Two pieces of legislation, which took effect on 1 January this year, were expected to galvanise the German M&A market. First came a change to Germany's tax laws.

This made the disposal of corporate assets a tax-free operation, enabling the country's complex web of industrial cross-holdings to be unwound, leaving its companies free to concentrate on core activities.

The second was the long-awaited Securities Acquisition and Takeover Act, which was widely expected to ease foreign companies' entry into the German market. Taken together, the two were expected to prompt a sharp upturn in corporate work.

"The majority of people thought there would be a huge M&A boom," says Oliver Felsenstein, deputy managing partner at Lovells' Frankfurt office. "That is part of the background as to why so many international firms moved into Germany."

Fast-forward to mid-2002 and things are not looking quite so rosy. The new takeover code hit some damaging hurdles on its way into law. While the code was passed in principle, important constraints on the use of 'poison pill' and 'white knight' defences had been scrapped under pressure from corporations and Germany's powerful trade union representatives.

The economy, too, has flagged. Germany's GDP grew by a dismal 0.6% in 2001, its worst performance in eight years, while M&A value for the second half of 2001 dipped to e60.7bn (£37.5bn).

The market for buying and selling assets was not looking so bright from either side. Unemployment is 4.3 million and rising and companies are looking to cut costs and tighten their belts. The main DAX30 index fell by 19.8% last year and the tech-heavy Neuer Markt is more than 90% off its peak.

The sale of cross-holdings is actually lower this year than before the new tax regime was established.
"One does not sell at a time when you think prices will go up," comments Wilhelm Haarmann, senior partner at Haarmann Hemmelrath.

"There are transactions waiting to happen, banks holding assets they are thinking about selling, but they have no need to do so at present."

And where once Frankfurt was threatening London as a financial centre, the city is now plagued with rumours of its banks and major corporates, including Germany's largest investment bank, Deutsche Bank, shifting their headquarters and financial operations to London.

Despite the bad news, Frankfurt's business community remains upbeat about the city's capacity to recover from the downturn. While the economic climate has postponed the effects of the new legislation, one factor is taking effect.

Under the new takeover law, majority shareholders in a company now have the right to buy out minority shareholders – the so-called 'squeeze-out procedure' – making it harder for those minorities to scupper a takeover against the wishes of the majority.

"One thing that is very important and which has triggered a lot of work is the 'squeeze out' option," says Dr Michael Lappe, a corporate and M&A partner at Linklaters Oppenhoff & Raedler in Frankfurt.

"This offers 95% of shareholders the possibility to get rid of minority shareholders by paying them money, whereas previously they could only be bought out by shares. These transactions are now taking place everywhere."

Most people are also optimistic about the longer-term prospects for M&A. While current economic
conditions may not favour a rush of deals, the fundamentals of a fixed takeover code and favourable tax conditions are now in place to encourage increased activity when the recovery does come.

And despite the damage to public confidence since the stock market slump, lawyers in Germany's financial capital remain optimistic that an 'equity culture' will eventually establish itself.

Traditionally, investment in the stock market has not been popular in Germany, with many companies remaining in private hands. In addition, legislation limited the investment that pension funds, key investors in the UK and US markets, could make in the stock market.

Last year, however, Germany launched its first public pensions fund vehicle and followed it with the introduction of tax breaks for investment in private pensions. Both measures were designed to increase pension fund investment in the stock market.

"Until recently most of Germany's occupational pensions were funded on the balance sheet and only a very small part of the fund was invested," says Christoph von Teichman, managing partner of Latham & Watkins' German practice. "That might now change.

Legislative changes have made equity investment more and more attractive for pension funds and they now have a greatly increased ability to invest."

Meanwhile, the collapse of the Neuer Markt, Germany's answer to the Nasdaq, has thrown up a wealth of restructuring work, as companies restructure to improve liquidity.

"In the past we had a big M&A business," says Andreas Voightlander-Tetzner of PwC Veltins. "Now we are finding we have a lot of corporate restructuring work coming in, which is more or less done by the same people. We do not have so much M&A business."

But now there is another cloud on the horizon. Edmund Stoiber, the main challenger to Chancellor Gerhard Schroeder in September's election, has threatened to reverse the tax reform programme, complaining that it is effectively a tax break that benefits big companies over the German mittelstand.

Germany's M&A boom could be over before it has even begun. This is an edited version of an article that first appeared in Legal Week's sister title Legal Week Global. For subscription enquiries, call Ben Martin on 020 7566 5627 or e-mail: [email protected].