Before last November, Lloyds TSB bank had been eyeing Abbey National for a few years without making any concerted effort to capture the converted building society. When Abbey began merger talks with the Bank of Scotland, however, Lloyds interpreted this as open season on the former mutual.
Abbey did not particularly like the terms Lloyds put on the table, and following what some called a “regulatory defence”, was rescued by a sensational decision from the Competition Commission. When on 10 July the regulator's decision was endorsed by Patricia Hewitt, the Secretary of State for Trade and Industry, the effects reverberated across the UK's banking sector.
Lloyds emerged from the early-1990s recession years relatively unscathed, with far fewer bad debts than many of its competitors. This left it well placed to take a predatory position in the banking market, allowing it to buy up TSB and Cheltenham & Gloucester. Along with HSBC, Barclays and NatWest/Royal Bank of Scotland, it forms the big four which dominate UK banking. By 2000, though, Lloyds needed another cost-saving merger to maintain its earnings momentum, but targets were few and far between. Meanwhile, Abbey was courting the Bank of Scotland in merger talks. Lloyds liked the look of the Abbey price-tag, felt that the former building society would be a good fit, and so decided to pounce.
Lloyds Bank is a long-term client of Linklaters & Alliance, but when it went to talk to the firm about Abbey, Linklaters declined to act, citing a conflict of interest. The firm will not say what the conflict was, but it seems likely that another Linklaters client already had its own designs on Abbey. Rumour has it that this could have been the National Australian Bank, which already owned Yorkshire Bank, attempting to expand its empire. At this stage, head of legal at Lloyds Jeffrey Johnson decided to try Clifford Chance on for size. The firm assembled a team consisting of Jim Wheaton and Chris Bright in the hope of steering Lloyds through the merger.
“There was significant operational risk in two organisations merging that compete head-to-head in the UK financial services market”
Mark Payne, Abbey National
Meanwhile at Abbey, there were no such problems. The bank is a longstanding client of Slaughter and May, which had been advising it on competition issues from November, when Abbey was discussing the Bank of Scotland merger. In the first two weeks of December, Lloyds put three offers in front of Abbey, during which time negotiations between Abbey and the Bank of Scotland were still ongoing. The first two offers were rejected fairly quickly, but, undeterred, Lloyds came back with a final proposal to Abbey shareholders of 260p cash and 1.5 new shares in Lloyds TSB for each Abbey National share. This was preconditional upon regulatory approval and unequivocal support from the Abbey board for the merger.
The Slaughters competition team, led by Bertrand Louveaux, and the corporate team, headed by senior partner Tim Clark, became involved from November onwards. While the Abbey board was considering the commercial viability of the deal, Lloyds ploughed on and notified the proposed merger to the Office of Fair Trading (OFT). At this stage, Abbey asked for an assessment on regulatory risk. According to Louveaux, who was heading a major Slaughters competition team for the first time, the firm advised Abbey that “there were very significant regulatory risks”, and that “the merger would very probably be referred, and if so, prohibited”.
Louveaux says that Slaughters had a meeting with Clifford Chance, at which he felt the Lloyds lawyers “did not properly address our regulatory concerns”. He says that Clifford Chance advised their clients that the merger would probably not be referred to the Competition Commission. Clifford Chance would not comment on the case, but if the firm believed the merger would not be referred, it was certainly not alone. In retrospect, Louveaux does appear to have had a hotline to the competition gods, but at the time most commentators believed that there would be no insoluble regulatory issues. As Louveaux says, received wisdom pointed in the opposite direction, with Slaughters giving “fairly controversial advice, because most analysts were suggesting that it wouldn't be referred”.
On 23 February, Louveaux's view was borne out as the Director General of Fair Trading made the decision to refer the possible merger to the Competition Commission for consideration. At this stage, Lloyds decided to turn back to Linklaters for advice. Whatever conflict the firm had before, it had clearly been resolved by this point, and a team headed by Bill Allan and Michael Cutting prepared to do battle with the regulator. In a very unusual move, Clifford Chance stayed on the deal in some capacity, although it is unclear exactly where each firm's responsibilities lay. All that Allan and Cutting would say was: “Clifford Chance handled the OFT process – we weren't involved. We handled the Competition Commission process, with Clifford Chance commenting on documents until the end of March.”
On the commercial front, the Abbey board decided not to recommend Lloyds' offer on 7 February. “Essentially, there were two reasons for this,” says finance director Mark Payne. “Primarily, the offer represented insufficient value for shareholders, but also there was significant operational risk in two organisations merging that compete head-to-head in the UK financial services market.” Once shareholder value and synergy were considered, says Payne, “regulatory risk was a secondary issue, but it had a lot of weight in this case”.
For Abbey, the Lloyds bid eventually signalled the end of the chances of a tie-up with the Bank of Scotland. Some commentators have criticised the Abbey board, saying that the Bank of Scotland deal foundered on the rocks of management ambition and a scramble for places in the merged entity, not to mention bickering over minutiae such as the location of the new head office. Abbey, however, says that it ultimately had to pull out because of the uncertainty created by the Lloyds bid. On 28 February, the bank officially terminated discussions with the Bank of Scotland, which according to Payne primarily “broke down because Lloyds had appeared and publicly threatened Abbey”.
