Subcontractors, security, and audit and termination rights will require special consideration under forthcoming EBA outsourcing guidelines.
Recent growth in divestiture and carve-out deals in the M&A landscape, including the financial sector, has brought renewed focus to transitional services agreements (TSAs), which typically feature in such deals. TSAs can facilitate an M&A deal by allowing a seller to continue to provide services to the divested business for a period after closing, providing operational continuity while the parties seek to untangle joint operations and effect integration with the buyer or to establish the target as a stand-alone business.
In our view, deal teams are increasingly aware of both the challenges of structuring a successful TSA and the burdens on parties of relying on such agreements long term. Parties are seeking to address issues prior to closing, and if a TSA is unavoidable, to establish a clear action plan and timeline for executing the necessary steps to exit the TSA in a timely manner. However, as buyers and sellers look to create efficient TSAs, both sides should understand the potential impact of the European Banking Authority (EBA) Guidelines.
Applying EBA Outsourcing Guidelines to TSAs Brings New Challenges to Financial Institutions M&A
The EBA Guidelines on Outsourcing Arrangements (the Guidelines) raise challenges for TSAs in European financial services sector M&A deals. While deal teams are becoming increasingly savvy as to the importance of separation and transition planning, in our view, the Guidelines should feature in the M&A planning process, as they could give rise to some difficult negotiations.
The Guidelines, while not specifically targeting TSA arrangements, have brought challenges to recent financial services M&A deals, as parties seek to determine applicability to TSAs in general and to each deal’s unique circumstances. The Guidelines apply to all “outsourcings” by financial and payment institutions within scope and must be considered whenever a third party performs a service that would otherwise be performed by the financial or payment institution itself. Accordingly, a TSA will invariably be caught by this broad remit.
As providers of services under TSAs are not professional service providers — rather, they are entities seeking to sell a business — many sellers will struggle to comply. Non-compliance can give rise to regulatory investigations and fines. Parties must therefore consider the nature of services provided under the TSA in light of the Guidelines. Some TSAs, such as shorter-term arrangements for standard back-office services, will likely be lower risk. Other TSAs, particularly those involving performance of a regulated activity, including the outsourcing of “critical or important” functions, will bring additional compliance obligations. The Guidelines have yet to be fully market-tested, but we anticipate that institutions may opt to take a more intentional approach when applying the Guidelines to TSAs entered into as part of an M&A deal.
Significantly, the Guidelines do not address commercial aspects of agreements. There is nothing stopping a seller from putting a price on compliance with some of the more stringent requirements.
Dealing With Subcontractors
Buyers and sellers should work out early in the deal process which third-party arrangements can be wrapped up or replaced. The Guidelines require providers to seek consent before subcontracting and place obligations on providers (which are the sellers under TSAs) to flow down key terms, such as rights of audit. Sellers may need to seek the consent of existing outsourced service providers in order to on-provide the relevant services to the buyer. Buyers may require sellers to seek appropriate subcontractor flow-down rights as part of such discussions, but this requirement is a bigger ask that may incur additional costs that need to be factored into the commercial mechanics of M&A deals, and will likely be a harder point to negotiate with third parties.
Planning the TSA and the Exit
Forward-planning is key. It is never too early to identify the target business’ dependencies on the retained business and how, and when, migration from those dependencies will occur. Due diligence to anticipate issues that existing outsourcing arrangements may cause will also prove critical.
While parties may be tempted to seek to resolve issues earlier in the deal process to limit a TSA’s scope or duration, in practice, the nature of services typically required under a TSA in a financial services deal suggests that full commercial and operational transition at closing is likely impossible. Accordingly, M&A deal teams will need to work with legal counsel to navigate the new requirements.
EBA OUTSOURCING GUIDELINES QUICK GUIDE
The Guidelines came into force on 30 September 2019. Any outsourcing arrangements entered into, reviewed, or amended after that date must comply.
Among other measures, the Guidelines:
- Apply to outsourcing arrangements entered into by financial institutions, including credit institutions, investment firms, payment institutions, and electronic money institutions
- Replace the 2006 Committee of European Banking Supervisors Guidelines on Outsourcing, and replace and incorporate the EBA’s final recommendations on outsourcing to cloud service providers
- Require that institutions update all existing outsourcing arrangements by 31 December 2021
- Distinguish between outsourcing arrangements that relate to an institution’s “critical or important functions” and those that do not