COVID-19: Bringing operational financial strength into sharper focus

The COVID-19 pandemic has brought the operational financial strength and sustainability of companies across the financial services industry into sharp focus and served to underline that financial strength is not a hypothetical risk. Guy Vanner, Managing Director, brings to life AKG's assessment and rating work in the platform sector.

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"Ensuring a customer-oriented focus to financial strength is key and sustainability revolves around a company's ability to maintain operational capability to meet the needs of customers. Expectations include the ongoing delivery of appropriate operational service."

Operational financial strength and the adviser/customer focus

AKG's approach to and definition of financial strength is to consider a company's strength to sustain an operation and continue to meet the needs of customers and their advisers.

This is fundamentally different to other ratings and assessments, such as credit ratings, designed to satisfy market investors. The strength and sustainability interests of market investors and customers are different and may even be at odds.

So, ensuring a customer-oriented focus to financial strength is key and sustainability revolves around a company's ability to maintain operational capability to meet the needs of customers. Expectations include the ongoing delivery of appropriate operational service. Hence a company needs strength and sustainability to do this, meeting various challenges over time.

Beyond just solvency or return of money to customers?

There are a couple of common, but understandable misconceptions associated with financial strength assessment. Firstly, that financial strength is purely about solvency. It is not. Whilst solvency will always be important and a factor in financial strength assessment, it is not the whole picture.

The definition of customer oriented and operational financial strength is useful here and at AKG we believe that a financial strength assessment should include the following objective definition:

"To go beyond purely a consideration of solvency (albeit this will always be an important part of the mix) and consider in what format an organisation may be able to survive to meet the reasonable expectations of customers and their advisers. Expectations, which must include the experience encountered by these two groups, will therefore include ongoing operational abilities and performance."

This definition is then also relevant to the misconception of believing that financial strength is just about the recovery of client assets. Recovery of assets is of course crucial, but to restrict financial strength consideration to this could be misleading and falls below the requirement to deliver a broader set of customer outcomes.

Many businesses, including platforms, thinking; 'well, the assets sit with a custodian, or there is a policyholder protection scheme which will kick in, and so my financial strength won't matter'. Is that good enough? Effectively saying that if that part of the customer value chain, somehow fails or is impaired, there will be no change in customer experience.

Unfortunately, that simply is not the case. The route to asset recovery or protection funds/compensation is not the experience the customer reasonably expected when they signed up. And the uncertainty, delay and distress cannot be so easily dismissed.

Outline of a balanced scorecard approach to assessment

The assessment approach used for all AKG ratings is that of a balanced scorecard, with a combination of criteria assessed and no single factor or measure being dominant. The assessment and rating take into account those of the following criteria which are most relevant:

  • Capital and asset position.
  • Expense position and profitability.
  • Structure (and size) of funds within the company.
  • Parental strength (and likely attitude towards supporting the company).
  • Operational capability, management strength and capability.
  • Strategic position and rationale.
  • Brand and image.
  • Typical fund performance achievements or product / service features.
  • Its operating environment and ability to withstand external forces.

At a high-level and using the AKG assessment report structure as a guide these criteria combine to consider attributes in four overarching areas:

  • Capital.
  • Strategy.
  • Administration.
  • Risk & Governance.

The factors and platform business model types which might provide elements of comfort or concern

A spectrum of factors, each of which tends to have a gradation and each of which may represent positive or negative aspects and for which a platform business may typically display a combination. These might include:

Management (tight/broad) – Smaller businesses might characteristically have smaller, tight management structures with a specific individual or a few individuals with significant experience, whereas larger groups will have often wide-ranging management structures, a combination of experience and access to wider pools of talent. The ability to recruit and restructure may also be different.

Scale (small/large) – Scale can have a number of relevant aspects. Cost efficiencies of greater scale, flexibility at smaller scale.

Access to Capital (restricted/deep) – Access to capital to deliver planned development activities but also react in timely way to change required either quickly, and/or unexpectedly, by market pressures and changes, can be a major strength and conversely a challenge.

Disclosure & Transparency (private/corporate) – There will be differences in the disclosures required and also the voluntary levels of transparency by different business. A lack of transparency either through what is not required or volunteered, whilst it might not obscure any issues, will necessarily be a cause of caution.

System Architecture (newer/older) – 'Future-Proofing' has been a much talked about objective in recent years and whilst this must be understood as impossible to ever be absolute, it is a key consideration given a landscape of multiple and interacting change factors. These include customer behavioural and regulatory for example and there is a clear need for any platform business to be able to accommodate the needs of such change within its technology architecture or to swiftly adjust to such.

Wrapping up – the need for ongoing review

And so AKG continues to keep a close eye on these factors and on platform market developments to ensure that we can continue to supply these independent platform financial strength assessment ratings and reports to the market to help underpin the due diligence processes undertaken by intermediary firms when considering the selection, or retention of platform partners.

The last 12 months has brought ever more sharply into our consciousness the fact that risks (foreseen or unforeseen) can bite in very real-world ways; can impact the operational and financial basis of companies; and thus, significantly alter customer and adviser experience. Selection and review which incorporates consideration in respect to this is not just a regulatory requirement, but also now seen as a very practical one.

Please email akg@akg.co.uk with any queries or for further information on AKG’s financial strength assessment work.

AKG’s November 2020 publication - Financial & Operational Strength, its role as a foundation in platform due diligence - is accessible at https://www.akg.co.uk/downloads.