What does the regulator expect from adviser acquisitions?

0:12Hi, and welcome to the FT Advisor podcast. I'm Chloe Chong. Today, we're going to be talking about the Financial Conduct Authority's consolidation review. Joining me to discuss is Mark Spears, a managing partner in the regulatory and compliance team at Acorion, and Donald Reid, who is a co-founder of Solve Partners, a wealth and investment management consultancy. So just to recap, the regulator announced this multi-firm review back in October 2024. A year later, they've published their findings. Mark, like with most reviews, the FCA found things that were good and things that need improving. Did anything in those findings stand out or surprise you?

0:57I think the surprise was how little surprise there was in it. We were talking about this earlier, and I think that the purpose of the review really was to find out what, if anything, was different about private equity as a shareholder and engine of consolidation within the industry. And I think it's safe to say that there wasn't a hell of a lot in there on the conduct side because the conduct piece is well known. So the concentration was around the debt structures and the resourcing and whether there was any sort of offshore link that the FCA or anybody else should be worried about. And really, I think it was pretty vanilla stuff, if I'm being honest.

1:54Donald, were you as unsurprised as Mark? I agree with Mark's view on this. Having said that, I think there are a couple of areas of concern that highlighted for me. So there was a comment around groups needed to ensure appropriate leadership and the right level of knowledge and expertise to deal with larger and complex issues. And I think this is a challenge throughout the wealth sector, particularly those firms who are acquiring and consolidating the capability that you need in an exec team to build a business that has assets of two, three billion and is then acquired is very different to the capability that you need to then take that business of two or three billion.

2:53billion and then grow it to, let's say, 20 billion over the next five years. And I think private equity in particular have sometimes struggled with that. I think what we've seen in more recent times is that as firms are acquired by private equity, we do then start to see changes in the leadership team being strengthened so that you've got the capability there to make sure you've got the right processes around risk and compliance, but also right processes around integration. But I think that is a challenge across the industry and that did come out in the paper. Yeah. Not just, I think, in the wealth space, it's a challenge across all fast-growing firms and I think that was something that the FCA did height around the nature of growth and what it means for governance and resourcing over that period.

3:55But it's not the first time that they've made that point in the financial services sector. They said it the same in digital banks as well. And so this is very much looking at how you can scale your systems and controls and stay appropriate to your size. And Mark, for an advisor who is thinking about selling, do you think these findings from the consolidation review can be used almost as a list of green and red flags in terms of what to look for in a consolidator? Yeah, I think, you know, if you're if you're thinking about selling a firm at the moment, some of the some of the pieces around ensuring that you have cultural alignment, I think that's super important.

4:41you can then think about how the acquisition and previous acquisitions because presumably you're not the first in in in this have been funded what the structures are like and whether you see anything that that are particular red flags in there the the piece around cultural alignment though I think is is is super important and I was you know really pleased to see that the FCA did highlight that. On the sort of the red flag side, I think if we think about the conflicts piece that was highlighted towards the end of the report, if there are incentives on offer, as attractive as they may be, they may not find much favour from the FCA.

5:33we've seen a few firms get into trouble in the last sort of year or 18 months over the incentives that they've offered advisors so I think there are things that you can take in that to sort of structure a decision around whether to go with one firm or another for sure. Yeah I think it's I think it serves as a very good guide but I think there are a number of other factors that an IFA should be considering in terms of selling to a potential consolidator. And I think the first thing is, you know, what are the drivers behind an IFA wanting to sell? Is that because the IFA is wanting to retire and crystallize some, you know, a lump sum, while there are other factors such as the burden of compliance, investment needed in systems and AI, or, you know, better proposition.

6:28And I think those IFAs who are only selling to realize the highest value in financial terms, that is often where deals fail. So I think the sale has to be done for the right reason. And the IFA needs to understand the expectations of the consolidator. and we did some research earlier this year and we're aware of a small number of consolidators out there that actually have a playbook so if you're going to be bought by that consolidator these are the terms that you will sign up to in terms of this is what's going to happen post deal around proposition around pricing and so on and that is an example of really good practice because it means that there are no surprises for the IFA when they do sale and they know what's going to happen post-completion.

