Guest post by Vladimir Dimitroff with Aastha Dhawan MSc, LSE
The Accelerating Consolidation within the UK Wealth Management Industry
The private banking and wealth management industry in the UK is going through a significant change. Historically evolved into a diverse ecosystem of company types and sizes, it responds to external challenges with a marked drive towards scale. Acquisitions and mergers between firms in this space are arduous undertakings, but organic growth takes too long for the rapidly changing market conditions. The current fragmentation in the industry is not necessarily negative in itself, but too many and too small players can suffer with revenues lagging behind managed assets and often behind growing costs. This incentivises everyone into up-scaling mode, creating the observed exponential increase in M&A activities in the sector. In this paper, we try to examine the root causes, the responses of different players and the possible future outcomes of wealth management consolidation.
The UK Wealth Management sector has emerged and evolved in specific ways that bear resemblances to the rest of the world, but also significantly differ for historic reasons and today present a unique amalgam of firms and roles in the market. The ‘usual suspect’ – private banks, are solidly present and recognised, both native institutions and subsidiaries of foreign private banks (or PB arms of multinational universal banks). They, however, do not dominate the sector. There is a separate and unique breed of wealth management firm (sometimes called ‘investment management’ or ‘asset management’ but with a distinct focus on private wealth). Many have their historic roots in traditional brokerages, and some have evolved from accounting firms. Today some UK wealth managers exceed in size (client base and AuM) the average private bank, and the segment as a whole outnumbers the banks.
The UK Wealth Management sector is not dominated by private banks – containing, instead, a significant segment of non-banking WM firms. This is further diversified by the entry of some asset managers and insurers, and the vast army of independent advisors. Ranging in size from one-man to global giants, the sector is arguably too fragmented for sustainability.
The regulated role of retail financial advice providers, in particular the IFAs, also differs from similar independent professionals elsewhere (e.g. the Swiss ‘external asset managers’, or the RIAs in the US). Some have ceded their independence to tie up with primary providers (or large distributors/wholesalers of finance products), and act effectively as their client-facing front.
Adding to the picture are insurance players in long-term protection segments like Life and Pensions, where the product has a distinct investment nature and the boundary with private asset management blurs to the extent that many insurers now have ‘asset management’ or ‘wealth management’ subsidiaries.
When this typology is seen from the perspective of size, a full spectrum from the single independent individual to the giant asset managers and global banks, completes a picture of massive diversity, with less-than-clear demarcation lines. Through most of history such fragmentation has been sustainable: consolidation always happened, but until recently was not a burning imperative. Today analysts and practitioners alike agree that in the UK market there are too many sub-scale players. Even a narrowed classification of private wealth managers yields in excess of 150 firms (excluding IFAs). We take a look at how this is changing.
Drivers of the Industry Consolidation
‘Size Matters’ was a teaser headline we used recently to introduce the 3rd Senior Executives Forum on Consolidation. There we predicted that ‘scale’ will become a most frequent buzzword and explanation why industry players acquire (or get acquired by) others. Scale, however, is not a goal in itself, there are some known root causes that can potentially be addressed by scaling up.
First and foremost, we cannot ignore the market conditions. Among them low interest rates, competitive price pressures and increasingly informed and demanding clients all present a challenge for the revenue yields on managed assets (AuM). Fees and resulting margins are squeezed too low for comfort.
Then there is regulation. Well intended to prevent financial turmoil and to protect consumers, piling regulatory requirements mean more complex and resource-intensive processes, monitoring, enabling technology investments – all adding to the cost base. At the same time required transparency of charges and other restrictions on revenue streams mean further limitations on profitability and downward pressure on shareholder value. This makes cost savings a very acute objective and the expectation that scale can improve the cost base is driving the M&A appetite.
Market and regulatory pressures on the revenue yield on AuM dictate reducing the cost base and scale is seen as one of the ways to do this. Other factors like diversifying propositions and/or target segments, innovation or repelling disruptors also contain a cost improvement opportunity and amplify the need for scale.
We conducted a study of 38 M&A deals in the Wealth Management sector announced in 2017 and, among other stats, combed the press releases and CEO interviews for some keywords to indicate the motivation behind the deals. ‘Scale’ was by far the top driver, followed by reaction to market conditions and improving the firm’s offering:
Source: Synpulse research, August 2017
It should be noted that these terms overlap and have dependencies, hence they cannot constitute a clear taxonomy. Most of the others are subordinate to Scale, representing challenges for which it is a perceived solution. Nonetheless, this is a strong indicator of the strategic goals of many industry players and the decision process to undertake M&A actions.
The path correlating other variables to Scale usually goes through the Cost objective. If we remove completely Scale form the picture, the cost base would clearly dominate. We also ran a small survey with 31 executives from the sector, and according to them the main drivers for consolidation are as follows:
Source: Synpulse summer survey, June 2017
Clearly all these objectives can be achieved through carefully considered and constructed upscaling of the business.
Digitalisation drives consolidation in a different way: democratisation of investment processes and services leads to choice overload. This in turn, not unlike the music industry, drives customers to the ‘top hit’ algorithms running on the largest platforms – a ‘winner takes all’ scenario.
The rapid advancement of digital services and business models is mostly seen as a cure for the other consolidation drivers, rather than one of them. Indeed, RPA (robotic process automation) is a proven cost-reduction strategy, and digitally enabled omnichannel front ends improve user experience and help to retain customers and their wealth. Digital wealth management, however brings to the market swarms of disruptive new players and creates an overload of choices. Eventually, the public is attracted to the best performers available from the most popular (i.e. most scalable and widest-reaching) platforms. Create Research and Dassault Systemes, in their latest study, liken this process to the ‘winner takes it all’ scenario that disrupted the music industry in recent years. They surveyed 450 wealth managers with global AuM over ISD 30 trillion – and a third of respondents expect their industry to be disrupted by fintechs. Quite a few of those in the study expected their incumbency to prevail, but history teaches us that denial is not the best strategy.
