Find out about our observations, good practice and identified areas of increased risk.
1. Who this will interest
- Firms in the financial advice and wealth management sector.
- Firms in any sector considering growth through acquisition.
- Professional services firms who work with financial services groups in this sector.
- Those who invest in or fund acquisition groups.
2. Why we did this work
We have seen an increase in consolidation in the financial advice and wealth management sector through acquisitions in recent years.
Consolidators play a significant role in this sector, including supporting retiring financial advisers who want to ensure their clients continue to benefit from receiving financial advice. We want to support consolidators to invest and innovate in this sector to provide their clients with good outcomes on a long-term and stable basis.
This paper aims to support sustainable growth in the sector through highlighting good practices and areas for improvement and reminding firms of the FCA’s expectations on consolidation.
We have seen consolidation support efficiency and growth by pooling resources, expertise, and infrastructure and enabling long-term innovation, stronger governance and enhanced financial resilience.
However, we have also seen that if fast growth of these businesses is not managed effectively, it may create poor outcomes. These could include poor client service, failure of business continuity and disorderly failure.
Careful consideration of our findings should help firms at our gateway to ensure a smooth and efficient process when looking to apply for a change in control.
3. What we did
We reviewed a sample of groups which were acquiring independent financial advisers (IFAs) and established wealth management businesses, providing discretionary investment management and advice solutions to group clients.
Our review focused on:
- Debt structures
- Organisational structure
- Approach to regulatory consolidation
- Treatment of group risk
- Overall risk management including inherent conflicts of interest
- Governance and resourcing of the group
- Approach to acquisition and integration
We identified a range of good practices and practices which could increase harm across groups in this sector.
Our key findings are summarised below.
4. Summary of key findings
Good practice
- Groups with a clear structure, strong governance and risk management processes are likely better placed to achieve sustainable growth and deliver good outcomes for clients, staff and shareholders.
- Groups ensuring regulated entities were well resourced and resilient despite debt levels elsewhere in the group.
- Groups considering risks across all entities, capturing capital and liquidity needs created by these risks.
Practices which could increase harm
- Groups which are not prudentially consolidated. This can lead to a difficulty recognising, measuring or mitigating group risk. This may also limit regulatory oversight of group debt, goodwill and associated risks.
- 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.
- Groups failing to grow their compliance and governance infrastructure to keep pace with their rapid growth.
5. Findings
5.1. Group debt management
Debt, and debt-like instruments, are typically used to finance acquisitions. We recognise the potential benefits of debt funding. However, funding equity investments through debt (double leverage) can weaken the financial resilience of regulated entities within the group if they face pressure to upstream cash to service the external debt.
This arrangement can cause us particular concern where debt is guaranteed by, or secured on the assets of, the regulated entities within the group. This can transfer the credit risk of the lender to the regulated entities and result in client interests being subordinated to the interest of the lender in the event of default on that debt.
Good practice
Recognition and monitoring of risks:
Group debt and its impact was closely monitored with appropriate early warning indicators and regular review at board level. This ensured proactive risk management.
Sustainable financing:
Groups ensured that regulated entities were well resourced and resilient in relation to overall levels of group debt.
Debt security arrangements protect firms and clients:
We saw some regulated entities that were not guarantors of debt or subject to any charge over their assets. While lenders to other group companies sometimes held a charge over the shares of the regulated entities, this did not expose the regulated firms to significant credit risk from debt in the wider group.
Areas for improvement
Group-level financial resilience and solvency:
Top-level consolidated financial statements often showed net liabilities or relied on intangible assets, such as goodwill, for balance sheet solvency. We found some evidence of high debt levels, limited stress testing, and short-term refinancing strategies.
Guarantees provided by regulated entities:
In some cases, debt was secured on regulated entities’ assets and some regulated entities guaranteed a holding company’s debt. This exposed firms to the credit and operational risks of the group and could reduce the assets available for other potential creditors (including clients) in the event of insolvency elsewhere in the group.
Reliance on short-term debt financing:
There was reliance at group-level on short-term borrowing. This can create fast-growing future obligations and heightened refinancing risk where guarantor arrangements existed.