The Competition Commission's regulatory process rumbled on throughout the spring. Critics complained in the press that Abbey ran a regulatory defence to the Lloyds offer, but this is something strongly denied by Slaughters. “We had to decide how to respond to the Competition Commission,” says Louveaux. “It was quite a difficult call, because it was seen as inappropriate for Abbey to do any lobbying.” He defends the stance taken by his firm, saying: “The Competition Commission is there to reach a judgment on all the facts, so you have a duty to put the case truthfully.”
The regulator sent Abbey and Lloyds detailed questionnaires and both banks had to attend two private hearings apiece, which Louveaux describes as “quite arduous. The Competition Commission probes and questions everything you say very thoroughly.” For the first time in the case of a commercial merger, the regulator also conducted a public hearing. Broadcasted over the internet, the open hearing was pioneered by the commissioner in charge of the inquiry Denise Kingsmill.
Jokingly referred to by some lawyers as 'Denise's kangaroo court', the hearing was seen as a public relations exercise rather than as a key part of the legal investigation. There is no doubt, though, that the regulator considered the open hearing as important and that we may well see more of them in the future. Kingsmill said it formed “part of our commitment to transparency. It was designed to hear the widest possible range of views and encourage as many people to participate as possible.”
Kingsmill largely managed to keep the lid on moaning members of the public, announcing at the start of the meeting: “I'm going to rule out of order any interventions that I think constitute whinges or grizzles or complaints about banking services.” Even so, a Dr Thaker managed to get in a few words about “a catalogue of mistakes, a catalogue of inefficiencies and a catalogue of lies from the higher management”, which he claims he had experienced in his 13 years as a customer of Lloyds. Other than that, comments were largely from consumer groups and City analysts, who held very mixed views on the merger.
A bigger problem for Lloyds than Dr Thaker's bank accounts were certain details in their own internal documents which were called in by the Competition Commission. In the regulator's report, where Lloyds and Abbey go by the codenames of 'Thomas' and 'Fish', there are quotes from Lloyds' papers which are, at the very least, highly embarrassing for the bank. The report quotes a Lloyds strategy document from September 2000 that admits: “So far, customers remain relatively price-insensitive for core banking services (ie current accounts).” The report also mentions a Lloyds paper on the planned Abbey bid, which boasts that after the merger, the bank would be “virtually unassailable in UK financial retail services”.
Allan and Cutting from Linklaters play down the importance of such disclosures, saying: “The Competition Commission agreed with the Director General of Fair Trading's analysis, reached without reference to the documents.”
Certainly, though, they could not have helped the bank's case, as surely Lloyds' admission that “the benefits of the cost savings and revenue increases which were expected to accrue to shareholders” did not either. Louveaux agrees that the Lloyds papers were embarrassing, but warns that “there is always a danger that, if you're the party in the driving seat, an employee who wants to impress senior colleagues will come out with bullish statements on merger strategy. Those documents can be dangerous later if you come in front of the Competition Commission.” He also concedes: “I don't think they swung the decision one way or the other, but they were not helpful, because it's important to maintain credibility.”
Although the Lloyds papers provided attractive press fodder, behind them sits a complex report by the regulator that extends to more than 200 pages. In its assessment of the personal current account and small and medium-sized business account market, the regulator just did not feel that it could risk the Lloyds-Abbey merger. The level of switching or transfer between banks in the personal account market is very low, something borne out by Lloyds' own paper, which states: “Customer inertia for banks has been high.” Louveaux believes that, because the Competition Commission was so concerned about the existing level of competition between the big four, there was little that Lloyds could ever have come up with in terms of benefits to counteract this core problem. Although another idea bandied about is that the merger was just slightly ahead of its time, because in a few years there may be enough competition offered by new competitors, such as internet banks in the personal current account market, to make such a tie-up acceptable to the regulator.
What almost everyone involved who spoke to The Lawyer agreed on, was that it will now be very difficult for any of the big four to acquire a significant competitor. The major players might also take a further hit this autumn if the regulator takes a tough line with its report on competition in the small and medium-size enterprise business account market.
For Abbey and its advisers, the decision was a triumph that even the loss of the Bank of Scotland merger to Halifax Building Society could mute. Mark Payne of Abbey claims that there are no regrets. “You don't drive a car by looking through the rear-view mirror,” he says. He believes Abbey's future lies in both organic growth and acquisitions, but that whichever path it takes, it seems safe from UK predators.
Lloyds, on the other hand, must surely look abroad. The bank has lost the chance to become a UK national champion and must now venture abroad without first further consolidating its UK business. Lloyds has a new Dutch chairman, who will surely be formulating a European strategy. Perhaps Linklaters should book tickets to Amsterdam for the bank's next acquisitive foray.
|The key players|
| Abbey National
Bertrand Louveaux headed the competition team. He has been at Slaughter and May since 1992, becoming a partner this year. He graduated in economics from the London School of Economics and has acted on several high-profile cases for Slaughters. Some of the cases he has worked on include a Shell-Exxon joint venture, the British Steel-Hoogovens merger, the Rothmans-BAT merger and the proposed Lincoln-Charter acquisition. Malcolm Nicholson and Isabelle Taylor also worked on the competition side. The corporate side was led by Tim Clark. He has been senior partner at Slaughters since 1 May this year. Clark has been resident at Slaughters since 1974. He is in the corporate department and worked on the demutualisation of Abbey National in 1989. Frances Murphy, Roland Turnhill and William Underhill also worked on the corporate side.