The Consolidation Players
Who consolidates – and how? It is tempting to describe consolidation as a ‘food chain’ – a somewhat cynical view to which we prefer ‘value chain’. At the bottom of it small-to-medium WM firms are busy attracting and absorbing the lowest unit in the trade: the IFA. Acquiring the business of several (or several hundred) IFA-s is a good way to climb the ladder with benefits to every party. The scale achieved in this way, has the additional benefit of turning the bidder into a more attractive target. Up the chain the bigger bidders have plausible incentives to acquire larger targets: the name of the game is scale.
“A firm should be agnostic as to whether it’s buying or selling – it’s all about scale”, said Ashcourt Rowan (then) CEO Jonathan Polin at the time they were acquired by Towry. Later they were in turn bought by Tilney Bestinvest.
Apart from the industry players themselves (private banks and wealth management firms), notably active and helping to fuel this consolidation trend are financial investors, primarily PE (private equity) firms. For them acquisitions are not an end in itself, but a move up the chain – often with lucrative profit. They may not just sell an acquired target after optimising it and making it more attractive, but they can even merge two acquired firms before offering the combined entity upstream.
An example of this PE approach is the case of Bridgeport, who acquired separately Quilter & Co. and Cheviot Investment Management, merged them, and then sold Quilter Cheviot to current owner Old Mutual.
Paradoxes of WM consolidation: While Brexit makes some institutions (notably investment banks) consider leaving London, foreign private banks seek to increase their UK presence. And while many banks are buying fintechs, we saw the precedent of Tandem buying Harrods Bank.
In the fuller landscape of wealth M&A players, there are a couple of odd, but nonetheless important ones. An obvious target for many banks (and to a lesser extent – wealth management firms) are the very disruptors they are trying to resist. A fintech is becoming a popular acquisition for those lagging behind in their digitalisation (and many in the PB and WM sector are), it is a rapid addition of critical capabilities, a safeguard against disruptors, and a new ‘door’ into the wider mass-affluent segment below HNWIs – all this at an affordable (for their scale) price. A paradox is that the reverse can also happen: in a ‘man bites dog’ scenario, an ambitious fintech challenger can target a smaller (or distressed) bank and thus shorten their path into a desired market. This is exactly what we saw in recent weeks, as challenger Tandem successfully bid for Harrods bank. This may not be the last and only case in these interesting times.
Another counter-intuitive paradox is the effect of Brexit on the sector. Prevailing assumptions (and observations) are about financial institutions seeking to abandon the City for other European financial centres. This is true, but mostly for investment banks. At the same time no less than 4 major European private banking players: Credit Suisse, Pictet, UBS and Societé Générale all declared to Bloomberg and the Financial Times that they plan to increase their UK presence. They see plentiful evidence that wealthy global citizens prefer vibrant London to Switzerland, especially when recent laws remove the famous secrecy. More important, a weaker sterling makes many assets cheaper for them and easy to add to their global pools. One more trend to watch closely.
With all the ‘fringe’ actors, it is still the mainstay players accounting for the majority of recent deals. Wealth management firms and private banks between them dominate the M&A scene:
Source: Synpulse research, August 2017
At present the WM firms, unique to the UK market and apparently in greater need for scale, are twice as active as private banks. Deals across them are quite rare, but with scale this is likely to change.
A Glimpse of the Future Landscape
It is easy to predict that opposite to the current fragmented state, the future wealth management market will be… consolidated. The question is: how consolidated? Which players will dominate? Where is the balance point after which healthy consolidation becomes a monopoly or cartel? The last scenario may sound gloomy but is rather unlikely. First and foremost regulators take care to prevent monopolies, but more important – the wealth market is too far from such state. With a solid middle tier of multiple players and growing long tail of ambitious challengers, the current number of 150 may drop to 100 or below, but highly unlikely to just a handful of quasi-monopolists. In our summer study we asked our 31 industry guests how many players they expect to be active in 2020:
Source: Synpulse summer survey, June 2017
The sample of respondents is small, but given the seniority of the group it is noteworthy that some even expect the number to grow. It is possibly a matter of which moves faster: the consolidation or the new fragmentation from influx of challengers.
One thing is certain about the future: wealth management will never look the same. Digital capabilities, innovative business models, connected and knowledgeable clients – all this is already changing the character and structure of the industry. Change is the only constant and beyond the scale we discuss in this paper, we think that the ability and willingness to change will determine the future industry leaders.
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Size does matter, after all. And scale is the name of the game – the ‘economies of scale’ from classic economics are amplified in the current conditions by subtle but important effects. The scale also enables qualitative improvements like faster and more effective innovation, diversified market strategies, and exciting ideas for… even more scale. The scope of this paper did not allow to cover scale-dependent and scale-enabling aspects like technology platforms or target operating models – but a strategically minded company would have the concepts and resources to develop all aspects and benefit in multiple coherent ways.
Synpulse, a company with 20 years of specialisation in the private banking and wealth management industry has deep expertise in strategic and operational aspects of the sector, business and technology disciplines, including profound M&A knowledge in a dedicated practice. We would be pleased to hear comments, opinions and ideas on this topic form anyone in the private banking and wealth management industry.