7:29That's really important. Yeah. Mark, you mentioned cultural alignment. I think culture can be quite an intangible thing. So do you have any tips on how advisors can assess whether a consolidator's culture kind of matches their own firm? Yeah, I think it probably goes back to the strategy point that donald was making if there is a clear strategy with the consumer at the heart the customer at the heart um and um a a longer term vision of what the um firm is going to stand for in the market i think that is one of the key sort of cultural indicators the other ones around remuneration, how that's structured, what does it really incentivize?

8:16Is it incentivizing growth above everything else or does it include the customer in it as well? So that would be where I would look as a starter. I mean, if you are selling, obviously the purchaser is going to put their best face on as much as the seller is going to put their best face on so getting to the really the the core culture can be quite difficult in that sort of quite arm's length process. It's really really important because these are people businesses and ensuring that there is the right cultural fit before you sign a deal is absolutely critical. So understanding what the deal is going to look like post-completion, what it means for clients, and what it means in terms of client segmentation, proposition, pricing, operating model, all of those discussions should take place as part of the due diligence phase.

9:29And that needs to be the principles of the business being sold and the principles and shareholders of the acquirer. And I've seen many deals fail where that has not been properly ironed out or understood in advance. And the ultimate test is if you're an IFA and you're selling you don't want to be in a position post-completion that you have to cross the road because you see a client walking towards you so that is absolutely key and you need to be thinking about that as a potential seller right and Donald I know at Solve you work with firms when they're merging acquiring integrating and you've mentioned it a bit already but as well as the good things the FCA has highlighted in their review what else should sellers look for in a consolidator?

10:29We've covered some of this already but it's really around you know what is the operating model going to be you know post-sale what's going to be the impact for my clients. So there are several cases where smaller IFA sell and actually the client experience is enhanced in the larger firm because there's a leading edge client portal and clients can then communicate in a secure way with their advisors. That's not always the case where the clients are having to log on to platform portals. Enhanced compliance and an enhanced advice process can actually sometimes lead to better advice going forward.

11:22Better investment capability. There are still, we reckon, about 20 % of the IFAs are still running their own investment advice process. and that may have served them very well over the last few years as we've been broadly through a bull market but that could change and I think if we do go into a more of a market downturn then having access to an investment product is really important and increasingly consolidators are now starting to look at how they can partner up with global asset management firms to deliver that investment product. So those are some of the other things that IFAs should be thinking about as they're looking to a sale.

12:20Let's move on to the wider impact of the consolidation review. Mark, do you think the regulators' findings could affect how much consolidators and the firms they're buying are worth? I don't think in and of itself it will have a huge effect. I think what it does highlight though is some of the potential structural problems coming down the track. There are mid-40s of these consolidators out there in the UK, somewhere between 40 and 50 depending on how you want to think about it. They're not the only actors in this market. The wealth market is actually quite diverse. You have asset managers and universal banks, etc., active in the market.

13:11So if you think about whether it will affect the value of the firms, I'd say that that is not the driver. The driver is something wider. You see in the economy generally that the number of deals has generally declined over the last quarter or two. There are lots of different reasons for that. But that deal flow is not as strong as it was. Those 40 to 50 firms need to exit somewhere. and there are only a certain number of firms that could be potential purchasers if you take IPO off the table, which I think at the moment, you know, most people would agree it's pretty much off the table for most firms.

14:08Unless it's heavily discounted. Yes, it's heavily discounted. So it's a trade sale of some description or a merger between two of the 45 or so firms. Is that value directly affected by the FCA's report? No. Some of the bad potential red flags that they've highlighted would create a price chip in the process if a firm is particularly over leveraged or had gone down a path that the fca didn't like then obviously that would affect the value of any acquirer whether that is trade to an asset manager or a bank or whether that is a merger between two consolidators that mega consolidator piece so I think it's that wider value piece in this wealth management market rather than the FCA's findings in and of themselves I would agree with that I think good firms that are exhibiting best practice around governance, risk compliance and the other factor is organic growth those firms will always attract a premium uh which is probably worthwhile touching on organic growth because that's been incredibly challenging for wealth managers um over the last couple of years partly driven by the current challenging economic situation we're in changes to taxation slowdown in other corporate activity and it's often corporate activity that delivers lump sums to owner-managed businesses that then fuels organic growth for wealth managers.

