looking for New assets (RWAs). The BCBS proposes that a Zealand banks to meet additional TLAC 0.0% calculation of a bank’s RWAs using internal requirements with equity capital. 2013 2014 2015 2016 2017 2018 2019 models should not fall below 72.5% of the calculation using standardised models. This Frameworks such as Basel are almost Tier 1 common minimum Capital conservation buer Systematically important lower limit is known as an ‘output floor’. universally welcomed by regulators, financial institution @250 bps governments and retail shareholders. For institutional investors, while recognising source: Avondale Asset Management. the merits, there is also an awareness that one of the outcomes of these changes is lower levels of profitability and lower shareholder returns.
42 M&A Outlook: Australian Financial Services Towards 2030 Further regulatory changes likely in superannuation
The recent Productivity Commission report, outstanding recommendations from the 2014 Murray Financial System Inquiry final report and FSRC recommendations will likely drive further changes to superannuation in coming years.
These reports have recommended many potential reforms to superannuation. A few potential key reforms to superannuation include: (a) procedures for winding down chronically underperforming funds; Many potential reforms (b) procedures for selecting default funds to superannuation for new employees who don't have an existing fund; and have been (c) the upcoming legislated increase in recommended." superannuation contributions from 9.5% to 10% and whether this is removed, or implemented.
MinterEllison 43 Australian regulatory structure and its impact on M&A
In a post-FSRC environment, we anticipate that many aspects of M&A, from due diligence to regulatory ASIC came under criticism during the FSRC for not being sufficiently approvals, may become more challenging. The following litigious in enforcing the law and has since changed its processes to section highlights some key issues that arise from the address this criticism. Understanding litigation and enforcement risk, and increased scrutiny of regulators anticipating future regulatory actions assumes additional importance for M&A activity.
Following the FSRC, ASIC has taken the stance of 'why not litigate?' when considering potential investigations. It is believed that ASIC is planning to put up to 50 matters into the courts in the coming months. In September 2019, ASIC announced that it was going to pursue the Bank of Queensland, and Bendigo and Adelaide Bank in court over 20,000 loans Part C written by: to small businesses with unfair contract terms. ASIC alleges that the Bank of Queensland has 3,018 non-compliant loans for sums of less than $1 Paul Schoff million each, while Bendigo and Adelaide Bank has more than five times Partner as many or 15,529 non-compliant loans for similar sums. ASIC has launched an appeal against a controversial judgment over [email protected] allegations of irresponsible lending by Westpac that found in favour of the bank. The regulator alleged the bank broke responsible lending laws 261,987 times because it used a benchmark in place of proper inquiries as to the suitability of the loans for the borrowers.
44 M&A Outlook: Australian Financial Services Towards 2030
APRA came under criticism during the FSRC for not being aggressive enough in The ATO may not be a direct financial The ACCC can take action in court to its interactions with a number of institutions, resulting in a subsequent review of regulator, but it does collect significant prevent a merger if it believes that it its operations. For example, IOOF’s acquisition of ANZ’s OnePath business was amounts of tax from the financial sector, will have the effect or likely effect of criticised for its lack of independence and poor governance. APRA has since launched with the major banks some of the nation’s substantially lessening competition. unsuccessful legal action against IOOF, and certain directors and senior management. largest taxpayers. Implications for this Acquisitions of regional banks during the As such, M&A in the future may require more corporate restructuring to meet APRA’s revenue base will be part of any scrutiny Global Financial Crisis were approved for best practice requirements, and M&A regulatory approvals may have more onerous of future M&A transactions. Given the prudential stability reasons but it is unlikely conditions attached to them. Treasurer is responsible for the ATO, that such transactions would be permitted concerns regarding tax revenue might again. Further, the ACCC is focused on the It is expected that there will be greater scrutiny of the remuneration of boards, be relevant to the Treasurer’s decision to risks to competition of large incumbents management and frontline staff, and the incentives offered in regard to product approve a financial sector M&A transaction. acquiring small or startup players – for sales. Should remuneration changes limit incentive pay, or change its structure, it example, fintech startups or digital banks could also impact M&A as it could alter the incentives for boards and management that may have few customers or a very to undertake such M&A. Alternatively, increased emphasis on long term incentives small market share but carry the potential (such as those discussed in the final round of hearings with Macquarie Bank) might to enhance competition in the future. lead to more M&A if any changes encourage boards and management to take more calculated longer term strategic decisions. Unlike the approach of other regulators, as a general rule, the ACCC tends to negotiate On 23 July 2019, APRA released a draft prudential standard (CPS 511) aimed at outcomes in the M&A space rather than go clarifying and strengthening remuneration requirements in APRA-regulated entities. through a court process. The key reforms APRA is proposing include the following: (a) to elevate the importance of managing non-financial risks, financial performance measures must not comprise more than 50% of performance criteria for variable remuneration outcomes. (b) minimum deferral periods for variable remuneration of up to seven years will be introduced for senior executives in larger, more complex entities. Boards will also have scope to recover remuneration for up to four years after it has vested. (c) boards must approve and actively oversee remuneration policies for all employees, and regularly confirm they are being applied in practice to ensure individual and collective accountability.
MinterEllison 45 Part D Technology
46 M&A Outlook: Australian Financial Services Towards 2030 Technology as a competitor in financial services
The shift in consumer expectations, rapid advancement of technology solutions and perceived gaps in the market have resulted in the entry of new non-traditional competitors from other sectors who look to offer innovative and valued solutions and take market share from the incumbents. This trend will continue with incumbents entering into strategic alliances to align with new technologies, making venturing arrangements with new startups or acquiring companies to keep intellectual property and market advantage.
