Posted: 29th September 2016
The current trend towards firms vertically integrating their business models is a concern for the regulator.
In recent years, some retail life firms have acquired advice networks, while a number of wealth firms have invested in their fund management capabilities, built platforms and moved into financial planning. Vertical integration (theoretically, dependent on effective strategy) can give firms clearer sight of all aspects of product and supply chain, making the mitigation of risk easier while allowing for greater business efficiency.
It comes with some positives for customers, too, for example; the potential for a more cohesive journey through the product lifecycle and easier engagement with the provider.
However, the way the benefits of vertical integration are distributed is largely down to individual firms. Theoretically, greater business efficiency should result in greater value for customers, and to some extent the regulator’s concern in this area centres around whether or not this is happening. Ultimately, vertical integration should benefit firms and their customers – but how can firms ensure they achieve the right balance between these interests, while meeting regulatory expectations?
Implications for customers
If a firm is looking to vertically integrate, it is important to consider the impact of the following on customers:
Governance and oversight
From a governance and oversight point of view, the consolidation of business functions appears to make some sense, especially when we look at the implications of recent regulatory work around individual accountability, the advice gap and delegating authority to third parties. Vertical integration can help firms provide a better experience to customers by virtue of a clearer view of the outcomes they are providing and the associated business efficiencies gained.
It’s no secret given regulatory developments that ensuring every element of a supply chain is set up for compliance costs more in today’s environment, and this has implications on return on investment for firms and cost implications for the consumer.
Under vertical integration, firms can lessen the costs of compliance, but how much of this value will make it to customers? This leads us to the concerns the FCA references in its business plan.
Conflicts of interest
In their 2016/17 business plan, the FCA noted that conflicts of interest posed issues in the investment management and wholesale markets, citing vertically integrated business models as one of the causes.
The FCA’s risk outlook for 2016/17 says that “where a firm provides a range of different client services, playing multiple roles with multiple clients, that could lead it to further its own interests rather than acting in the best interest of its clients”.
Is the advice you offer your clients restricted to in-house products? It may be good news that vertical integration can increase consumers’ access to advice, but if clients are not given a whole-of-market view and are instead recommended a solution from a potentially narrow band of in-house options, a conflict of interest may arise. Firms should think carefully about suitability and the effect of their sales incentives here – what is the scenario in your firm if it’s determined that your product/s do not cater to a particular individual’s circumstances?
Competition and value for money
Vertical integration could increase innovation by helping firms to better understand the nuanced and continually changing markets they operate in, allowing them to design more effective products and better processes for their customers. The view of the whole supply chain that accompanies a vertically integrated business model provides firms opportunities to realise business efficiencies, too, by virtue of a more ‘joined up’ approach to sales, customer communications, discerning and reacting to vulnerability and handling complaints.
With a lack of customer trust in financial services often cited as a limiting factor in getting consumers to engage with firms, a key question arising from firms’ drive to adopt vertically integrated business models is ‘who benefits from this trend?’.
Any cost efficiencies uncovered in this area, if reflected in customers’ typical return on investment or the cost of fund management, for example, could help to bridge trust gaps between investors and firms. Firms should be thinking about the potential, given this greater efficiency, to pass value on to customers, becoming more competitive while strengthening brand in the process. There have been recent assertions that the value gained from a vertically integrated business model is not always passed to customers, yet this could be how firms obtain the real long-term benefits from vertical integration.
The role of regulatory due diligence in mergers and acquisitions
As well as potential conflicts of interest for firms to contend with, it will be vital to ensure that any mergers and acquisitions are subject to stringent regulatory due diligence. Firms taking on problematic back books in their bid to become vertically integrated will almost certainly feel the impact in the future as cohorts of customers having not received good outcomes could result in enforcement.
Analysing the business model, senior management and governance, culture and controls of the firm being acquired can give the acquiring firm the assurance they need that the deal is a good one.
Using business efficiency to LEVERAGE Trust
There are some real challenges posed to firms looking to bring their supply chain in-house to gain competitive advantage.
Ensuring regulatory issues are spotted and addressed can be easier, but conflicts of interest arising from providing limited advice on a limited range of products can cause detriment. Similarly, greater efficiency can be achieved in a vertically integrated business; yet in the process firms must avoid issues inherited through mergers and acquisitions which could fly directly in the face of their cost saving aims.
Lastly, and perhaps most importantly, firms should not forget the trust and advice gap that currently exists in financial services, and how vertical integration can be far more than a cost saving device if it results in better return on investment for customers.
Clearly, the key to successful vertical integration is ensuring it serves the interests of all principal stakeholders – achieving commercial and operational aims while managing any conflicts of interest that could cause concerns for the regulator. This is a delicate balance that needs to be carefully managed.