The recent multi-firm review
As a little Halloween treat, the FCA published their observations from the recent multi-firm review of consolidation in the financial advice and wealth management sector. Whilst the observations relate directly to firms in those sectors, they also have read-across to firms in other sectors that are planning growth through acquisition as well as the firms funding that growth, including private equity investors.
The FCA acknowledges the importance and value of consolidation in the financial services sector, with it bringing economies of scale, deeper pools of expertise and innovation. However, rapid growth needs careful management regardless of whether it occurs through acquisition or organic growth. In the case of consolidation, the growth experienced is likely to be far more significant and rapid than anything that is reasonably expected through natural scaling of a business and for that reason, even more care is needed.
A good part of the FCA findings relate to prudential and consolidation matters, debt management, group structures and financial resilience. However, wider findings around the acquisition process itself and post-acquisition integration from a controls and governance perspective were the areas that piqued our interest and reflected what we see in the work we do with consolidators.
We have supported firms with change in control applications where it’s evident that due diligence carried out by the acquirer offers little insight into the risks being acquired. We also see cases that whilst the acquirer might understand and accept the risks it is taking on, little is done post-transaction to address those risks or integrate the acquired business into the wider group. This can create disjointed control frameworks with different parts of a consolidated business working to different standards. Indeed, we have also worked with firms that realised, long after acquisition, that more is needed on integration to ensure good customer outcomes, effective risk management and consistent advice processes. This can result in costly and time-consuming remediation activity being needed.
The FCA publication urges “careful consideration” of the findings and notes that this will help firms with a smooth change in control experience. This suggests that we can expect the FCA to scrutinise change in control applications more closely to understand:
- How well the acquirer understands the business and associated risks being acquired;
- The integration plans that the acquirer has and how ready it is to implement them;
- How the acquirer plans to address any issues identified during acquisition due diligence; and
- How the acquirer plans to ensure consistent governance and oversight across the whole consolidated business.
Some key areas that consolidators and their financial backers should consider are:
Acquisition due diligence
The reason for carrying out due diligence can vary, with some acquirers wanting it to support the decision of whether (or not) to proceed with the acquisition and others using it to identify any issues that will need to be addressed. Either way, there’s no doubt that carrying out robust due diligence is a must for any acquisition because it underpins subsequent integration, remediation if needed and ongoing risk management.
The FCA findings note that in some cases, due diligence can be a ‘tick box’ exercise and fail to address basic compliance considerations. In our experience, this can be caused by the acquirer carrying out due diligence in-house without appropriate skilled resources available to provide enough challenge to the target firm. It can also be caused by the acquirer choosing to focus on financial and legal matters at the expense of due consideration of regulatory risk.
The starting point for any useful regulatory due diligence must be identifying the regulatory risk areas that the firm is subject to and using the due diligence to interrogate how well risks in those areas are managed. The FCA findings highlight that third party support can underpin strong due diligence pre-acquisition – this is something that we echo. The work we do on pre-acquisition due diligence ensures deep subject matter expertise and tried and tested methods for completing the process. Areas where we find third party support can add particular value for wealth managers and financial planners include; the assessment of historic advice, governance and reporting arrangements, quality of proposition and value, financial crime risk management, and client asset arrangements. Due diligence that results in risk rated findings and practical recommendations can help the acquirer understand any issues and plan the work to ensure effective and efficient remediation when needed.
Operational integration
For some acquirers, the goal can appear to be the transaction itself, with little consideration given to how the acquired business will integrate with the existing group in terms of operational controls and risk management. However, for an acquirer to really benefit from the increased client bank and assets under management, it needs to properly capitalise on potential efficiencies and economies of scale.
The FCA noted that clear and disciplined integration plans underpinned by well resourced teams deliver the best outcomes from a business and customer perspective. Indeed, our experience is that this type of planning can bring significant benefits in the long-term, by driving positive change and tackling issues head-on rather than kicking them down the track when it’ll be more costly and resource-intensive to address them.
The starting point for a good integration plan is the identification of the core operational standards that should be adopted across the group. That could involve the acquirer implementing controls from the target firm into its own group. For example, the target may have a well embedded tech-enabled approach to financial crime risk management that can replace more manual processes at the acquirer. More often, we find that it involves the acquirer implementing its own well established controls into the target firm. For example, the acquirer may have a well-defined centralised investment management proposition that could be rolled out within the target firm to replace a more fragmented, bespoke approach to wealth management.
Whatever the approach taken, good implementation will involve clear documentation of the operational controls that the firm as a whole will work to as well as good training on new processes and the standards staff will be expected to maintain. We also carry out post-integration reviews to assess how well new processes and controls have been adopted across the business. This can help the acquirer identify any parts of the business or control framework that are causing particular challenges, so that additional support can be provided to address identified gaps.
Governance and culture
Bringing two separate firms together is always going to present challenges from a governance perspective. In any acquisition, care is needed to ensure the firm is equipped to manage the growth of the business and any new risks it is exposed to.
The FCA note good practice examples of firms that invested to ensure the senior management team have the skills and experience needed to manage the bigger, more complex business. Conversely, a failure to scale systems and controls with growth or to have effective governance structures and information can directly impact the firms ability to achieve controlled and sustainable growth.
For any acquisition, it’s essential to look at the governance arrangements in place and the information available to Boards and committees. Firms should assess how well the governance arrangements enable it to manage the growth in a controlled and compliant manner. The information available to support the governance arrangements must take account of all entities under the remit of the governing bodies and provide useful insights to support the senior management in their roles.
As the FCA note in their publication, there are no new requirements or expectations being announced, simply a restatement of what the FCA have long expected from the entities involved in consolidation. If you’re an acquirer, seller, or funding acquisitions, you should take time to consider the FCA’s findings in the context of your acquisition activity and think about whether you’re doing enough to understand and manage risk, and whether you are integrating the businesses in a way that supports compliant growth and commercial success.
At Square 4, we have extensive experience of supporting firms with regulatory due diligence, integration plans and post-integration assessments covering all aspects of regulation. Get in touch if we can support you with your acquisition activity. For further information about our due diligence services please see our Regulatory Due Diligence services brochure by clicking the link below.
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