Over the past 12 months, due to economic instability, geopolitical tensions and rising inflation, some firms have been hesitant with expansion. But should they be?
According to the latest EY CEO Outlook Pulse Survey, 98% of CEOs plan to pursue a strategic transaction in the next 12 months [compared to] last January, [where] the number was at 89% - with 58% of them looking to mergers and acquisitions (M&A)(EY: 2023 CEO Outlook Pulse survey). Alongside this, and promisingly, the UK and Ireland are expected to enjoy the highest growth in M&A activity this year according to a separate report by CMS(CMS: European 2024 M&A outlook).
Research shows that 2024 will shift from a buyer’s market to a seller’s market – demand is high, supply is low. While high interest rates, inflation and rising cost of capital has affected appetite, it hasn’t changed the volume of deals; and with fewer publicised deals across the acquisition market it may seem as if the waters are stilling, but a lack of announcements doesn’t mean a lack of activity. So what will the driving factors of M&A within Financial Services be, and what can we expect to see in 2024?
Embedded finance and diversification
Historically, convergence has been a survival strategy in times of uncertainty. But as non-financial platforms and retailers adopt finance elements into their public offerings, cross-industry convergence is quickly becoming an evolution strategy for the specialism.
Embedded finance has emerged as a transformative trend across the specialism, with mainstream attention skyrocketing in the last two years. It integrates traditional Financial Services into non-financial platforms, thereby completely redefining how consumers interact with payments, banking and insurance. Examples of this include AI powered payments network Klarna’s expansion into retail giants like ASOS and Pretty Little Thing, where customers are able to sign up to an interest free monthly payment plan.
SS&C Intralinks describes this convergence as a “proven strategy that allows major players to maintain a diverse product line, keep pace with digital transformation and, in the current environment, meet the changing needs of a stressed banking system” (SS&C: How financial services M&A is responding to the 2023 bank shock). As a result, the relationship between fintechs, bigtechs and banking institutions has evolved from competitive to collaborative. 2024 promises convergence between agile consumer-facing fintechs and larger incumbents.
Furthermore, PwC describe the asset and wealth management (AWM) sector as “solid, with potential profitability quite attractive [to prospective buyers]” (PwC: Next in asset and wealth management 2023). Professional services firms are increasingly diversifying their offering through the acquisition of AWM practices, and this is a trend expected to continue throughout 2024.
Interest rates and confidence
Interest rates have soared across the UK plateauing at 5.25% as of December 2023. Such high rates have undoubtedly made smaller-sized Independent Financial Advice (IFA) firms question their acquisition strategy, leaving the market wondering if all that remains in the current climate are consolidators and private equity-backed firms who can afford the cost of capital.
Whilst 2024 is showing promising signs in the stabilising of interest rates, the overall cost of growing through acquisitions has absolutely increased. The specialism remains attractive thanks to the value financial planning firms offer. Broadening the service offering by selling to the clients of newly acquired businesses paired with a regular income significantly improves profitability and reduces investor risk.
2024 will be particularly exciting for small to medium (SME) IFA businesses. "We saw increased acquisition appetite amongst SME IFA practices last year, perhaps because of the stabilisation of interest rates and the impact this has had on the cost of capital. We expect this trend to continue through 2024, as SME practices are looking to capitalise on the opportunity available through retiring IFA's and the onboarding of spoke acquisitions to compliment and realise synergies within their existing operations” notes James Salmon, M&A Specialist, IDEX Consulting.
Implemented in July 2023, the new Consumer Duty regulatory framework demands that financial advisers prove their services provide fair value. While this may not necessarily cause huge changes in deal volumes, firms are doubtlessly going to be more scrupulous which could prolong the dealmaking process. Following exchange, the average process of embedding new regulation such as Consumer Duty takes around three years. Firms with poorly implemented Consumer Duty run the risk of failing integration, losing value and ultimately seeing deferred payments defaulting. This is why having a well-defined strategy and plan for effectively and reliably embedding Consumer Duty is going to be vital for firms looking to sell.