16:08But that's been a massive challenge. And those firms that can exhibit some element of organic growth will always go for a good valuation. I think that the firms that are struggling and, you know, some firms have been quite open during the course of the last few months that they are looking for a buyer. It's interesting that there don't appear to be any deals associated with those firms that have actually been announced. But I think some firms are struggling at the moment. And I think buyers are much more focused on the due diligence process than they may have been, let's say, three or four years ago.

16:48Again, we sometimes characterize the period sort of 21 to 23, a little bit as the Wild West, where a number of firms are being acquired. And it was quite clear that the level of due diligence was quite limited. And some of those are now struggling. So I think there are a number of factors at play. But I don't think the FCA paper in its own will inform a change in valuation approach. And Donald, I was looking at some research that your firm did about consolidation in the wealth management sector, which I know you've brought a copy of you in the studio today. And you published your research before the FCA's review findings came out.

17:32In the report, you mentioned that more than 88%, so 9 in 10, known deals have been boosted by private equity money since 2021. Do you think the FCA's review will impact the level of private equity investment in the sector? I think the sector remains attractive to private equity. And that's because as a private equity investor, you're seeing a regular annuity income from investment management fees or ongoing advice fees. there is increased demand for advice as we work through changes in pension legislation pension consolidation the move away from db to dc we've also got intergenerational transfers advice around inheritance tax so one-off advice there is you know higher demand and also from a PE angle, they will be able to see opportunities for efficiency gains.

18:35So AI is a massive hot topic in the sector at the moment, particularly around financial planning support. And there are a number of new AI providers out there. And there's already evidence that implementing the right AI in the right way can deliver tangible benefits. So that again is an opportunity. So our view is that the sector remains attractive to private equity, but execution is absolutely key. So doing the right due diligence, and we're seeing that there is more control over that and due diligence is taking longer. Executing the deal in the right way with the right mixture of debt and equity is important but then also if you're going on a buy and build strategy and you're going to be doing several acquisitions thereafter making sure that you've got a senior individual who is accountable for integration so again in our report we highlighted that where there is a dedicated integration function then the financial objectives are far more likely to be met and i think the financial synergies were met in something like 80 percent of the cases where there's dedicated integration capability whereas if there wasn't that dropped to about 30 percent so making sure this dedicated integration capability is absolutely key as well as my earlier point around leadership so if you're buying and build you need to make sure that Your exec team grows as the business grows.

20:22Going back to one of the reasons why the FCA launched this review in the first place, in October last year, they mentioned there had been a rise in firms being acquired or their assets being acquired over the last two years. I mean, Mark, you mentioned about how the number of deals has declined in the last quarter or two. But do you think this review could end up slowing down that pace of consolidation in the sector even more? I think, you know, going back to the sort of previous answer about the wider economic background to this, I think the report highlights some drivers within that that might add some headwinds.

21:05um it's donald's point this is still a really attractive sector for um for people to be active in um we have the move from pretty much entirely defined benefit um pensions to almost entirely outside government service anyway divine contribution pensions over the next 20 years owning the ears and the eyes of those people who are owning those assets is going to be pretty key if you're going to be successful in the in financial services so that would indicate there's still a market for all of those services is there a market for ever larger providers of those services to individuals well i think you know there's a there's a um there's there's 40 to 50 uh consolidators you can see that there should be um uh an increasing market for larger players there um but is the deal flow going to massively accelerate um i think you know we had discussion about this i don't see that there's a that there's a wider economic piece of news on the on the horizon that's going to suddenly unblock um a pipeline of deals i think yeah i think i think buyers are going to be more cautious um i think we need to remember there are still over 5 000 firms authorized to provide investment advice in the UK.

