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Check on the back books

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IFA firms should be largely motivated by the goal of increasing the capital value of their business. As they consider the retail distribution implementation programme they should think about which business models are likely to help them achieve that goal.

The IFA landscape is going to change over the next few years as firms react to the pressures of having to cope with increased capital require-ments, an enhanced qualifications’ regime and adviser charging changes. All these changes are anticipated to produce both a short-term cashflow squeeze and a long-term decline in profitability for many commissiondriven firms.

If I were looking to improve profits and increase capital value of an IFA network or support services business, in advance of the 2013 RDIP deadline, I would cost out each service my firm provides and ensure in all cases that my firm is charging a fee to its members or clients. This fee should provide a mark-up to ensure it is sufficiently profitable year on year to withstand a one-off potential uninsured regulatory risk. I would also cease to provide those services which are expensive to deliver and are perceived by my firm’s members or clients as having a low value.

A wealth management business focused on share-holder value should use RDIP as the trigger to create a business model which encourages clients to pay decent fees from professionally-minded and qualified advisers whose bonus is closely linked to the firm’s overall profits. It would also have a model that enables my firm to service its clients by reference to a portfolio of assets under its advice. Clients would pay for that advice via an annual fee linked to the value of that portfolio.

Whatever the post-RDIP landscape might look like, the risk of misselling is not going away. This risk lies at the heart of the value of an IFA business whatever its operating model.

Financial advisory businesses under close FSA scrutiny are generally unattractive to prospective buyers. The need to sort out back-book issues is likely to derail the firm’s plans to drive through some growth or cost-saving efficiency plans.

One option for a firm suffering from such issues could be to pass the problems to a new owner by selling the business. However, in my experience, a buyer’s ambitions for achieving growth and synergistic cost savings will take second place to fears of having to deal with a toxic back book.

Any firm undertaking a strategic review should take into account the future risk profile of the business it is looking to build. Businesses which operate on very thin profit margins will find a regulatory hit could take them into a loss-making position and potentially worse. National firms and network businesses should remove existing advisers and end recruitment of new advisers or members who they perceive may increase risk.

Any IFA consolidator looking to take advantage of the historically low prices currently being paid for IFA firms must conduct detailed due diligence on the cultural acceptability of the target company’s advisers and on the quality – and more specifically the potential for toxicity – in its back book. A buyer should negotiate back-book warranties from the vendor.

Operating an RDR-compliant business should mitigate the risks of future misselling given transparency of advice, the removal of commission bias and the improved qualifications of advisers but these alone are not going to guarantee a liability-free future. Such risks can be further mitigated by embedding within a business operating model the use of technology that directs advisers to products/portfolio allocations which fit the client’s fact-find and risk profiles and automatically monitors delivery of such advice.

A CEO of an IFA business looking to increase capital value must develop a detailed plan to control adviser behaviour so as to mitigate the risk of subsequent misselling-related regulatory problems.

Richard Clarke is corporate finance partner at KPMG

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