How an arms quality gap is helping European financial consolidation

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Everyone likes to get more for less. For European bankers, the so-called Danish compromise is the gift that keeps on giving. The once transitional regulation, which dates back to Denmark’s 2012 EU presidency and grants capital benefits to banks that own insurance businesses, became permanent in EU law earlier this year.

With the bancassurance model blessed by regulatory overlords, the industry is reacting: take BNP Paribas’ €5.1bn acquisition of Axa Investment Managers in August. As the dust settles on the deal, it’s becoming increasingly clear just how powerful this regulatory fudge will be.

Careful readers will note that Axa IM is actually an asset manager, not an insurance company. The regulatory magic comes because BNP does the business through its insurer, BNP Paribas Cardif, where the business will then remain. The result is that the deal will eat up around €2bn of BNP’s Common Equity Tier 1 capital – 60% less than it would have if BNP had bought Axa IM outright.

This happy outcome is the result of an overlooked detail in the Danish Compromise, which allows banks to ignore goodwill in purchases through insurance units.

This detail amounts to a “plutonium enrichment” for the Danish Compromise, says Mediobanca’s Andrea Filtri, who claims it could trigger a series of new deals by European banks.

In fact, the goodwill taken over by BNP Cardif from Axa IM’s balance sheet is outside the regulatory boundary for consolidation. Banking regulations then consider the transaction as a non-bank equity investment. Axa’s existing goodwill is added to risk-weighted assets instead of being deducted from CET1 capital.

That looks like a boon for banks that can take advantage, which should include many of the biggest banks in France, Italy, Spain and the Nordics. For these bancassurers, acquisitions of tax-generating asset management businesses have become potentially lean transactions. This opens the door for a wave of mergers and acquisitions, given Europe’s fragmented asset management and insurance sector.

This is not regulatory oversight either. In implementing the new Basel rules, which are supposed to be stricter, the EU introduced this loophole. Banks are exposed to a greater risk that valuations will not live up to the prices paid and that the depreciation will come through core bank capital.

One conclusion is that EU policymakers have seen this as a risk worth taking if the new rules help promote what regulators really want: long-awaited cross-border consolidation of financial services.

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