The Impact of M&A on Software License Agreements in Financial Services

Mergers and acquisitions (M&A) in any sector of business can be a prolonged, complicated and expensive process.  M&A transfers or consolidates ownership or operating units with another company or business unit to achieve growth for market share, geographical expansion, intellectual property and/or product/market diversification.

In PWC’s 2024 Outlook – Global M&A Trends in Financial Services (Jan 2024), it predicted that, “The challenging market environment creates a strong headwind for market participants to consider M&A transactions.” Indeed, the author of that report, Christopher Sur (Global Financial Services Deals Leader, Partner, PwC Germany) went on to state, “… I firmly believe that now is the time – when others may be hesitating – to take advantage through acquisitions or disposals in order to solidify future positioning.”

Financial Services is a heavily regulated sector across all geographies. It’s therefore incumbent on financial institutions to have a robust process to identify, assess and mitigate risk under various regulatory frameworks and supervisory letters.

• Continuity of services ensures that critical software and applications can be seamlessly integrated and transitioned as part of the M&A process to maintain business operations and avoid disruptions
• Regulations such as the FCA Handbook, PRA Rulebook, and various EU directives (e.g. GDPR, DORA) impose strict requirements around the management and control of software assets and acquiring entities need to thoroughly understand the software landscape of the target company to avoid unnecessary costs
• The FCA Handbook, and in particular the Senior Management Arrangements (SMCR & SMF), Systems and Controls (SYSC8 & SYSC 14) requires firms to have robust processes for managing their software assets, including maintaining accurate records and ensuring appropriate licensing
• The PRA Rulebook has similar requirements around operational resilience, with firms expected to have effective controls and governance over their technology assets including critical third parties through Audit rights and independent audit reports e.g. ISAE300 or SOC1/2/3

With an increase in M&A activity forecast for 2024 in the Financial Services sector, it’s imperative that financial institutions have a firm grasp on the processes and requirements they must follow to minimise non-compliance risk.

Let’s examine the license and contractual challenges that could either be unintentionally overlooked, or indeed misunderstood, when financial institutions enter merger and acquisition discussions, and how an independent view of software contracts could help avoid additional (and often unbudgeted) cost and business disruption.

Until you know what your contract contains, it’s very difficult to begin to understand the impact M&A will have and what options are available to you. Due diligence in the M&A planning stages should include close examination of your software license policies and our recommendation would be for an independent third-party expert, such as Version 1, to provide advice and guidance in this area.

The impact of not understanding your license entitlement during M&A can be substantial:

• If software licenses are granted to a company that’s then acquired (merged or divested), those licenses may not automatically apply to the new parent organisation, entity or business unit
• A financial institution using potentially thousands of seats of software for which they do not possess a license grant will create a substantial non-compliance breach potentially costing millions to remedy
• Failure to effectively identify, assess and mitigate the risk related to software licenses and entitlements can lead to significant regulatory fines and penalties – none of which would be welcome in the current economic climate
• This unwelcome and unbudgeted bill could adversely impact the M&A business case affecting shareholder value and the new business’s bottom line
• Reputational damage to your business is also a risk if news of a substantial license non-compliance discovery hits the media. These can become very public as illustrated with this example here (press release here) with another example in the news here including the unavoidable social media attention when banking related failures hit customers
• Not only would that cause embarrassment to the business, its board members and those responsible for the M&A project, but could also negatively impact shareholder value and customer sentiment and retention

From a software vendor’s perspective, a merger or acquisition (or indeed any structural change) is a trigger – an opportunity for the vendor to approach you for a conversation. They are within their rights to examine whether their software is appropriately licensed within the new structure, and they will not hesitate to audit any business that they suspect has contravened their compliance policies.

They will be very keen to understand the new entity structure, how this relates to your existing entitlement posture and what, if any, remediation is necessary to cover any license gaps. If non-compliance is found during an audit resulting from M&A, the penalties can be punitive and, unfortunately, negotiating on the back foot is not a strong position to be in.