Bigtech
Bigtech, namely Google/Alphabet, Amazon, over charges for using it. ANZ was able to Figure 15 – How bigtech is moving Part D written by: Facebook and Apple (amongst others), differentiate itself through its early adoption into financial services have the balance sheet, 'disruptive spirit', of Apple Pay. existing infrastructure and capability to build Google Wallet alternative solutions for consumers who Social media-based messaging programs Android Pay have traditionally used big financial services are also offering fund transfers via Google Finance Google Savings institutions. At the same time, they can offer messaging programs such as WeChat Pay solutions that are convenient and easy to and within Facebook Messenger. While Amazon Payments use, reducing friction for customers. Apple Pay Cash and Facebook Messenger payments are not yet available in Australia, Amazon Cash Amazon SME Figure 15 highlights some of the current we are already seeing strong growth Amazon Credit Card Anthony Borgese ways in which bigtech has started moving in WeChat Pay, and in the other major Partner into financial services. Apple Pay, Google Chinese money transfer platform Alipay on Messenger Payments Pay, Samsung Pay, and the Microsoft and the back of a large increase in the number Messenger and PayPal Mastercard identification initiative are all of Chinese visitors to Australia. Partnership [email protected] Libre Crypto Currency existing threats from bigtech which may be just the opening foray into a larger financial Facebook has more recently floated presence. We have already seen the impact its ‘Libra’ digital currency proposal, Apple Pay of Apple Pay, with Commonwealth Bank a ‘stablecoin’. It then lost support from Apple Cash via Messenger Apple Credit Card of Australia (CBA), Westpac, National a range of other companies once the Australia Bank (NAB) and Bendigo Bank, regulatory complexities of its proposal all delaying its adoption due to disputes became evident. source: FT, Company Reports.
MinterEllison 47 Technology as a competitor in financial services (cont.)
Fintech
Outside of bigtech, new fintech players Figure 16 – How fintech is disrupting the Payment networks have seen significant New credit sources continue to show are seeking to improve and automate the financial services sector innovation in Australia from a range of strong growth in Australia. ‘Shadow delivery of financial services. Following fintechs. This has already encouraged banking’ or the provision of credit an initial 'land grab', further consolidation the major banks to lift the opportunities intermediation via wholesale finance rather Fintech is disrupting existing businesses in in the fintech space might occur as the financial services industry from three they offer in this space. Notable examples than deposits, operates under much lower institutions look to increase their scale. distinct angles: include several buy-now pay-later regulatory hurdles than an APRA issued Additionally, larger incumbents might look institutions which have emerged over banking licence. Interestingly, restrictions to acquire fintechs as a way of securing, recent years, including Afterpay, Zip around using the word 'bank' have rather than developing, more efficient Money and Humm from FlexiGroup. encouraged many of these fintech-inclined credit sources financial services systems and processes ASIC recently conducted a review into businesses to use 'money' or 'financial' in that will better enable the transfer of their investment platforms this rapidly growing sector, given some their company names instead. existing customers onto these digital and robo-advice businesses within it are not covered by offerings. For example, CBA recently paid credit or lending laws. Other segments The Financial Services Royal Commission $100 million to invest into Swedish fintech payment networks where fintechs are gaining relevance in (FSRC) examined how bank credit Klarna. the Australian market include independent underwriting met responsible lending POS terminals and alternative FX requirements. This has led to a credit Figure 16 highlights that smaller, more agile payment networks. squeeze, with banks conducting much fintech players are already gaining market source: MinterEllison. greater due diligence on potential share through offering payment networks, borrowers, slowing down the flow of credit sources and investment platforms. credit and lowering borrowing capacities for a number of borrowers. As such, many borrowers are now opting for non-bank lenders, who are providing either larger
48 M&A Outlook: Australian Financial Services Towards 2030 borrowing capacity or faster access to Backed Securities repurchase agreements. credit. This trend is clearly observable in the As the US experience has shown, once mortgage market and small to medium- shadow banks receive banking licences, sized commercial borrower market. they eventually begin to offer traditional Through this process, many shadow banks banking products such as deposit and are embracing a fintech approach to sales, savings accounts, providing competition to distribution and servicing. existing banks.
In Australia, Latitude Financial is probably Robo-advice is another avenue of the most high-profile business to transform growth for fintech investment platforms. itself into a fintech. To allow this evolution, Groups such as Hub24, Netwealth and the business, formerly known as GE Praemium are offering their services to Money Australia, has aggressively invested independent financial planners. These in technology over recent years. Other businesses are gaining market share of businesses operating in the area between flows into investment platforms, and shadow banks and fintechs include Prospa, growing assets under management. In the Athena Home Loans, LaTrobe Financial, same way as we are seeing in payments Bluestone, Pepper Money and RESIMAC. and credit provisioning, the robo-advisor fintechs are offering greater functionality, Given the credit growth occurring in flexibility and accessibility, and lower prices shadow banks, we anticipate that at some compared to the traditional businesses. stage there might be a regulatory impetus Potential future growth could be aided by for some of them to obtain banking customers shifting away from larger wealth licences. The precedent for such action management businesses after the FSRC. occurred during the depths of the Global Financial Crisis when American Express, Some of the robo-advisors currently Goldman Sachs, Morgan Stanley and operating or set to launch in Australia others were issued banking licences to include Stockspot, InvestSMART, Ignition permit the US Government to support Direct, Quiet Growth, Raiz Invest, Clover, these institutions with Treasury Asset Relief Plenty, Six Park and Acorns, while AMP has Program (TARP) funds. The Australian effectively been developing robo-advice analogy would be for shadow banks to to assist its planners through its online receive banking licences to allow the goals-based advice initiative. A common Reserve Bank of Australia to provide them feature of these robo-advisors is the use liquidity, although this might already be of exchange traded funds (ETFs) to keep possible through Residential Mortgage investment fees down.
