Kirsty Adamson examines how the transformation of the regulatory environment is driving change - and consolidation - on the investment and wealth management landscape.
It has been nearly a decade since the first clouds of the approaching financial crisis emerged - and the resulting economic and political impact paved the way for increased regulation of the financial services sector.
Financial advisers and wealth managers in the UK have been grappling with regulatory change in recent years, which has been generated by both UK and European legislation.
Take the implementation of the Retail Distribution Review (RDR) for instance. When it was introduced on the last day of 2012, the RDR was described as one of the most significant overhauls in financial regulation in nearly 25 years, raising the minimum level of adviser qualification, removing commission payments and providing greater transparency over charges.
The effects on advisers and wealth managers who provide advice on retail investment products to retail clients have been numerous and the impact is continuing to be felt more than four years after the RDR's introduction. Transitioning from a commission-based model to one based on fees and pressure on advisers to obtain new qualifications have been just two of the pain points and these have been felt especially by smaller firms.
Adviser and wealth management firms who undertake business anywhere in the European Economic Area meanwhile are now bracing themselves for ‘MiFID II' - the second Markets in Financial Instruments Directive - which comes into effect on 3 January 2018.
This European Union legislative framework will affect many aspects of a business's operations, including trading, transaction reporting and client services, IT systems and HR management. According to research from Deloitte, MiFID II is likely to have a major impact on the long term strategies of advisers and wealth management firms.
That is no big surprise, given such companies will need to improve product governance and monitoring processes and enhance their systems to enable them to disclose more detail on costs and charges.
Increased costs and reduced profit margins for these advisers and wealth managers are the likely consequences of MiFID II, as investment managers will have the challenge of demonstrating the appropriateness of costs that are passed on to investors.
In this scenario, larger operators and niche practices are likely to be the most well equipped to deal with the changes, with small firms again bearing the brunt of regulatory developments. And this is before considering the impact of Brexit …
There is more change on the horizon. The UK Senior Managers and Certification Regime (SM&CR) will be extended to encompass investment managers in 2018, throwing the spotlight on reputation and personal accountability as well as on effective governance.
SM&CR - which is already applied to banks, building societies, credit unions and Prudential Regulation Authority-designated investment firms - will be applied to around 60,000 additional firms next year. In light of the change, firms will need to identify ‘senior managers' and devote resources to training, documenting responsibilities and additional record-keeping.
The challenge of navigating through these shifting sands - and the impact of the associated pressure on profit margins - is pushing the adviser and wealth management market towards consolidation.
Many advisers are now welcoming the opportunity to remove themselves and their businesses from the onerous obligations generated by increased regulation and are attracted to the more powerful administrative and technological capabilities of larger financial services providers. This allows advisers and wealth managers to focus on what is important to them - their clients.
In this environment, more innovative solutions are making their presence felt. Over the last 18 months, we have observed and worked with an increasing number of market consolidators, all of which take a different approach to structuring an acquisition.
Stability and security
Many advisers and wealth managers have been attracted to consolidation because of the stability and security it offers to their clients, against the backdrop of increased regulation and the challenges faced as a result of the increased cost of professional indemnity insurance.
Private equity is currently a driving force, investing in consolidators for the acquisition of smaller operators. While this remains the case, many advisers and wealth managers are taking advantage of this as part of their ‘exit strategy' - conscious of the fact the current opportunities to realise value for the business they have built may not always be available.
With the market for consolidation currently so active, advisers and wealth managers are in a strong negotiating position as there are a number of consolidators actively looking to acquire.
The funds that consolidators currently have will not always be there, however. History tells us there will come a point in the future when the consolidators will pause their acquisition strategy and focus more on integrating the advisers and wealth managers they have already acquired and take the time to consider the next strategic move in their growth story.
Our message to advisers and wealth managers is clear: the market is currently very active, consider your options now and speak to consolidators to see if they share your values, before there is a pause in market activity. The sales process may appear daunting but good and commercially-astute legal advice can help to steer all parties towards a successful outcome.
Kirsty Adamson is a corporate solicitor at law firm Watson Burton
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