Stress testing and realisation of resources:
We saw heavy reliance on cash generation from regulated entities to service group debt. Some groups had contingency plans in case cash was not available, but some did not. This risk was often unrecognised and not effectively stress tested. While some firms transfer cash via dividends, many built up intra-group receivables which may not be realisable in a stress.
5.2. Group risk management
Legal entities within groups often share clients, revenue streams, control frameworks and back-office functions. While this offers potential coordination and cost efficiency benefits, it can also introduce risks, including disorderly failure or inadequate assessment of resources.
Effective group risk management ensures consistent oversight of risks across all entities, captures new risks effectively and ensures proper assessment of adequate resources for regulated entities. We consider the financial resources of the wider group, and the way the group manages risk, when we assess whether a regulated entity meets threshold conditions. MIFIDPRU specifically requires the quantification of material risks or potential harms arising from membership of a group in a firm’s Internal Capital and Risk Assessment (ICARA).
Good practice
Comprehensive group risk coverage:
Explicit consideration of risks across all group entities, including those outside of any investment firm group (IFG), capturing capital and liquidity needs created by these risks, for example in the ICARA.
Structural efficiency and governance:
Groups managed their growing complexity by promptly deauthorising dormant firms, ensuring future liabilities were retained within the group and prioritised client interests.
Area for improvement
Inadequate group risk recognition:
Some groups did not consider group risk and may underestimate interconnected risks and resource needs. The requirement to consider group risk in the ICARA process is not limited to entities in an IFG (MIFIDPRU 7.9.3G).
5.3. Group structure and approach to consolidation
For investment firms, FCA prudential consolidation requirements aim to mitigate the risks described throughout this review. They do this by treating all relevant financial undertakings below the top UK parent entity (i.e. investment firms, financial institutions and ancillary service entities) within a group as a single entity.
The parent undertakings of IFGs must ensure a minimum amount of capital and liquidity at the consolidated level. This mitigates the risk of disorderly failure and allows us to have overall visibility of the relevant entities and risks.
Consolidation also entails the quantification of purchased goodwill from the acquisition of entities. Goodwill has an unreliable valuation and limited realisable value during stress, and so is deducted from capital.
Like other investment firms, wealth managers must comply with prudential requirements and complete their regulatory reporting on a consolidated basis, where relevant. Advice firms within the group may be included as relevant financial undertakings.
Firms sometimes structure their acquisitions through offshore holding companies. This may limit the applicability of FCA consolidation requirements, despite there being highly integrated businesses, supplying complementary services to the same clients through different legal entities, with significant shared services such as IT, HR and Finance. The insertion of an offshore entity is unlikely to change in any material respect the risk of harm that the MIFIDPRU consolidation requirements were designed to mitigate.
Good practice
Integrated group frameworks:
Connected entities within the group were included within an IFG. This supported effective governance and oversight at group level enabling effective regulatory supervision.
Area for improvement
Financial resilience:
Goodwill being held outside the IFG means that the inherent uncertainty of value is not recognised in the assessment of adequate financial resources.
Some groups also used dual-parent structures, often with one or more offshore, meaning they limit prudential consolidation. These practices may undermine the financial resilience of regulated entities, making effective regulatory oversight harder and increasing the risk of harm to clients and markets.
5.4. Acquisition and integration approach
Well managed acquisition and integration can create real value for clients, employees, buyers and sellers of regulated entities.
To effectively manage significant change, groups should ensure that they have the resource, frameworks, expertise and support needed to deliver good outcomes to all parties.
Good practice
Strong due diligence pre-acquisition:
Groups conducted rigorous due diligence, usually with third party support, which was challenged and understood by decision makers. Such firms evidenced effective risk identification by the acquirer, such as back-book advice liabilities.
Managed integration post-acquisition:
Some groups had clear and disciplined integration plans, with well-resourced teams monitoring integration and client outcomes. They assessed client needs, staff capabilities, the firm’s service offerings and overall cultural alignment, with focused resources to remediate any issues. They evidenced adaptable acquisition and integration processes tailored to the profile of the acquired firm.