MinterEllison 49 Technology as a competitor in financial services (cont.)
Neobanks
Neobanks, a sub-category of fintech, are (c) many of their employees are sized enterprise market while Revolut The proliferation startup companies looking to become experienced bank executives who is planning to launch in Australia, with a completely new banks. They are often have become disenfranchised with reported waiting list of 20,000 potential of neobanks may funded by venture capital or via strategic perceived inefficient and clunky customers. see consolidation investments by other companies and processes within major banks and have investment funds (including superannuation innovative ideas on how to perform In time, the proliferation of neobanks may within the sector. funds). Many neobanks globally are those processes better; see consolidation within the sector, or Alternatively, attempting to position themselves alternatively, larger institutions acquiring (d) the shift to open banking will allow neobanks for some of their technology as enabling better personal financial neobanks to quickly and efficiently larger institutions management, through the use of spend platforms. NAB’s launch of Ubank was acquire customers from existing effectively it launching its own neobank may acquire trackers and budgeting tools, and are digital banks; and institutions (i.e. technology companies), under its banking licence. neobanks for some that do not use paper-based processes. (e) consolidation of or cooperation between neobanks and other fintechs CUSCAL has now made a similar move of their technology Neobanks are noteworthy for several and/or shadow banks could enable with its 86400 neobank, while Douugh is platforms." reasons: neobanks to offer a broader product partnering with Regional Australia Bank to use its banking licence. (a) their processes are fully digital, which range. It may also reduce the relative provides superior operational leverage advantage existing banks have in being once these businesses achieve scale, able to conveniently provide a wide allowing them to price products more range of services to a client. aggressively; There are several neobanks targeting the (b) they are working to provide a better Australian market. Volt and Xinja have both customer experience and provide recieved unrestricted authorised deposit- better financial management tools than taking institutions (ADI) licences. Judo offered by existing banks; Capital is targeting the small and medium-
50 M&A Outlook: Australian Financial Services Towards 2030 White labelling
White labelling can be used to the benefit (b) white label credit cards are provided large companies with significant scale. The ACCC has of both product manufacturers, and the to several regional banks, retail outlets This concentration can act as a barrier to companies that place their brand on (Woolworths) and an airline (Qantas) new entrants into the market served by the flagged that it is the white labelled product. The product from a major international bank, white labelled product. starting to monitor manufacturer benefits from increased allowing these other businesses to sales, while the brand selling the white benefit from economies of scale in White labelling also has the effect of the impact of white labelled product strengthens its customer credit card operations; creating illusionary competition, with labelling, particularly relationship, increasing the number of multiple brands offering effectively the (c) insurance products are often labelled same product from the identical product products in the relationship. This has with brokers, or agents, brand names. by groups that own associated benefits such as reducing the provider. The effect of such illusionary However, they are underwritten by competition can be to reduce the amount multiple retail brands." tendency to lapse and increasing expected a non-related licensed insurer, often customer lifetime. However, if the product of shopping around customers do. They where the broker has arranged a find no price differences between different manufacturer is providing the customer particular insurance package or service, poor service could damage the white labels of the same product, so might product with the underwriter – in abandon their search rather than looking brand and reputation of the brand selling general, life and health insurance; and the product, and adversely affect its further. The ACCC has flagged that it is other business. (d) annuities are also white labelled starting to monitor the impact of white by some industry super funds, labelling, particularly by groups that own Common financial services products manufactured by the only specialist multiple retail brands, and can create the in Australia where some white labelling provider of annuities currently illusion of competition between their occurs include mortgages, credit cards, operating in the Australian market. own brands. insurance and annuities: When smaller companies switching (a) mortgage brokers have access to a from product manufacturing to white range of white labelled mortgages, labelling another company’s product, provided from the major banks broker it increases the scale of the white label aggregation businesses and through product provider, creating a handful of RMBS packages;
MinterEllison 51 Technology as an enabler, with a focus on the customer
The financial services Incumbent institutions are responding The multi-purpose application of Figure 17 – How financial services sector is increasingly to the competitive pressures presented technology was highlighted by CBA institutions are investing in fintech by technology. Figure 17 highlights that in May 2019 when it stated that it reliant on agile technology banks, for example, are investing in fintech would continue its investment in digital infrastructure and systems through direct replacement of legacy technology to increase its edge and of retail banks will to meet the demands of systems, development of mobile apps or fight off of fintechs. CBA is forecasting replace legacy customers and regulators, the development of their own tools. that it will spend over $5 billion in the banking systems confront risks posed by next five years. In 2018, according to 25% through startup Technology within financial services is KPMG, spending on technology by the providers by the competitors and cyber increasingly seen via several different big four banks rose 7% to $7.2 billion in end of 2019 threats, and make best use perspectives, as: total. Similarly, NAB is currently investing of its most valuable asset – (a) a key enabler in the drive to acquire aggressively in technology. While laying its data. and retain customers; off 6,000 employees as part of its (b) a source of productivity gains and cost transformation strategy, NAB is also hiring of financial services savings from process automation and 2,000 employees in the technology clients will use artificial intelligence; space, seeking to increase productivity 61% mobile apps at least and automation. It is lifting its technology once a month (c) an area with significant legacy, resulting spend to $4.5 billion over three years, in heightened operational risks; and while reducing total expenses by $1 billion (d) a potential disrupter, not only per annum by FY20. Westpac recently from the fintechs but from the announced that it is partnering with 10x of financial services technology giants. to provide 'Banking-as-a-Service (BaaS)' executives believe functionality. parts of their business 83% are at risk of being lost to stand-alone fintech companies
source: Centric Digital.
