US embassy cable - 04FRANKFURT10394

UNCLAS SECTION 01 OF 03 FRANKFURT 010394 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EUR PDAS, EB, EUR/AGS, AND EUR/ERA 
STATE PASS FEDERAL RESERVE BOARD 
STATE PASS NSC 
TREASURY ALSO FOR IMB, Monroe ICN COX, HULL 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EUN 
SUBJECT:  Council Agrees on Cross-Border Merger Directive: 
Another Step Toward EU Corporate Governance 
 
 
This cable is sensitive but unclassified.  Not/not for 
Internet distribution. 
 
1.  (SBU) Summary:  The European Council's agreement on the 
proposed directive on cross-border mergers concludes a 
nearly 20-year process.  The directive is to facilitate 
cross-border mergers of companies with share capital, 
particularly small and medium-sized enterprises that opt not 
to establish a Societas Europa (SE), a European Company. 
Key to the Council's adoption was a compromise on worker's 
participation rules which are broadly similar to the rules 
of an SE, albeit slightly less stringent.  Germany was the 
sole holdout for retaining the SE measures.  Commission 
officials are confident that the measure will move swiftly 
through Parliament. 
 
2.  (SBU) While agreement on the measure is a major 
accomplishment for the Commission, the measure may have 
little immediate effect.  By replicating the SE regime it 
broke no new legal ground and the legal issues it did 
address do not seem to impede cross-border mergers, an 
activity that is already robust.  However, like the SE and 
other measures that ensure free movement of capital in 
Europe, it adds to the EU legislation that increases 
competition among various forms of business organization 
that can take place not only among member states but also 
within member states.  These steps, indirectly, could lead 
to more business consolidation.  Risks that the measure 
could get stalled in Parliament are not negligible if the 
directive is perceived as an attack on Germany's worker's co- 
determination regime.  It would not be the first time 
Germany changed direction on a directive involving corporate 
governance once the measure was in Parliament. End Summary. 
 
Agreement on Cross-Border Mergers 
--------------------------------- 
 
3. (SBU) On November 25, the European Council reached 
agreement on the European Commission's proposed directive on 
cross-border mergers.  The proposed directive would require 
each company participating in the merger to be governed by 
the provisions of its national law on domestic mergers. 
However, common draft terms of the cross-border merger would 
be governed by the new directive, e.g. the name, form and 
registered office of the merging companies, and other 
details of the merger relating to the exchange or allotment 
of securities and application of new accounting rules.  The 
new directive would overcome legal problems in some member 
states where mergers are not legal, e.g. Netherlands, 
Sweden, Ireland, Greece, Germany, Finland, Denmark and 
Austria.  At present, to circumvent this legal obstacle, 
merging enterprises create a third entity that would be 
comprised of the two "merging" enterprises, a time-consuming 
and expensive operation. 
 
Long History 
------------ 
 
4.   (SBU) The Commission first proposed the directive in 
December 1984, but withdrew it in 2001.  The major sticking 
point was employees' participation rules that would be 
adopted by the merged firm.  As a recent European Parliament 
report put it, there was an "overriding fear concerning 
cross-border mergers that the process might be hijacked by 
companies which, faced with having to live with employee 
participation, might try to circumvent it by means of such a 
merger."  In 2001 the regulation and directive were adopted 
for a Statute for a European Company, the Societas Europa 
(SE).  An SE could be a wholly new company, but when created 
out of two merged firms, a special negotiation body is to be 
established to set the terms of employee participation. 
Failure of the body to agree in six months would result in 
adoption of the worker participation rules that apply to 25% 
or more of the total employees of the companies 
participating in the merger.  Generally, this would be terms 
most favorable to the employees. 
 
5.  (SBU) In November 2003 the Commission issued a new 
proposal on cross-border mergers incorporating by reference 
the SE solution on worker's participation.  Again the 
sticking point was employee participation.  This time most 
member states wanted to increase the threshold to 50%, 
increasing the possibility that participation rules less 
favorable to the employees would be adopted.  Germany 
resisted.   According to press reports, in German 
Parliamentary hearings on the directive, the German 
government declared the directive would not make it possible 
to "flee from German co-determination."  Germany, however, 
could not muster sufficient votes to retain the SE rules. 
 
6.  (SBU) The compromise is complex.  Basically, where the 
two merging firms have employee participation rules, the 
rules most favorable to the employees will be adopted. 
Where one of the merging entities has no employee 
participation rules a special negotiating body is 
established.  As in the case of an SE, failure to reach 
agreement in the negotiations would mean that employee 
participation rules that apply to at least 33% of the total 
workers in the merging companies would be adopted for the 
entire merged firm.  This is a slightly higher threshold 
than in the SE directive.  Falling under that threshold 
would imply that negotiations would have to produce an 
acceptable result for the merger to proceed.  A new element 
was added with respect to participation on the board. 
Again, if negotiations failed to produce an acceptable 
result, the number of employees represented on the board 
would be at least 33% of the total if, in one of the merging 
entities, employees had at least one-third of the board 
seats.  A German official called the compromise "fair" and 
something "right down the middle." 
 
