Asia’s rising star

AKG’s Managing Director, Guy Vanner, discusses DFM due diligence requirements for advice firms and the role played by consideration of financial strength within a robust framework.

The requirement for due diligence

It is in the best interests, and the responsibility, of advice firms to carry out robust, repeatable and recordable due diligence exercises when selecting (or retaining) partners for their business, including outsourced investment partners such as DFMs.

This requirement has a business imperative in best ensuring that partnerships will not present future operational challenges and the costs and disruption associated with them for the advice firm. And, concurrent with that, can maintain operations in line with delivering positive customer outcomes, so clearly underscored by Consumer Duty, for the adviser’s clients.

Robust

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

• Client fit / Business fit. 
• Proposition quality. 
• Portfolio performance. 
• Service delivery. 
• Financial strength.

Repeatable

Requirement to repeat due diligence on an ongoing basis: 

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

Recordable

Requirement to show your workings: 

• Explain your due diligence rationale; Create an audit trail for partner selection / retention process.

These 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 due diligence being carried out by firms.

In a highly competitive marketplace, experiencing a concerted period of change and challenge, due diligence 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 due diligence 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, advisers need to demonstrate that they’re partnering with companies that facilitate good service for good outcomes. In this new regulatory environment, most firms are not only considering their own compliance obligations, but how meeting these obligations may depend on others.

As distributors of other organisations’ products and services, advisers need to check that these are fit for purpose and how they help to deliver their service. No criteria is likely to be as important as financial strength and consequent ongoing ability to offer robust service support for the long-term.

A company's financial strength demonstrates its 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 as now more than ever, advisers need to be confident that companies they partner with (Platforms, DFMs, 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 a 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 the following:

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 their due diligence 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 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 due diligence.

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.
• Business Performance.
• Competitive position / Peer group performance.
• Strategy and proposition.
• Governance / Risk Management.
• Administration / Service.

Group level:

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

Approach to assessment – information and input

The team gathers important company information available in the public domain, including annual report and accounts and Pillar 3 documentation. Whilst some ratings are issued based solely on information available in the public domain, companies are also invited to engage on a deeper-dive, participatory basis where the process is underpinned by a formal assessment meeting. This has the benefit of providing the AKG team with invaluable additional intelligence and strategic context.

Reasons to review – shifting sands of DFM market

Due diligence 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 evolution of the DFM market in recent times:

• Economic backdrop – COVID, war in Europe, inflation and the cost-of-living crisis have impacted companies operating across financial services and consumers.
• 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 (or 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 on pricing.
• 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 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.
• 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 due diligence.
• Regulatory proof points for due diligence and provider consideration.
• Understanding who you are placing business with – requirement for company-level assessment.
• Tapping into specialist knowledge to support due diligence exercises.
• Evolving marketplace necessitates ongoing review

Get in touch

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