52 M&A Outlook: Australian Financial Services Towards 2030 Regulatory Technology (Reg Tech) is Tech giants offering innovation in the also poised to play a key part in assisting payments space are also pressuring existing banks, other financial institutions and institutions. Apple Pay, initially resisted regulators to comply with and monitor by CBA, NAB and Westpac, has now their many regulatory obligations. This been adopted by a number of Australian process automation should lead to more banks (for reference see https://www. comprehensive legal compliance, while apple.com/au/apple-pay/banks/au/en- reducing the cost of compliance. ASIC au.html ), with Westpac likely to adopt and the ASX currently use algorithms and it soon. Many retailers have obtained machine learning to look for suspicious Alipay and WeChatPay facilities to cater trading activity and to track the activity of to international visitors to Australia from people associated with market participants. China. Increasingly these alternative It is also likely that Austrac uses algorithms payment methods are attracting transaction to classify and risk score the thousands of funds, and reducing the transaction funds daily reportable transactions. held with traditional banks. Morgan Stanley suggests that $22 billion of revenue is at A key area of investment is artificial risk across the major banks in Australia, with intelligence (AI). We are already seeing 30%, or $6.7 billion, of CBA’s revenue at risk, this in financial advice through the given its overweight consumer presence. development and rollout of robo-advisors by AMP, IOOF and fintechs. Banks use AI to gain additional customer insights to improve services, such as fraud detection, lifting cross sell via 'next best' offer algorithms and creating a digital banking experience that is seamless and easy to use.
MinterEllison 53 A key enabler in the drive to acquire and retain customers
Open Banking, being the first relationship management (CRM) and in the retail industry. The smartphone implementation of the recently legislated application programming interface (API) enabled consumer demands a tailored Consumer Data Right (CDR) has the software overlays, addressing most of their experience, delivered in real time, at the potential to become a major disrupter needs in real time. Others have moved to push of a button or the swipe of a finger. through facilitating greater competition modernise their core banking to gain the The increasing number of neobanks looks with consumer-initiated transfers of data. flexibility and efficiency that will enhance set to accelerate change and increase the This can be seen as both a threat and an the customer experience. pressure on existing institutions to adapt. opportunity for the major banks. The provision of APIs may be a key way The major banks are well placed to use that banks can differentiate themselves in Figure 18 – Most important trends for retail banking the implementation of open banking in coming years, making banking a little less their own drive for customer growth. By commoditised, and with APIs potentially combining customer data, analytics and AI becoming another barrier to customers they have the potential to add real value for switching banks. The use of APIs might Removing friction from the consumers. This presents a challenge to cement existing customer relationships. customer journey better use available customer information. The first signs of this occurring are from the integration of banking APIs into business Use of big data & AI In order to bring personalised experiences accounting software packages such as to customers and compete with new, Xero, MYOB and Reckon, with adoption more agile players, financial services of these software packages being further Integrating multichannel delivery institutions need to increasingly employ encouraged by initiatives such as the systems that easily draw upon the vast Australian Tax Office’s single touch payroll pools of data at their disposal. Legacy reporting initiatives. Building partnerships with fintechs systems generally make it more difficult to gain customer insights that could help There is now extreme pressure on formulate vital strategies for the future. financial services institutions to adapt to Expansion of digital payments The result is that traditional banking the digital age. Pressure is coming from infrastructure cannot react fast enough digital-savvy customers who expect their 10% 20% 30% 40% 50% 60% 70% to form valuable interactions in real time. bank to provide the same transformative Some banks have attempted to solve experience they receive from Uber in this by implementing modern customer the transport industry, or from Amazon source: DBR (2018 survey of a panel of over 100 global financial services leaders).