 
On to Parliament 
---------------- 
 
7.   (SBU) The directive now goes to the Legal Affairs 
Committee of Parliament for consideration.  European 
Commission officials are confident that the legislation will 
move "smoothly" through the legislative process.  They point 
out that the lead manager in Committee for the legislation, 
Klaus-Heiner Lehne, is "on board" and will use the 
compromise produced by the Council.  The measure may pass in 
one reading in the spring, according to a Commission 
official. 
 
Comments: Parliamentary Risks, Broader Implications and a 
--------------------------------------------- ------------ 
Touch of Reality 
---------------- 
 
8.  (SBU) Risks that the directive may get stalled in 
Parliament are not negligible.  Mr. Lehne spearheaded the 
German Government's weakening of the Takeover Bids Directive 
after the German Presidency had secured agreement in Council 
on the measure.  While Parliament's initial report in April 
regarded the proposed directive as "positive and practical," 
it also stressed the need to reduce the risk of  "lower 
employee participation standards."  The Commission staff 
believes that the German Government has run the necessary 
traps to give them confidence there will be no repeat of the 
Takeover Bids saga.  Should the directive gain public 
notoriety as a perceived effort to weaken Germany's co- 
determination rules, the politics could change.  Few 
expected the German government to turn against the Takeover 
Directive that it had endorsed earlier. 
 
9.  (SBU) With respect to broader implications, the merger 
directive is another step toward easing rules for cross- 
border business formations and capital mobility within the 
EU.  One was that the SE created the ability for a business 
to establish in any member state using either a unitary 
board responsible for administration and supervision, as 
practiced in the UK, or a two-tier system, such as practiced 
in Germany, with separate management and supervisory boards. 
Another was by a European Court of Justice ruling, based on 
the freedom of capital movements, that held that member 
states have to recognize the legal form of a company 
incorporated in another member state even if not established 
under its own laws.  The Commission's planned proposed 
directive on transfer of seat (headquarters) will mark 
another step.  This measure, which the Commission hopes to 
submit early next year, is designed to allow firms to move 
their headquarters to another member state without requiring 
them to wind down their operations that would entail 
substantial tax and other costs. Under continental European 
law, the seat of a corporation is its legal headquarters as 
well as the place it conducts business. 
 
10.  (SBU) Easing firms' mobility and their choice of 
corporate governance rules suggests more competition among 
forms of business organization and regulation and, 
potentially, tax regimes.  Firms could establish in Germany, 
for example, with only one-tier board system and, 
conceivably, less employee participation than other German 
firms.  Alternatively, a German firm could merge with a firm 
in another EU state and operate under the corporate 
governance rules and tax regime of that other state but 
still have its major base of operation in Germany.  Whether 
such scenarios play out is an open question.  However, the 
possibility they could more readily take place may change 
perceived bargaining positions for new investment decisions. 
 
11.  (SBU) In reality, the merger directive is unlikely to 
spark an increase in cross-border M&A activity which is 
already robust.  According to the October 2004 Mergers and 
Acquisition Note of DG Ecofin, M&A activity in the EU 25 has 
ranged from around 9,000 operations in 1995, peaking at just 
over 15,000 in 2000, then settling back around the 8,000 
level in 2002 and 2003.  Throughout this period, cross- 
border M&A activity within the EU accounted for around 15% 
of the total number of operations. 
 
12.  (SBU) M&A activity is driven by other factors.  EC 
studies suggest that GDP size and financial variables (stock 
market capitalization, credit) and other institutional 
factors (free trade agreements, common language, supply of 
skilled labor) strongly influence M&A decisions.  An EC 
study published in September 2004 also suggests that M&A 
activity (a) is more robust in countries where investor 
protection is better (better institutions, less private 
ownership means a higher willingness to sell); and (b) is 
more likely to occur between companies with different levels 
of investor protection - firms with weaker governance 
targeted by those with stronger governance. 
 
What might these findings mean for cross-border M&A 
--------------------------------------------- ------ 
activity within the EU? 
----------------------- 
 
13.  (SBU) A 2000 DG Ecofin study on merger trends might 
provide some insights.  Using 1998-1999 data the study 
measured the relative intensity of EU cross-border merger 
activity by using the ratio of each country's share of the 
number of cross-border transactions to its share of EU GDP. 
The top scorers were Luxembourg, Ireland, Sweden, Finland, 
and the Netherlands followed by the UK, Belgium and Denmark. 
The lowest scorers were Italy, Greece and Germany. If the 
merger directive, the SE and other measures contribute to 
increased competition driven by M&A activity, firms located 
in the top scorers are likely to benefit and those with 
lower scores will find increased competition not only from 
corporate governance rules in other member states, but from 
new firms within its home territory. 
 
14.  (U) This report was coordinated with USEU and Embassy 
Berlin. 
 
15.  (U) POC: James Wallar, Treasury Representative, e-mail 
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)- 
7535-2238 
 
Bodde