In the months following the federal government's Future of Financial Advice (FOFA) reform package, Australia's financial services sector has languished in a haze of instability.
Australia's financial advisory groups, in particular those in the privately-owned or 'independent' dealership sector, have felt the initial force of the industry reform with uncertainty creeping down from the large-scale dealers to the smaller players.
As a result, a subsequent avalanche of dealership consolidation has befallen the $85 billion sector.
In the past eight months alone, the dealership industry has experienced a large number of mergers and sales.
In December last year, Professional Investment Services (PIS), Australia's largest independent dealer group by adviser numbers with 1354, according to IFA's latest dealer group survey, merged with listed financial services firm Centrepoint Alliance.
In April this year, West Australian dealer group Plan B purchased a 33 per cent stake in Queensland dealer group My Adviser. At the time, Plan B stated its intention to acquire the remaining shares at a later date.
In May, Snowball Financial Group surprised the market with the announcement it had entered into a merger agreement with fellow dealer Shadforth Financial Group that would form a privately-owned wealth management business with more than $14.3 billion in funds under advice, administration and management.
In early June, just weeks after DKN Financial Group's largest shareholder, Zurich Financial Services, sold off its interest in research firm Lonsec, DKN announced it was in discussions with IOOF.
On 14 June, IOOF announced it had submitted an indicative proposal to the DKN board to acquire, through Austselect, 100 per cent of the ordinary shares it did not already own in DKN for $0.75. A week later, IOOF moved to better the deal to shareholders by offering $0.80 per share, thus valuing DKN at $115.4 million.
Last month, Hillross Financial Services acquired Iris Financial Group, with the AMP-owned group set to provide the firm's 12 practices and 37 advisers with licensee services.
The acquisition increased Hillross's funds under advice by $2.2 billion to $12.2 billion, Hillross managing director Hugh Humphrey said.
Haze of consolidation
As Paragem managing director Ian Knox explains it, the "haziness of FOFA" has left industry participants stuck on the interpretation of the reforms, and not on the implementation or positive move for change.
Knox says in the longer term, a potential way for the industry to reduce the haze is to embrace a vertically-integrated model. However, he says he understands such a shift is not for every player.
"It seems to me that [suggestion] is one of the challenges that the true independent networks are struggling with in that they don't necessarily want to become vertically integrated," he says.
"That [suggestion] appears to be an inconsistent message from what FOFA is trying to achieve."
Count Financial chief executive Andrew Gale says the effects of some of the FOFA reforms is likely going to benefit the vertically-integrated organisations, such as the big four banks and AMP.
"They [the reforms] would encourage further vertically-integrated moves, there would be industry consolidation because whilst large non-aligned organisations like a Count or a Centrepoint, Professional Investment Holdings can make those changes, it's more challenging for the smaller to mid-size dealer groups," Gale says.
"So what we're going to see is an increase in institutions buying non-aligned groups and the overall effect of that arguably will be a diminishing in the overall level of advice from independently-owned, non-aligned operators."
For PIS group managing director Grahame Evans, the end conclusion that can be drawn from consolidation of the independents is an industry lacking competition.
"Let me paint a picture: if IOOF swallows up someone like DKN, then they get a bit bigger and swallow up a CAF [Centrepoint Alliance] and/or a Count and then somebody like an AMP comes along and swallows up IOOF, and then we're sitting there with the five pillars but very little competition in the marketplace in that independent space except for the boutiques," Evans says.
"Now the boutiques are going to suffer a bit because we know that the resellers' margins, as we call them, they receive from platforms are an integral part of the financial effectiveness of operating those small licensees."
He says the removal of the margins will make it substantially more difficult for boutiques to operate.
"Obviously the value of their business will go down and I think then they will start to say 'is it worth it being here, I'll just sell out to an Axa or MLC in that process because I just can't compete'. I think that's where we are heading with this situation," he says.
Futuro Financial Services managing director Dennis Bashford says the spirit with which the government put together the package is not the issue, but rather the far-reaching, long-term impact from the way it proposes these changes to be implemented.
"At risk is the fundamental provision of true arms-length advice to consumers across a broad array of financial products and services," Bashford says.
"The broad debate about FOFA so far has focused on specific and important issues such as the proposed opt-in regime, the ban on upfront and trailing commissions within superannuation and a ban on volume-based payments.
"They will result in advice services being even more controlled by the banks and other large financial manufacturers because the reforms will further accelerate vertically-integrated distribution models."
However, he says the real elephant in the room is the "death knell for independent advice", which he believes will be replaced by teams selling product on behalf of institutionally-owned networks rather than advisers acting in the best interests of consumers. "If this sounds alarmist, we are already seeing a preview of how the world of financial advice will be radically altered," he says.
Challenges for the independents
Knox says one of the key industry challenges at present is the liquidity or successor planning capability, an element he believes is feeding into the debate around consolidation.
"Although people like to make it [consolidation] sound sexy, with regards to scale it is actually the handing over of the reigns to another party who buys the business," he explains.
"I think underneath all of that we often look at the industry and say you have to be big to survive. One of the aspects of the current market conditions is the buyers of planning practices are continuing to do so with an intention of selling product, not overtly promoting the quality of advice.
"I make that observation on the grounds that it's the old supply and demand and increasingly if you don't have a network of advisers, then you get quarantined from the annuity streams that come with that."
He says one has to be amused by the larger entities "vocalising" that they have significant value propositions, when as they buy the businesses they have to lay out $100 million to keep the planners and often also provide four times buyer of last resort to those practices when the practices use the products of the organisation.
"That sounds like 1985 to me and here we are in 2011 dressing up consolidation as a pig with lipstick," he says.