54 M&A Outlook: Australian Financial Services Towards 2030 Reducing customer friction
Dai-ichi Life, the Japanese life insurer Its efforts question, as the FSRC Figure 19 – Dai-ichi's partnership initiative with Yamato Transport. who in Australia owns TAL and recently Commissioner did, the defence some acquired Suncorp Life, is now considered industry participants raised that they had to be one of the leading life insurers in not been notified of a customer’s passing. Japan, renowned for its customer service principles and execution. Dai-ichi uses simple and effective technology partnerships and systems Dai-ichi has not always had its claims to minimise errors and exhibit clear process right. The Japanese Financial customer service. It clearly documents 1 2 Services Agency, its regulator in Japan, how its claims process works on its issued it with an administrative order in July website (https://bit.ly/330kf5h). In relation Sending of 2008 to improve its claims administration, to life insurance claims, Dai-ichi uses Delivery leaflets etc after finding numerous shortcomings direct data feeds from a range of different including underpayments and poor sources in Japan, filters them through its advice to customers regarding their ability own systems and generally pays out to Collaboration on to claim. To its credit, the subsequent the insured’s beneficiaries or estate before 3 delivery status investments Dai-ichi has made in its claims they even make a claim. Furthermore, payment processes and in educating Dai-ichi has created a partnership with its staff has now made it a leading Yamato Transport Co., Ltd. Originally it was 4 global example on how to get claims to meet proceeds of crime regulations, Customer service provided when necessary administration right. by verifying customers identities, however it also enables Dai-ichi to check on the For Australian life insurance and financial welfare of elderly residents via Yamato’s advice businesses, who received severe delivery services. criticism during the FSRC for charging dead people, Dai-ichi makes a useful case study Graphic source: Dai-ichi Life, https://bit.ly/330kf5h, accessed 25 January 2019 on how to improve claims administration.
MinterEllison 55 Personalised offerings using artificial intelligence and machine learning
Growing amounts of customer data Banks have also been getting more Figure 20 – Most valuable attributes of a bank (survey findings) are enabling greater personalisation of personal regarding fraud detection. financial services. Software used by banks and other credit providers builds customer profiles and Most Valuable Attributes of a Bank It is now common for banks to use analyses each transaction. By comparing Internet banking service algorithms, similar to those used by online this data to past behaviour, banks can Mobile /tablet banking service retailers, to personalise cross selling via estimate whether a given transaction is phone, internet banking or mail offers. fraudulent. Low account fees Availability of other data sources, such as No ATM fees supermarket loyalty card data, provides Robo-advisors provide another avenue for Convenient ATM locations additional information which helps providing personalised financial advice to Competitive interest rates develop a more complete and refined the mass market in a cost effective manner. categorisation of individuals. These Robo-advice uses algorithms employing Ease accessing funds when travelling larger datasets are facilitating the use of personality questionnaires in order to Low international transaction fees AI and machine learning (ML) to derive conduct a needs and goals analysis and Innovative products & services and implement superior algorithms and recommend appropriate investments. Rewards program interfaces, such as for offering robo- 0% 20% 40% 60% 80% 100% advisors. Failure by financial services institutions to embrace developments in Extremely Important Very Important these technologies risks them being left just as custodians, with the ownership source: BPay Banter. of the customer relationship shifting to the providers of AI and ML algorithms and interfaces.
56 M&A Outlook: Australian Financial Services Towards 2030 Failure by financial services institutions to embrace developments in artificial intelligence and machine learning risks them being left just as custodians. Ownerships of the customer relationship would shift to the providers of algorithms and interfaces.”
MinterEllison 57 24/7 capabilities and availability through multichannel delivery and digital payments
Like many businesses, financial services are also using rewards and reduced cash transfers between accounts (subject The predominant forms of institutions sometimes struggle to keep premiums to encourage customers to use to some anti-money laundering (AML) banking transactions now up with evolving customer demands. digital interfaces to undertake and measure and counter-terrorism financing (CTF) occur via digital interfaces, The evolution of internet banking over healthy activities, such as physical exercise. restrictions). accounting for the past 20 years from, for example, slow websites accessible only via desktop Similarly, convenience created by digital The threat of competition (even through computers to portable apps featuring point-of-sale (POS) payment systems, customer benchmarking against other in real‑time facial recognition for smartphones especially the emergence of Tap and Go perceived leading sectors such as $3 every has been remarkable. It has been and Near Field Communications (NFC) online retailers, travel providers and accompanied by extraordinary growth technologies provided by Apple Pay and communications businesses) has kept in the number and value of transactions Google Wallet, are creating additional financial services institutions busy updating occurring via these digital interfaces. These pressures for financial institutions. For their POS and digital interfaces to be faster are now the predominant forms of banking example, Figure 22 highlights the large and easier to use and provide convenience increase in the use of Tap and Go for customers. Failure to keep up with $5 transaction, accounting for $3 in every $5 worth of transactions. This is also evident payments by CBA customers (from less these demand driven changes, provides of transactions in Figure 21, which highlights the steady than 1% to nearly 18% in four years). This an opening through which competition increase in the use of digital interfaces by highlights the demand for fast and effective can emerge. CBA’s customers (from 50% of transactions payments and reinforces the fact that in 2014 to 60% of transactions in the consumers are now carrying less cash. December 2018 half). Seeking to improve the timeliness of Other segments of the sector have also financial transfers, the RBA established seen advancements in 24/7 capabilities. For a real-time payments system. The New example, insurers encourage customers Payments Platform went live in 2018. The to immediately record information on first-generation technology platforms built potential claims through websites and on top of this system, such as PayID and mobile phone apps. Life and health insurers OSKO payments, allow real-time 24/7
58 M&A Outlook: Australian Financial Services Towards 2030 Figure 21 – The growth of transactions through digital interfaces, CBA (2014–2018) Figure 22 – Growth in reliance of tap and pay transactions CBA customers (2014–2018)
Digital Transactions - CBA Customers Tap & Pay - CBA Customers % of total transactions - by value* Volume of transactions*
60 18
16 58 14
56 12
10 54 8
52 6
4 50 2
48 0 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18
*Digital transactions include transfers and BPAY payments made in the CommBank app and via NetBank *Volume of Tap & Pay transactions for each six month period (includes HCE, Paytag and Tokenisation).
