Watch out: Federal Reserve Begins Systemic Reviews of Pending Acquisitions

At first blush, it might seem strange that the Federal Reserve would be scrutinizing Capital One Financial Corp.’s announced $9 billion acquisition of ING Groep NV’s U.S.-based online banking unit to gauge whether it poses a systemic risk to the financial system. Capital One focuses primarily on retail businesses including credit cards and branch banking, and the operation that it’s acquiring from Dutch banking giant ING is an Internet bank. And when most people think of activities that might entail some element of systemic risk, they probably think of large trading or derivative operations—not consumer banking. 

The Dodd-Frank Act now requires the Fed to review bank mergers to determine whether they pose a systemic risk, so to a certain extent, its review of the Capital One/ING deal might turn out to be a pro forma exercise. Brian F. Gardner, a senior vice president and Washington-based government affairs analyst for Keefe Bruyette & Woods Inc., points out that the combined entity would be “pretty plain vanilla. It won’t be derivatives intensive. It won’t be capital markets intensive.”

“I think [the Fed is] serious about systemic risk, but I don’t think this is a good test case for [the systemic review],” Gardner adds. “I think the deal will go through with few objections from the Fed.”

It will probably take some time before acquirers and their financial and legal advisors understand fully what the Fed is looking for when it does a systemic review of a pending acquisition. Bankers certainly understand the concept of systemic risk including size, inter-connectedness and counterparty risk, to name a few its elements. But as Gardner points out, “It’s a term of art, not a term of science. There’s no clear, bright line definition.”

A recent memo from Wachtell, Lipton, Rosen & Katz, a New York-based law firm with a large M&A practice, does shed some light on what the Fed will be looking at when it performs a systemic merger review. 

According to Wachtell, “(T)he Federal Reserve is focusing on the availability of substitute providers of critical financial services and the interconnectedness of the company post-acquisition and seeking information about each party’s involvement in providing numerous wholesale and institutional (and some consumer) financial services, including repo funding, prime brokerage, underwriting of equity or debt or asset-backed securities, clearing and settlement, asset custody, corporate trust, credit cards and mortgage servicing. The Federal Reserve is also seeking information about market shares and specific competitors in these markets, as well as the dollar volume of overlapping activities. In addition, they are requesting information about each party’s three highest positive and three highest negative counterparty exposures, including information about any collateral or hedges.”

These are some of the things the Fed will be looking at during its systemic reviews, but is there a formula or methodology it will use to decide that one acquisition poses no systemic threat while another one does? Gardner says that even if it does have a specific methodology in mind, he doesn’t expect the Fed to articulate it for the benefit of the M&A market. 

“That preserves as much flexibility for them as possible,” he says. And while that ambiguity leaves potential bank acquirers in large, complex transactions in the dark about what to expect, “Ambiguity is the ally of the regulator.”