Wealth Consolidation - FCA Review Findings

The FCA has published a multi-firm review of consolidation in the financial advice and wealth management sector.

The review responds to a recent uptick in consolidation in the financial advice and wealth management sector by so-called "consolidators" acquiring other businesses in the area.

The FCA acknowledges that consolidation can support efficiency and growth, but it also highlights concerns that if such growth is not managed appropriately, it may drive poor outcomes in terms of client service and business continuity.

The publication sets out a series of "good practices" and "areas for improvement" following the FCA review, which involved a sample of groups acquiring IFAs and wealth management businesses.

In this blog, we explore what the FCA's findings mean for firms and sponsors in this area in terms of acquisition financing arrangements, group structuring and risk management, prudential consolidation and post-acquisition integration.

Quick read

• The key highlights are that the FCA sees the benefits of consolidation of the wealth/advisory sector such as pooling of resources, expertise and infrastructure, and enabling innovation, stronger governance and financial resilience.
• However, the FCA sees certain practices as potentially problematic. Chief among these are:
  • arrangements that result in lack of UK consolidation through offshore parents or dual-parent structures especially in groups where entities in a group are highly integrated businesses, supplying complementary services to the same clients through different legal entities, with significant shared services such as IT, HR and Finance - lack of consolidation in these circumstances could limit regulatory oversight and can lead to a difficulty identifying and managing group risk;
  • group debt arrangements weakening the resilience of regulated entities. This includes regulated entities transferring cash to unregulated parent companies (upstreaming) via intra-group loans or guaranteeing the holding company's debt, exposing them to the group's financial and operational risks;
  • lack of robust pre-acquisition due diligence and clear integration plans; and
  • groups failing to grow their compliance and governance infrastructure to keep pace with their rapid growth.
• Overall, the themes identified by the FCA are not necessarily new and a number of these are underpinned by existing risk management and prudential requirements. However, the formalisation of these views within the multi-firm review is likely to lead to additional scrutiny during the change in control process. It is therefore important for firms to ensure that proposed acquisition structures, financing arrangements and integration plans are considered in light of the FCA's findings, calibrating these as needed in light of the nature, scale and complexity of their business.

Key themes and findings

Group debt management

• The financing of acquisitions through debt is a common practice. The FCA does not seek to proscribe this practice and in fact acknowledges its potential benefits.
• However, the FCA considers that the practice can in some instances weaken the financial resilience of regulated entities. Example of poor practices are:
  • regulated entities guaranteeing (unregulated) affiliates' debt obligations or granting security over their own assets to support those obligations;
  • arrangements predicated on cash generation by regulated entities to service group debt. This is particularly and issue where there are no contingency plans in case cash is not available; and where there is a build up of intragroup receivables (which may not be realisable in times of stress) rather than transfer of cash from regulated entities via dividends;
  • parent company balance sheets that show net liabilities, or which rely on intangible assets (e.g. goodwill) for balance sheet solvency; and
  • reliance on short-term debt financing arrangements at the group level, which can create fast-growing future obligations and refinancing risk.

Group risk management

• The FCA acknowledges the efficiencies gained in sharing clients, revenue streams, control frameworks and back-office functions across a consolidator's group.
• However, the risk of disorderly failure and inadequate assessment of resources must be effectively managed by taking into account group-wide risks.
• The key takeaway here is that, in line with ICARA requirements, firms need to consider risks across all group entities, including those outside of an "investment firm group" and to capture interconnected risks and resource needs.

Group structure and approach to consolidation

• Acquisition structures can vary, but broadly where there is UK consolidation (i.e. a top UK parent entity that sits above all the investment firms, financial institutions and ancillary services entities in the group) the FCA can exercise effective regulatory supervision.
• The FCA does not outright indicate that UK consolidation is required in all instances. However, it highlights the below practices as limiting regulatory oversight and increasing risk of harm to clients and markets:
  • acquisition through offshore holding companies; or
  • dual-parent structures (we assume meaning sister subgroups sitting below different parents without a UK consolidating parent).
• The FCA also highlights the related practice of holding goodwill outside of the consolidated group. Goodwill has an unreliable valuation and limited realisable value during stress and therefore is deducted from regulatory capital where the goodwill is held within the consolidated group. Holding it outside the consolidated group means that this is not appropriately deducted and the inherent uncertainty of value is not recognised in the assessment of adequate financial resources.

Acquisition and integration approach

• In terms of the acquisition process, the FCA highlights the need for firms to ensure that they have the resources, frameworks and expertise to manage the acquisition and integration processes.
• Key to this is undertaking robust pre-acquisition due diligence, having a clear and well-managed integration plan and operating within a clear acquisition strategy.

Governance and resourcing

• Firms should ensure that their governance and resourcing arrangements keep pace with the increasing scale and complexity of the group as it grows through consolidation.
• Good practice includes ensuring that staff are trained on new systems, products/services are monitored under a robust product governance framework, and senior leadership skills remain appropriate for the complexity of the group.
• Examples of poor practice include regulated entities not operating with sufficient autonomy from unregulated parent company boards, and boards generally not posing independent challenge of management decisions.

Conflicts management

• The FCA highlights the need to ensure that groups manage conflicts of interest between firms and clients that may arise as a result of consolidation (e.g. inappropriately placing client orders into a group product).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.