Strategic growth:
Groups with a clear acquisition strategy, including defined commercial, cultural and client acquisition targets were more likely to achieve good outcomes for all stakeholders. This was characterised by strong frameworks for identifying, assessing, and integrating acquisitions and cultural fit assessments.
Areas for improvement
Due diligence:
Some firms need to improve due diligence, monitoring and resourcing of the process, and ensure they had an ability to adapt processes to the client/staff profile of the acquiring firm. Some groups’ due diligence did not review basic compliance and some due diligence exercises appeared to be ‘tick box’ in nature.
Acquisition of issues:
Some groups acknowledged that risk and compliance frameworks needed improvement pre-acquisition. Where issues were not addressed quickly, substantial further investment of financial and non-financial resource was required.
5.5. Governance and resourcing
Where groups seek to grow quickly through acquisition, resourcing must keep pace with the increasing scale and complexity of the group. This means ensuring that compliance and risk management functions are well resourced and that robust systems and controls are in place to make sure management can monitor and act upon emerging risks appropriately.
As groups grow, senior management must have the knowledge and experience necessary to manage the increasing size and complexity of the business. Having independent challenge at committee and board level is normal practice for businesses of reasonable size and scale.
It is also important for groups to embed knowledgeable staff in the acquisition and integration process and ensure appropriate governance to road-test proposed acquisitions and assess any potential risks.
Good practice
Training and monitoring:
Good evidence of investment in staff training on migration to new systems. This included product testing and ongoing reviews monitored by a robust product governance framework.
Leadership:
Some firms invested to ensure that senior leadership retained the requisite skills and experience to manage the increased size and complexity of their group, either via training and mentorship or recruitment.
Processes:
Extensive evidence of strong acquisition and integration processes, clearly understood by relevant staff and managed with robust systems and controls. This produced useful management information, which was acted upon by senior management.
Areas for improvement
Systems and control frameworks:
Some groups did not scale systems and controls in line with their growth. They needed management information to allow for effective governance of multiple entities within the group and infrastructure. This resulted in poorly controlled growth.
Leadership:
Groups need to ensure leadership have sufficient knowledge and experience to deal with increasingly large and complex issues is maintained.
Autonomy:
Sometimes, decisions materially affecting regulated firms were made by unregulated boards, without adequate consideration of the impact on the regulated firm’s business.
Challenge:
Some groups did not have independent challenge on boards and others had little independent challenge at important board committees. Such oversight could offer unbiased scrutiny of management decisions and challenge group assumptions.
5.6. Conflicts management
Incentives for sellers and/or to their staff to achieve certain client decisions presents potential for conflict of interest. This could contribute to client harm such as inappropriately placing clients into a group product. These incentives may be out of alignment with the Principles for Business[1] for firms and our rules on inducements.
Vertically integrated groups, where advised clients are placed into products offered by other group entities, should properly identify and manage the inherent conflicts associated with this type of business.
Good practice
No incentives:
Incentives were not offered based on the investment decisions made by the client, either through adviser remuneration or via the deal structure.
Choice:
A broad range of investment options were available, with robust compliance monitoring for inappropriate use of internally manufactured services.
Robust compliance monitoring:
Onboarding assessments ensured investment suitability, with strong compliance monitoring to identify and manage actual or potential conflicts of interest effectively.
Areas for improvement
Incentives:
Some groups offered explicit or implicit incentives to invest in group products or services, including investment products.
Risk management:
We identified conflicts of interest registers which recognised many of the relevant conflicts at play. However, consideration of how to mitigate them could be unclear or under-developed.
6. What firms need to do
We are not setting new expectations. Our findings are intended to help firms understand those that already exist. If you are a firm with this business model, you should factor in the nature, scale and complexity of your business when considering these findings and their underlying principles.
Compare our findings to your firm or group’s arrangements to see if your arrangements might lead to increased prudential and conduct risks.
Consider where you may need to reassess your risk management arrangements or group structure to deliver resilient and well-managed growth, in line with the Consumer Duty and in the best interest of market integrity. These attributes are likely to support timely change in control processes.