The future is bright… but it will be a bumpy ride

AKG’s Communications Director, Matt Ward, discusses DFM due diligence (DD) requirements for advice firms and the role played by consideration of financial strength within a robust DD framework.

The requirement for DD

We believe it is in the best interests of advice firms to carry out robust, repeatable and recordable DD exercises when selecting (or retaining) partners/providers for their business, including outsourced investment partners such as DFMs.

- Robust

Requirement to carry out a multi-faceted process which considers key factors, including:

✓ Client fit/business fit.
✓ Proposition quality.
✓ Portfolio performance.
✓ Price - competitiveness/value.
✓ Service delivery.
✓ Financial strength.

- Repeatable

Requirement to repeat DD on an ongoing basis:

✓ Annual review or more regularly where circumstances dictate need for review.

- Recordable

Requirement to show your workings:

✓ Explain and record your DD. rationale; create a framework and audit trail for partner selection/retention process.

These DD exercises should be done to facilitate best practice within the advice firm and, crucially, to support the delivery of good customer outcomes. Furthermore, the regulator remains keen to see evidence of deeper and more engaged DD being carried out by firms.

In a highly competitive marketplace, experiencing a concerted period of change and challenge, DD will continue to play an important role and advice firms should be reminded that these exercises should be done when first identifying and selecting DFM partners, and then regularly reviewed to support ongoing partner decisions.

Adopting strong DD processes will have the benefit of putting advice firms on the front foot when it comes to managing relationships with partners.

Regulatory proof points

Consumer Duty - Essentially under the Consumer Duty, advice firms need to demonstrate that they’re partnering with DFMs who can help them to facilitate and deliver good service for good client outcomes. Hence, in this new regulatory environment, firms are not only considering their own compliance obligations, but how meeting these obligations may depend on others.

As distributors of other organisations’ products/ services, advice firms need to check that these companies are fit for purpose and can help them to consistently deliver their services to clients. And this is where consideration of financial strength comes into sharper focus, understanding a company's ongoing ability to provide robust service support for the long-term.

Financial strength demonstrates a company’s ability to not only adapt to changing market conditions and to unforeseen challenges, but how it can:

• Commit to its development for the long-term.
• Respond effectively to issues when they arise.

These capabilities are vital now more than ever, and so advice firms need to be confident that companies they partner with (DFMs, Platforms, Providers etc) will provide the robustness of support to help them deliver for their clients, day in and day out.

Thematic Review TR16/1 - If further reminder were needed, and it has admittedly been a while since this was published, FCA’s Thematic Review TR16/1 - Assessing suitability: Research and due diligence of products and services - specifically discussed regulatory expectations, including consideration of ‘the provider’:

ii. Research and due diligence - we use this expression in this paper to refer to the process carried out by the firm to assess (a) the nature of the investment6 , (b) its risks and benefits7 and (c) the provider8 (to establish whether they believe it appropriate to entrust the provider with client assets). The firm needs to understand these factors in order to judge whether the solution is suitable.

Financial strength focus and positioning

AKG specialises in carrying out company-level financial strength assessment work and so it’s here that our independent ratings and reports are designed to help advice firms with DD work.

• Independent assessment - Getting ‘under the bonnet’ of financial services companies for advice firms so that they can better understand who they’re doing business with

• Customer focus - Considering a company’s strength to sustain ongoing operational capability and continue to meet the needs of its customers and their advisers

• Supporting DD requirements - Providing a core company-based component to support comprehensive research and DD

Approach to assessment - balanced scorecard

Each of AKG’s financial strength assessments is based on a consistent approach, where a balanced scorecard is applied over numerous business areas, including:

Entity level:

• Capital - access/availability
• Business performance
• Competitive position/peer group performance
• Strategy and proposition
• Governance/risk management
• Administration/service.

Group level:

• Financial strength of the group
• Role, positioning and importance of the entity to the group.

Approach to assessment - information and input

AKG’s assessment team gathers and scrutinises important company information available in the public domain, including annual report and accounts, regulatory disclosures and other documentation. Building on this information, our preference is then to engage with companies on a deeper-dive, participatory basis where the process is underpinned by a formal annual assessment meeting.

This has the benefit of providing the AKG team with invaluable additional intelligence and strategic context, and enables the production of a detailed assessment report to accompany the rating. Both of which can be used to support DD.

Approach to assessment - simple rating structure

Whilst the assessment behind AKG ratings is complex, the scale used for presentation is deliberately simple to maintain accessibility and comparability. For the overall financial strength rating the scale used is: A (highest), B+, B, B-, C, D (lowest).

Reasons to review - fast moving DFM market

DD should be repeated on an ongoing basis and one of the key reasons for this is that the market continues to experience change and challenge. Here is just a flavour of items impacting on the evolving DFM space in recent times:

• Trend towards outsourcing investments - the growth in the market and the number of players has been fuelled by advice firms outsourcing investment duties and decisions to third parties.
• Regulatory backdrop - It has been a busy period for the FCA including key work on Consumer Duty and the Retirement Income Market Review.
• MPS proposition hotbed - The development and delivery of Managed/Model Portfolio Services in the mainstream advice market has been a hotbed of activity, becoming the ‘me too’ proposition in a fiercely competitive space, including pricing levels.
• Sheer range of competitor types - The diversity of MPS market players, including traditional DFMs, platforms, asset managers, advice consolidators and research/ratings houses, warrants exploration of company-level credentials.
• Continued M&A activity - M&A activity and its impact has been consistent in recent years and is set to continue, including in the DFM space where the number of market players will inevitably consolidate over time.
• Tech adoption requirement - For cost efficiency purposes and service delivery improvements DFMs will need to successfully employ technological solutions and will also need to ensure they can interact with advice firm tech stacks.

In summary

• Requirement for Robust, Repeatable and Recordable DD
• Regulatory proof points for DD requirement, and provider consideration
• Understanding who you are placing business with - requirement for company-level assessment
• Tapping into specialist knowledge to support DD exercise components
• Evolving DFM marketplace warrants ongoing review.

Get in touch:

www.akg.co.uk
akg@akg.co.uk