"The purpose of consolidation is to enable large institutions to sell their products through to consumers. So that's what's happening; we can dress it up as much as we like."
The liquidity issue, according to Alan Kenyon, is more about the banks requiring more information and as a result of Commonwealth Bank of Australia "bailing out of the market", the other banks have been able to pick and choose, so they are picking the best businesses.
"I think that's a factor [of consolidation] and certainly my view is, and I'm not sure of the percentage, but maybe there is 20 or 30 per cent of the industry that haven't been evolving in some form or another to a fee-for-service business model that clearly will struggle. But sometimes you've got to cut your cloth accordingly," the Kenyon Partners managing director says.
"You go back to FSRA [Financial Services Reform Act], sometimes it can be the straw that broke the camel's back. I think it's a combination of business owners who were ready to sell around the time of the global financial crisis (GFC) and didn't have to sell deferred so they are coming back to market now as revenues have started to come back and ahead of the changes."
Kenyon says the argument that FOFA is placing unnecessary pressure on the mid-tiered, privately-owned sector is accurate, though drawing the conclusion that FOFA is the sole cause of consolidation is drawing too long a bow.
"I don't think it's quite that simple and I think it's components, for instance, quite a number of mid-tier businesses that have come out of the back of the GFC have said 'we don't ever want to go through that again if we can help it, and how do we insure against not having a 40 per cent drop in our revenues', so one way is to add other services or other revenues streams," he says.
"So a traditional planning practice might be offering accounting, mortgages, insurance, self-managed super funds, so trying to build other revenue streams. So you could argue they are getting scale as distinct from what they're really doing is trying to diversify their revenue streams.
"Whereas others, depending on what they are using as their value proposition, just need to pump in another million dollars in the front door to get back their profits."
Kenyon says the other part of this is since the GFC the majority of businesses have not been writing much new business and so another way to get top and bottom lines back is with acquisitions.
"If you're prepared to put up your house and your car and your kids, they [the banks] will lend you money and if you are not writing much new business, then you can get your scale back and your profits back," he says.
"So these things are not just one simple answer and I think too many in the industry think it's either this or it's that - if you're not big you won't survive, it's just nonsense."
Matrix Planning Solutions managing director Rick Di Cristoforo says industry consolidation is likely to continue whether driven by FOFA or poor markets.
"Certainly certain elements of the FOFA proposals are anti-competitive and as a result you are seeing the weaker groups basically having no other choice but to do things, whether or not it is consolidation or whatever," Di Cristoforo says.
"Now that being said, there are some groups in the industry that are making these sorts of commercial decisions regardless of FOFA or whether or not the market was poor.
"They actually had some of these discussions going on for quite a long time and it's not that easy to observe the difference between people under pressure and people who are just making a smart business decision."
Future outlook
Minter Ellison corporate mergers and acquisitions partner Christopher Brown says the advisory market in the wake of FOFA will experience a fundamental change, with the potential for market fragmentation and the creation of "true independent" dealer groups.
Brown says the difficulty is without the support of fund manager subsidies in the future, the profitability and the value proposition of going it alone is less compelling, so there are headwinds.
"At a practice and small dealer group level I think there are opportunities for scaling up and buying out those who are perhaps looking to exit the industry, creating a franchise model and in fact industrialising and segmenting your clients," he says.
He says dealer group consolidation is also likely to continue, particularly as the advice industry scrambles to adapt to an environment not reliant on volume payments.
"The industry chat is 'we'll just have to capture margin which was previously paid to us by selling [product]'," he says.
"Now there is no reason why they [dealer groups] shouldn't set up their own products, their own platforms, their own funds and the like, but I suppose if one of the policy objectives was to ensure small peripheral players like Storm [Financial] didn't sort of repeat themselves, then query whether forcing advisers into the manufacturing space is the way to achieve that particular policy objective."
In Gale's view, there is going to be an increase in institutions buying non-aligned groups.
"The overall effect of that arguably will be a diminishing in the overall level of advice from independently-owned, non-aligned operators," he says.
While Dixon Advisory and Superannuation Services managing director Alan Dixon doesn't agree advice will necessarily suffer as a result of the consolidation, privately-owned advice houses will need to fit more for their client.
"They will start to realise that whilst it is financial advice and quality advice, it's a bit like shopping for a car. If you go to the Audi dealer, they'll fit you to the right car for you and your family's needs, but it's going to be an Audi," Dixon says.
"If you go to a big four bank I don't think you're going to get bad advice, but the reality is you're going to get sold their car."
He says it is time for privately-owned groups to become more ruthless by putting their clients' interest first, particularly on cost.
"If you're an independent group, this is your opportunity to ruthlessly beat up your product manufacturer and get low-cost products. A lot of the other retail [providers] will manufacture lower-cost products because they will need to for MySuper and everything else," he says.
Di Cristoforo says it is perhaps too early to determine the exact cost pressures industry consolidation will have on the privately-owned groups.
"A lot of people have been talking about the pressure on the licence. There are a couple of layers within our industry that are going to be feeling the heat in a very big way and they are probably already feeling it now, it's just that maybe they haven't defined just where the heat is coming from," he says.
"You've got to look at the funds management environment, you've got to look at certain elements of services, those areas have also got to look at their top line and bottom line and saying 'what are we charging, what are we doing, what's our value proposition?'
"I think advisers who properly and fully engage with their clients if anything should absolutely be looking at things and saying 'I have a way of delivering my value proposition, I can clearly talk about it and clients are going to value it and I may actually be earning more money'."
The next few months will no doubt be critical for the privately-owned sector, with the government's draft FOFA legislation due. Time and experience will be the telling factors for the industry.