22:50And a large number of those firms have less than 10 financial planners. And in many cases, the leading principals are of an age that they are starting to look at what they're going to do with their retirement. and I think we will continue to see firms come onto the market but I think buyers are going to be more cautious than they maybe have been in the past for some of the reasons that Mark has highlighted in terms of the general economic situation.

23:29So the volume has absolutely slowed down So we actually track the number of deals on a regular basis. And year to date, we've seen 135 deals in the sector up until the end of November. So annualized, that might hit 150 maybe by the end of the year. And if that's the case, that's going to be the lowest number of deals since 2021. So it has slowed. The other factor that I'll just bring in is that private equity has been very focused in the last 18 months or so on professional services firms. And we've seen a number of deals in that sector. And we've also seen some of those professional services firms now start to acquire as part of their strategy IFAs.

24:26um so that brings in another dynamic of professional services firms entering the wealth sector which is also interesting because 15 20 years ago they went through the process of exiting the wealth sector so things go round in cycles so i just just add that for extra content um something that is being expected and mark you mentioned it earlier is the consolidation of consolidators i mean do you think this review could hinder that at all um i don't think i don't think it'll it'll hinder um that if you think about who is going to fund those um uh larger mega consolidator deals i think that's where the questions uh will come and where And if that is an aggressive, leveraged play, then the FCA will clearly be interested in that.

25:28If it is a well-funded, well-thought-out, strategic play, which I'm sure anybody wanting to put two of these consolidators together would, of course, be thinking about, then it shouldn't. But, you know, it's sort of going back to the question we gave before. In the wider context of the economy, where is that capital going to come from? There's a lot of competition for that capital. As you say, you know, there are other very interesting targets for private equity to make a return in professional services amongst other spaces. My feeling is that the buyers will come from the rest of the value chain as you see potentially banks or asset managers try to expand their distribution by acquiring one or more of these consolidators.

26:38um the i guess the the counter to that is whether they would be prepared to pay the sort of multiple leverage uh that the um that the current owners uh would expect to um to realize um and i think the i think the other sort of challenge here for anyone looking at this is what is the value opportunity so if you're a consolidator and you're going to go out to market to get funding to go and buy another consolidator uh what is the what is the business case uh and yes you'll be able to make some cost savings because you're bringing two two businesses together so you're going to have cost savings across you know shared technology finance compliance and all the sort of central functions um but then the integration that becomes more complex because what are you going to do about proposition um because both those consolidators are probably in the situation that they have gone through a review of their proposition and launched their go-to proposition so you're then going to have to move to one uh and that also then plays into operating model operating platform so any consolidator looking to go down that route yes you can make some cost savings but you're going to have a significant one-off cost associated with bringing the two businesses together in terms of getting to one operating model supporting one set of propositions.

28:24And I think for firms and advisors who've been through this before, there is a risk that they're going to get a bit wary of every two, three years, we've a new owner and we're going through the journey yet again. And what is absolutely key as I said earlier, this is a people business. The advisors, they don't run the business, but they manage the clients and how they feel is really, really important. And I think if you lay on too much of a burden, then there is always the risk that advisors may then choose to leave and go to another firm that is not under a consolidation umbrella or even go and start up a new firm again.

29:26So there are absolutely risks with the consolidation consolidator approach. And that brings us back to that sort of FCA point around efficiencies. Quite a lot of the value in the deal is from efficiencies or synergies. Um, and if that is too aggressive, not only do you get advisors who don't necessarily have the support that they would expect within the, um, organization to help them to do their jobs, but equally you may go down some quite dangerous paths with, um, support for compliance or for the sort of more customer regulator, um, interesting parts of the, parts of the business. I think support on compliance is absolutely key because, again, we found in the research that we did earlier this year that quite often you have cost dis-synergies when you are consolidating because there are scenarios where maybe the smaller IFAs in some cases, not all cases, have maybe underinvested in compliance and risk capability.

