FINANCIAL PLANNING
IFA FIRM BUYOUTS
DEALING WITH NOVATION
Mark Dennison considers some of the challenges and pitfalls of acquiring an IFA business
A storm erupted recently when an
acquisitive adviser attempted to block
novate clients without getting letters of
authority from those clients. In the
circumstance of the case the selling
adviser had assets on the same platform
as the buying adviser. The purchaser
attempted to change the agencies by
novation only to be informed by the
platform that explicit client agreement
was required.
Forgetting the particular issues of this
case for a moment, there are tangential
considerations that can be raised in all
buying and selling situations.
Pivotal to the discussion, the Financial
Services Authority (FSA), in its March
Retail Distribution Review (RDR) paper
(PS 10/6 ‘Distribution of retail
investments: Delivering the RDR –
feedback to CP09/18 and final rules’)
confirms ‘where commission can be
switched we would expect it to be paid
to the client, given that the new adviser
did not provide the service for which the
service was payable’.
Advisers and the market have reacted in a
knee-jerk fashion, saying it makes business
sales very difficult at best and probably
impossible. We would interpret it slightly
differently. Our view is that this is the FSA
saying that in relation to Treating
Customers Fairly (TCF), (Principle 6,
PRIN2.1, FSA Handbook) clients need to
be offered a service from a buying firm,
and explicitly agreeing to it, before the
trail can be re-directed. Again in relation
to TCF, we are of the view this goes
directly to consumer outcomes 3,
‘Consumers are provided with clear
information and are kept appropriately
informed before, during and after the
point of sale’ which relates to the service a
client is paying for, and outcome 6,
‘Consumers do not face unreasonable
post-sale barriers imposed by firms to
change product, switch provider, submit a
claim or make a complaint’ (Sarah Wilson,
FSA speech, August 2007), which relates
to barriers to freedom of asset movement.
Reverting back to the case in question, in
considering the FSA’s stance as set out
above, it can be argued that the platform
provider is operating within FSA
parameters even without a view of the
legal contractual issues which remain
unresolved to date as far as we are aware.
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FINANCIAL PLANNING
The novation waters and the FSA’s views
of them are to some extent muddied
because elsewhere in the FSA handbook
there is apparently explicit acceptance of
the principle of novation as an efficient
means of transfer. In its Policy Statement
on prudential regulation in January
2001, the FSA said at section 5.2 para 4,
that it regarded novation in the transfer
of assets as ‘a clean transfer’ and the
‘cleanest transfer of risk’. This was
accepted as made text in the prudential
sourcebook for banks at the time.
implementation). It suggests that
novation is at the heart of any buy / sell
transaction and that there is a right way
and a wrong way to novate. Going
forward novation implications will
impact on the buy / sell price, and
probably the initial margins for buying
firms. Broadly, in our view, novation
should be accompanied by a letter of
acquiescence by the client (probably in
the form of a novation agreement),
following an invitation and a description
of the buying firms’ services and costs.
Where the intention is to novate on to a
platform it should be done in two stages,
one to move agencies, the second to
move to platform (if appropriate).
It would seem then, that the FSA may
not be averse to novation per se, but
that where it happens, the operational
procedures need to be client TCFcentric.
A knock on effect of the regulator’s
position is the methodology of buying
and selling firms. Currently the perceived
best practice is to carve out client banks
and pay for the recurring income
identified therein, then let the selling
firm fall away. A key incentive for this
process from the seller’s point of view is
the speed and efficiency of transfer of
clients through block novation
Under the FSA’s RDR proposals, this
would be more difficult, and would
certainly be more costly, given the
implicit requirement to obtain explicit
client consent. This would indubitably
bear down on valuations, and in extreme
cases could cause deals to collapse.
The simplest way to avoid the problem
would be for the acquisitor to buy the
selling firm (instead of client bank) in
which case there is no novation. There
are potentially a whole lot of problems
that come with such a purchase though,
the largest of which is the past service
liability issue, which is far more difficult
to carve out under this method.
Selling / buying transactions, if we are
blunt, tend to primarily consider the
financials of the deal, with the goal of
the acquisition vehicle to gain as large a
pool of assets under influence as
possible. The clients get left in the
vacuum. The FSA’s latest direction seeks
to re-address that balance. The
underlying principle, it seems to us, is
that clients must get continuity of service
that they understand and buy into at a
known price.
One way to do that (if the selling firm is
not to be bought intact) is for a buying
firm to take the advisers of the selling
firm on-board for a transition period.
This alleviates the continuity issues. It
probably allows for a better end result as
settlements to the advisers can be
staggered and paid on successful
transfer, to some extent obviating cash
flow short outs. There is also scope for
accumulating discovery assets not
included in any novation (because there
is no trail). Some might argue that that
is diluting value, because it is an exercise
for the buyer and part of the reason for
the purchase in the first place.
To return one last time to the case we
considered at the beginning of this
piece. It focuses our minds on the issue
of platforms / wraps in a sell / buy
situation. Our expectation would be for
most sellers to be old model advisers
(without platforms), while buyers are far
more likely to be new model adviser
firms with platform(s) in situ. Again
referring to the FSA March papers, in this
case Discussion Paper 10/2 ‘Platforms:
delivering the RDR and other issues for
discussion’, it is clear to see that a
transition model that transfers assets on
to a platform without due consideration
to suitability issues, is bound to
encounter justification problems. At the
very least a client categorisation project
is advised.
The novation process should be handled
as a project with sufficient resources
(human) allocated to it together with a
documented policy and process. Our
view is that is should have a run period
of at least six weeks before transfer, to
avoid unnecessary cash flow and time
lags. Novations can be unwound for
transactions that fail at the 11th hour.
The avoidance of the novation
conundrum seems to us to force IFAs
potentially to purchase selling firms
rather than ‘asset books’. This has
implications for valuations and liability
carve out.
Mark Dennison
STC
www.wlcholdings-ltd.co.uk To sum up then, this note is aimed at
buying and selling firms. It has its
genesis in the FSA’s direction with regard
to trail income post 31.12.12 (RDR
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