Source: CBA Source: CBA
MinterEllison 59 Legacy systems
Most of Australia’s financial services Successful post-M&A system integration Figure 23 – Examples of challenges faced by ageing legacy technology systems institutions continue to operate using the can be a significant differentiator of same core banking systems, that emerged efficiency and productivity. In contrast, the in the 1970s. While legacy systems have complexity introduced by lack of, or poor, Batch Account- Obsolete Inflexible and Diculty processing as centric as generally been effective in the past, Figure system integration, can lead to significant programming unscalable integrating opposed to opposed to 23 highlights a critical need to make operational expenses. languages systems with new real-time customer- systems transformative changes to IT infrastructure processing centric and operations just to remain competitive. The result of this scenario is that significant budgets, expectations and burdens are This is due to recent and significant Challenges of legacy banking systems improvements to technology, performance, being assigned to IT teams to maintain trust and data use, coupled with growing competitive advantage and avoid market customer requirements for on-demand and share erosion from the customer-rich flexible access to services in real time and experiences offered by innovative and agile Figure 24 – The top priorities of global bank executives up to 2020 the rise of agile competitors. fintechs and bigtech.
Similarly, as highlighted in Figure 24, some Responding to regulatory requirements senior global bank executives expect that in the near term banks will focus Ring-fencing retail operations on shifting customers from physical to digital interaction, as well as using Cutting costs / improving margins on retail & business lines technology to cut costs and improve Better customer segmentation margins, while delivering better customer segmentation experience and meeting Shifting customer usage from physical to digital regulatory requirements. Responding to anti-globalisation sentiments
Integration of front & back o ce systems
0% 20% 40% 60%
source: temenos, EIU.
60 M&A Outlook: Australian Financial Services Towards 2030 MinterEllison 61 Legal issues arising from poor legacy systems
While internal budgets for upgrading legacy enhanced AML and CTF requirements. (c) the 'no worse off' requirement for life (e) financial services companies also systems may be set based on operational However, legacy systems are insurance feature upgrades has led to face the regulatory constraint of not objectives, there are also a diverse range making it more difficult to fulfil these cohorts of legacy or acquired policies being able to develop processes via an of complex legal issues associated with requirements, as evidenced by CBA’s where some aspect of a change has iterative fast-fail approach (i.e. make legacy systems that financial services $700 million penalty from AUSTRAC for violated this requirement. This means mistakes) embraced by technology institutions need to grapple with. This regulatory reporting failures, stemming legacy systems are kept running to companies for customer products is often because of these operational from a coding error when updating support these legacy policies, creating and systems, given their prudential objectives. Legacy systems typically hold its ATM fleet, which resulted in it operational inefficiencies. Insurers may requirements and the loss of public longstanding customer information on failing to report over 53,506 threshold be better off asking a court to rule trust due to misbehaviour revealed by superseded products or information from transaction reports and properly that policy changes do not violate this the FSRC; and acquired institutions. The FSRC and other monitor 778,370 accounts. At the time requirement, to maintain scale and (f) the introduction of Open Banking, recent regulatory actions have highlighted of writing, AUSTRAC had just alleged product administration efficiency; presents numerous corporate some of the dangers of prioritising that Westpac had breached AMI and (d) a variation of legacy policy tranches governance and privacy challenges operational and financial objectives (and CTF rules on more than 23 million emerged during the FSRC, where some for existing institutions that will need systems) ahead of regulatory, compliance occasions; financial services institutions were not to meet forthcoming open data and customer relationship needs. These (b) some intitutions have failed to keep improving investment product offerings requirements. changes include: legacy or acquired products compliant for existing customers, but instead (a) some institutions have failed to keep with legislative and regulatory reforms, launching new products for new The appetite of financial services customer records up to date where sometimes through an inability to customers, to maintain existing product institutions for investing in regulatory and legacy or acquired systems are modify algorithms and processes profitability. This behaviour came under customer systems will increase in the wake incompletely integrated into other CRM coded in obsolete programming heavy criticism at the FSRC, given tax of the FSRC Final Report. The technology systems (i.e. lost customers). This may languages. This is due to the people considerations act as a disincentive investments involved will likely cost billions have contributed to the charging of familiar with these languages having for switching from superseded of dollars and take years, but should dead customers revealed by the FSRC. all retired, or in code that has been investment products, raising legitimate mitigate the risks or prevent a recurrence of The regulatory risks of failing to keep lost following corporate activity, legal questions as to whether trustees the circumstances which led to the FSRC. CRM systems up to date in real time which may have contributed to were acting in the best interests of the is growing as 'know your customer' overcharging customers; trust members; requirements increase in response to
62 M&A Outlook: Australian Financial Services Towards 2030 Financial reporting
The most popular way for banks operating Financial services in a legacy environment to achieve digital core transformation is to adopt core institutions' appetite banking platforms that are already built for investing in on modern technology. This method of transformation remains a pain point, as it is regulatory and a large undertaking that creates a multitude customer systems of risks that would otherwise be minimised, given many layered systems have been will increase in designed around financial controls that need to be updated. the wake of the FSRC final report. Such a complex operation may take years and is also extremely expensive. The technology As this process is often longer than CEO investments will likely (or board member) tenures, CEOs and boards also often lack the appetite to cost billions of dollars make such investments as they will not and take years, but benefit from these investments during their tenure. Hence the high rate of failure, with should mitigate the McKinsey suggesting less than 30% of first- risks of recurrence of generation Core Banking Systems (CBS) replacements having succeeded. the circumstances that led to the Royal Commission."