AI and emerging technologies
By now it’s evident that artificial intelligence has instigated a paradigm shift across industries, with the pace of generative AI adoption being faster than some startups. ChatGPT, for example, reached 100 million users in just six months (Guide to next: Publicis sapient 2024 outlook). This has inevitably bled into the M&A process, with nearly three quarters (71%) of CEOs surveyed using AI as part of the transaction strategy process, either significantly or through pilot programmes. Only a small group (5%) claim they have no plans to use AI (EY: 2024 CEO outlook pulse survey).
Improving technology capabilities and innovation will be a huge driver of M&A in 2024, with 16% of businesses stating that this a primary investment goal(FutureCFO: M&A Trends: Business leaders expect rebound into 2024) and 40% of FS businesses reporting a marked improvement in customer satisfaction thanks to AI, according to the 2023 IDEX AI Report.
Helping to mitigate a famously complex process, financial businesses looking for smooth M&A undertakings are increasingly leveraging the power of artificial intelligence to optimise the journey. However, there also comes increased risk with automated business/asset auditing. Deloitte warn: “the technological turbulence [of] generative AI, transition to the cloud, increased fraud and cyber risk, and blurring of industry lines, such as the embedded finance trend—will require financial services leaders to be much more agile than ever” (Deloitte: 2024 financial services industry outlooks). Businesses looking to sell need to use compliant tools to ensure a smooth transition, artificial intelligence will remain a powerful advantage but needs careful leveraging.
Furthermore, genAI offers huge opportunities for financial institutions. The only limit of the technology is that it’s only as powerful as the data it has access to. Firms may want to partner with large technology companies to access this infrastructure and M&A will be a fantastic way to feed the machine – adding to and enhancing their existing data. Expect to see data-motivated acquisitions in 2024.
Mirroring a trend in convergence, and a direct response to rising rates, tougher times call for portfolio reviews from firms as they look to execute a series of smaller transactions in 2024. These smaller deals, while modest in comparison to some of the huge undertakings in years past, offer real advantages in the current financial and regulatory environment.
Law firm Foley & Lardner mention, “the prevailing high-interest-rate environment has sparked a distinct trend in M&A for 2024, and that is a heightened importance on smaller-scale deals. Acquirers are opting for more modest transactions, partly due to the interest rate situation. These smaller deals present reduced financial risk and are more in line with a cautious approach to risk management”(Foley: M&A trends to watch in 2024). Alongside being more achievable, a series of well planned, de-risked acquisitions are just as transformative as front page news deals, and are a trend we can expect to see throughout 2024.
ESG as a dealbreaker
Lastly, environmental, social and governance (ESG) considerations are no longer a pleasant afterthought in financial services M&A and will continue to be a central focus for businesses looking to expand. Sustainability is an essential consideration in a business’ offering. As a result, 2024 will see ESG integration take a pivotal role in successful M&A transactions. This is reflective of a growing demand from both investors and clients for companies that not only perform well financially, but demonstrate continuing commitment to sustainability and ethical practices.
Larger financial institutions looking to sell need to be aware that potential buyers will be scrutinising their ESG targets and performance. These environmental and ethical factors will also be integrated into the due diligence process, making them vital to successful M&A deals and therefore non-negotiable for companies looking for M&A appeal. Foley & Lardner aptly mention “as long as ESG factors align with economic performance, expect the political backlash to remain just that” (Foley: M&A trends to watch in 2024).
Although the vast majority of respondents (85%) expect M&A activity to come under more scrutiny relating to environmental, social & governance (ESG) regulations over the next three years, almost two-thirds (64%) also believe ESG regulation will ultimately provide a boost to dealmaking in Europe (CMS: Turning the corner? CMS European M&A outlook 2024).
From industry convergence, an updated regulatory climate to the emergence of AI and other new technologies, the Financial Services specialism will see further transformation throughout 2024 – and with it comes exciting opportunities for acquisition and diversification.
Looking for advice on the Financial Services M&A landscape or keen to explore a new opportunity? Contact our specialist consultant James Salmon today, on 07947748173 or email email@example.com