30:42and also under-invested in technology, particularly controls around cyber. So when you bring all that together, there are scenarios where the cost base goes up and you have dis-synergies as a result of becoming part of a larger organisation because the standards are set at a higher level, quite rightly, and some of those smaller firms haven't been operating at that level. um last question before we wrap things up at the end of their review the fca said they were not setting new expectations our findings are intended to help firms understand those that already exist um donald do you think just publishing the findings goes far enough well i think it's a very helpful refresh on what firms and potential investors need to be thinking about and as Mark said earlier there was no massive surprise there nothing particularly new so I think it's very helpful in that context but you know it obviously doesn't cover everything that should be covered as part of consolidation and I will just draw out a couple of points that could have been covered but weren't covered um so restricted advice versus independent advice um so larger firms have gradually moved to more of a restricted model um whereby the investment solution is an in-house solution or supported by that firm which means the advisor doesn't need to go out and do a full whole of market review in terms of what is in the best interest for the client.

32:37Increasingly, though, as firms consolidate, advisors are often quite wedded to having that independent label. But actually, they are presented with a series of investment options that are almost restricted independent investment options. And I think over time, in our view, the importance of truly independent will gradually reduce. And, you know, one area we thought might have been raised by the FCA was their views on restricted versus independent because I think it's getting increasingly confused in terms of this independent label because in many cases it's more of a sort of restricted independent.

33:38And then the other challenge that consolidation brings, although it's a challenge regardless of consolidation, is the advice gap. and you know i have seen uh through the research we did over the course of the last year you bring firms together uh there's then a review in terms of well what are we doing around proposition and segmentation and then sometimes you find there's this sort of lower value um a range of clients below I know 100 ,000 200 ,000 uh it varies and what is the what is the solution for them uh and some some firms are very focused on that and have gone out to develop a more of a sort of guidance type model there uh supported by a remote contact center of you know junior advisors or trainee advisors and that works that can work very well um but uh i think a lot of firms are still grappling with the smaller end book um as to whether that sits within the business going forward whether they develop a solution linked to that uh or whether they move that book um and you know sell it on to someone who can service that book more effectively so again that is another theme that i think comes through consolidation that some firms are grappling with so those are two areas that um i would have touched on as well and mark do you think the sea went far enough by just publishing areas for improvement and not making any new rules um yeah i think they have um you know all the tools they they they need um they have i think reinforced that the essentials haven't really changed you know the essentials of wealth management financial advice are the right product to the right person at the right time um and within the conduct rules that the fca sets it doesn't really matter who your shareholder is or your funding structure, that has not changed and will not change.

35:57And as a shareholder and a business, you need to make sure that your business still cleaves to those essentials. And the FCA, we shouldn't forget, has a chance every single deal to intervene or not intervene through the change in control process. So, you know, it's not as if they've published these and then they'll go away and we'll have no opportunities for intervention. on every single deal that there is in the market, they will be able to give a view as to whether they think it's appropriately funded, whether the strategy continues to be appropriate, whether the incentives are still aligned to the FCA's objectives.

36:40So I think we should bear that in mind. I think what we have here, and you touched upon it earlier, is some really good pointers about if you want that change in control process to go successfully and smoothly, these are the sorts of things that you should bear in mind when bringing that to the FCA. And if you don't, you can expect to have a challenge in that process. It'll take longer, it'll cost you more, and it may not ultimately even be successful. I think that change of control process is really, really important. And actually, going back to one of your earlier questions around what an ifa should look for in a consolidator you know challenging what is the change of control process and historically how quickly can you get it through because i'm aware that there are some firms that have got this down to a t and have got a really built a really good relationship with the fca and it can happen in a matter of weeks and then you hear other situations where it's taken much much longer and that's generally because there's maybe been a lack of lack of experience, haven't got the right information at the right time.

37:48But that's a key question to be asked. Or that they're showing some of these red flags within the deals and therefore they get challenged. Well, that's all we've got time for. Thanks so much for joining us. If you want to read more on our website, my colleague Emma Jackson-Obbott has written a piece. It's called Consolidation Review, Why the FCA is Concerned About Debt. Until next time, thanks for listening. Thank you.