Vertical integration is about controlling multiple parts of the value chain. A value chain can be defined as ‘… a string of collaborating players, who work together to satisfy market demands for specific products or services …’
So, who are the collaborating players in financial services?
- Distributors (e.g. financial advisers);
- Advice technology firms (e.g. robo-advisers);
- Discretionary Management firms;
- Asset Management firms;
- Authorised Corporate Directors;
With so many collaborating players, vertical integration can take many forms. For example, a discretionary manager having its own distribution / advice capability. Or a robo-advice/technology firm being owned by the same group giving the advice.
We have noticed an increasing trend towards vertically integrated models. We wonder whether the FCA will focus on these at some point.
Better outcomes for the client?
From various publications over the past year or so, it is apparent that the FCA has been increasingly focused on Value for Money (VFM). The FCA has made it quite clear that a key element of the impending RDR & FAMR review this year will be Value for Money (VFM).
The FCA’s Asset Management Study looked at VFM and noted price clustering – where the OCF of many funds were all in a narrow range. The FCA’s Platform Study also touched on the value chain. So, is vertical integration the answer?
The premise behind vertical integration is that it reduces costs, as slicker, more efficient processes are possible due to the interconnectedness of each part of the value chain with the others. It will be interesting to see if the FCA finds that the reduction in costs due to slicker process is passed on to clients … or not, and whether clients are aware of the benefits and risks that vertically integrated models present.
Conflicts of interest?
There are undoubtedly potential and actual conflicts of interest in vertically integrated models, including but not limited to:
- Advisers selecting their own ‘in house’ investments over others to the detriment of the client;
- Firms’ advice charges being reduced to make investment in ‘in house’ products appear more attractive than others;
- Firms using ‘in house’ investments in their model portfolios to boost firm / group profitability at the expense of the client;
- Remuneration & sales incentives that drive behaviours that could lead to bad customer outcomes.
Consolidation is also increasingly prevalent in the market and there are risks of conflicts of interest in this space too. For example, paying greater multiples for firms / clients that are invested in the group’s / firm’s in-house products or invested on their platform, or both.
Finally, we know that the FCA also intends to look at how well firms are implementing product governance rules this year. From a distributor’s perspective, these rules force firms to look at the client proposition on offer and to clearly understand how it drives good value for money for the client. For example, for each of a firm’s client segments …
- What should the ongoing service regime look like?
- What should that review look like?
- What are the costs associated with delivering that ongoing advice?
- Where a platform is used, why is it used?
- How is the use of a platform driving good outcomes for the client?