MinterEllison 63 Regulatory reporting aided by regtech
Historical financial reporting has had Regtech, a segment of fintech, is the most management attention and supporting financial services institutions subsequently it has also been the area to overhaul their regulatory reporting where the technology has focused on. processes to increase efficiencies. Since the FSRC, there has been a view ASX listed Kyckr is one such regtech that financial intuitions need to bring their organisation assisting major multinational regulatory systems up to the same standard banks. It specialises in real-time 'know your as financial information systems. customer' information on businesses, using real-time feeds from government company Some regulatory reporting is based on registries. manual processes, done via spreadsheet, which are prone to errors and omissions, Major Australian financial institutions rather than with formal automated (and including ANZ, Westpac, NAB and IAG audited) systems used to aggregate, are corporate partners of fintech startup process and report the data. Sometimes hubs such as Stone and Chalk. One of spreadsheets are used because they the benefits of being a corporate partner are a quick fix for fulfilling regulatory is that it allows these large institutions to requirements pending a more permanent identify regtech offerings that will enhance response. or supersede their current regulatory reporting processes. It also helps them to However, updates to automated systems identify other fintechs of interest, that they can also lead to errors and omissions, as might like to secure a strategic interest CBA was unfortunate to experience with in, or potentially acquire. They can show its intelligent deposit ATM machines. It their interest in these fintech businesses took two years to fix a coding error, which by participating in the fintech’s funding meant that CBA failed to comply with rounds, or undertaking some other form of AML and CTF laws during this time. This partnering. then leads to an array of questions around corporate governance.
64 M&A Outlook: Australian Financial Services Towards 2030 International drivers in technology
The rapid pace of technological change Making effective over recent years has the potential to usher in a new phase of financial globalisation, use of technology's with benefits for investors and consumers potential will require across the world. For governments and regulators, however, making effective use a new wave of global of technology's potential will require a policy coordination. new wave of global policy coordination, meaning that regulatory frameworks will Regulatory need to be internationally coordinated and upgraded. frameworks will need to be internationally The way in which these regulations come about is set to evolve. What has already coordinated and become apparent is that globally aligned upgraded." standards, data templates, protocols, conduct-of-business and anti-fraud rules are necessary.
MinterEllison 65 Coding error and Australia’s largest ever civil penalty
CBA takes its regulatory obligations AUSTRAC alleged CBA’s IDMs could accept extremely seriously and prior to agreed up to 200 notes per deposit, or up to breaches of AML and CTF laws suggested $20,000 per cash transaction, with no limit it had invested 'more than $230 million in to the number of transactions made per anti-money laundering compliance and day. It accused CBA of not assessing the reporting processes and systems. risk of the machines being used for money laundering or counter-terrorism financing. Despite this sizeable technology and CBA suggested that the failure of its IDMs compliance investment, CBA and AUSTRAC to report transactions above the reporting agreed to a $700 million penalty – the threshold was due to a coding error, which largest ever civil penalty in Australian AUSTRAC suggests took two years to corporate history – to resolve Federal Court fix after the error’s discovery. AUSTRAC proceedings relating to serious breaches claimed action was not taken prior to of anti-money laundering and counter- rolling out the machines nor once they terrorism financing (AML/CTF) laws. were in use and even allegedly when law Used overseas by leading global banks prior enforcement raised “significant instances to their deployment by CBA in May 2012, of money laundering” occurring through intelligent deposit machines (IDMs) are a the IDMs. AUSTRAC also alleges that after type of ATM that accepts cash and cheque CBA became aware of suspected money deposits and credits them 'instantly' to the laundering, it failed to report suspicious recipient’s account, which can be located matters and did not monitor customers for domestically or internationally. IDMs are money laundering risk. faster, more efficient (removing staff from CBA has since limited the size of deposits at the process) and more convenient than its IDMs and restricted the ability to deposit the envelope deposit ATMs that many funds at its IDMs into CBA accounts only. IDMs replaced. These actions go a long way to preventing further recurrences of its ATM problems.
66 M&A Outlook: Australian Financial Services Towards 2030 Coding error and Australia’s Are branch networks largest ever civil penalty now legacy systems?
With the increase in digital payments, the However, falling numbers of branches Figure 25: Australian branch numbers FY13–1H18: WBC had the largest branch cut since volume of transactions occurring in bank present problems for sections of banks' FY13, although all major banks are reducing branches BEN is the only bank with rising branches is declining. Banks have taken customer bases including: branch numbers. notice, and branch numbers are now (a) regional, rural and remote customers, declining too. Operating a large branch where the distance to the nearest footprint is an expensive proposition, branch becomes unreasonable (a focus 1400 1,292 1,292 due to the cost of both the real estate of some of FSRC case studies); 1,282 1,201 1,201
1200 1,166 and headcount involved. Increasingly, 1,150 1,147 1,131 (b) older and disabled customers who are 1,121 1,085 1,085 1,082 1,082
challenger banking institutions are seeking 1,046 unable to use or uncomfortable with 1,025 to compete digitally rather than building 1000 digital payment technology (a subject 863 out a branch network, where the costs 853 828 820 796 784
of complaints to the Disability Anti- 770 774 774
800 751
of customer acquisition and service are 724
Discrimination Commissioner); and 684 a fraction of those through a broker 658 600 546 (c) young customers, such as those aged 544
or branch. 527 523 512 under 14, who need to obtain their 489 With banks facing an outlook of slower parent's or guardian’s permission to 400 270
revenue growth and increased regulatory 252 use digital payment systems (apps 234 211 190 180 200 182 scrutiny (and compliance spending), the 152 and cards) – something hard to obtain 129 need for expensive branch networks are efficiently electronically. being reassessed and optimised. Many 0 urban branches are being closed with Anti-discrimination laws exist to ensure CBA WBC NAB ANZ BEN BOQ SUN little customer complaint, due to the that segments of the population are not 2013 2014 2015 2016 2017 1H18 low frequency with which customers discriminated against. Some disability now use branches given the digital advocates have achieved favourable court alternative available. decisions against banks with some banks' offerings found to breach discrimination Note: CBA, BEN and SUN are showing FY18 figures, not 1H18. WBC’s FY14–16 branch reductions were driven by in-store kiosks being closed. NAB’s reported branches include some business banking centres. legislation. It is possible that further legal ANZ FY13–14 numbers estimated via APRA branch data. cases could be run against banks where people may be able to argue that some source: Company data, Morgan Stanley Research, APRA. branch closures are discriminatory.
