Cablegate: Council Agrees On Cross-Border Merger Directive:

This record is a partial extract of the original cable. The full text of the original cable is not available.





E.O. 12958: N/A
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

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

15. (U) POC: James Wallar, Treasury Representative, e-mail; tel. 49-(69)-7535-2431, fax 49-(69)-


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