MinterEllison 67 Part E Conclusions and key contacts 68 M&A Outlook: Australian Financial Services Towards 2030 Towards 2030 – M&A will be an important mechanism for boards and management
While much of the focus in the last year The FSRC has shown that issues can no Combining these with existing financial While the short term has been on the FInancial Services Royal longer be dismissed as non-systemic, services headwinds such as low interest Commision (FSRC), we believe that there because if they are repeated or exploited rates, high household debt levels, falling impact of some of the are many other factors that may prove even frequently enough, they become a house prices, legacy systems and intense changes discussed in more important for the financial services systemic issue – from charging dead and innovative competition, the financial industry in the longer term. Some of these people to coding errors inadvertently services landscape over the next 10 years this report are more factors relate to issues highlighted by the facilitating money laundering. If these will change more rapidly than it has over foreseeable than FSRC including changes to governance, problems aren't nipped in the bud they the past 10. culture, remuneration, simplification become so large, that the easier solution is longer term impacts, and the need to reestablish trust. Other to separate the problematic division from Banks, insurers and other regulated factors include an increased focus on the the rest of the company. financial services businesses are legally the long term customer (assisted by the move to Open required to perform their regulated impacts are likely to Banking), technological changes along with A similar phenomenon occurs with functions correctly, with the FSRC likely increased competitive and commercial ignoring small, fast-growing segments ensuring this will remain a focus for create the greatest threats. The final report of the FSRC will act of markets. Eventually these segments management for some time. However, the need for M&A." as a catalyst for a transformation within the become so large that they can no longer IT industry has demonstrated that moving financial services sector. be ignored. What would have previously to minimum viable functionality, embracing been trivial bolt-on M&A to serve such a rapid failure and iterating rapidly allows for Bill Gates famously suggested that “most market is instead replaced by materially faster product development and evolution. people overestimate the change that strategic M&A to fill a key gap in the This places financial services at somewhat will occur in the next two years and company’s market offering. of a competitive disadvantage in innovating underestimate the change that will occur in new functionality. However, as long as the next ten”. While the short term impact A few regulatory changes will significantly financial services industry players are able of some of the changes discussed in this shape the Australian financial services to be fast followers, existing market share report are more foreseeable than longer landscape in coming years. Namely, the and customer relationships should allow term impacts, the long term impacts are recommendations that arise from the them to largely safeguard their existing likely to create the greatest need for M&A. FSRC impact of Open Data legislation, and market positions. changes to banking capital requirements.
MinterEllison 69 Towards 2030 – M&A will be an important mechanism for boards and management (cont.)
In theory, the FSRC presents an opportunity growth is beckoning particularly in light A key element of change in the financial over the medium term for fintech of the likely continued tightening of credit services sector will be M&A as existing businesses to grab market share from from APRA regulated banks. companies look to transform themselves. traditional financial services providers. In They will do this by slimming down and the near term, this will probably not be There are steps that the banks need to take becoming more focused, expanding into realised given that banks dominate market to address the challenges highlighted in this areas promising higher growth, or acquiring share and that many fintechs are seeking report. This will inevitably involve trade-offs, or integrating with innovative fintechs to work with larger players, rather than with banks still pursuing growth as credit offering superior customer experiences, or directly compete. However, with fintechs potentially slows, and as they attempt to stronger regulatory compliance. currently only having about a 1% share deleverage their existing exposure while of the Australian consumer loan market, focusing on upgrading technology. the potential for them to experience solid
A key element of change in the financial services industry will be M&A. Existing companies will look to transform themselves– by slimming down and becoming more focused, expanding into areas promising higher growth or acquiring or integrating with innovative fintechs.”
70 M&A Outlook: Australian Financial Services Towards 2030 About us
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MinterEllison 71 Get in touch with us
Victoria Allen Rahoul Chowdry Partner Partner P: +61 2 9921 4567 P: +61 2 9921 8781 M: +61 434 565 615 M: +61 4 55 887 887 E: [email protected] E: [email protected]
Contributors and key contacts
Louella Stone Mark Standen Paul Schoff Anthony Borgese Harriet Eager Partner Partner Partner Partner Partner
Michael Lawson Donna Worthington Maged Girgis Geraldine Johns-Putra Glen Wellham Partner Partner Partner Partner Consultant
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