The Financial Conduct Authority has warned that debt-fuelled acquisitions can impair client outcomes, raising questions about the sustainability of the buy-and-build model while interest rates remain high.
In its latest observations from a multi-firm review of consolidation in financial advice, the regulator highlighted good and harmful practices and areas needing improvement, reminding firms of its expectations when pursuing acquisition-led growth.
The FCA said: “We have seen consolidation support efficiency and growth by pooling resources, expertise, and infrastructure and enabling long-term innovation, stronger governance, and enhanced financial resilience.
“However, we have also seen that if the fast growth of these businesses is not managed effectively, it may create poor outcomes. These could include poor client service, failure of business continuity and disorderly failure.”
How debt is central to buy-and-build
Consolidation has accelerated in recent years across financial advice and wealth management, especially through private equity buy-and-build strategies. Under this model, a PE firm acquires a platform independent financial adviser and uses it to buy multiple smaller firms — typically with debt — to gain scale, efficiency and a higher exit valuation.
Paul Joyce, partner at Lava Advisory Partners, says the model still works, but only when acquisitions genuinely add value.
The consolidation review does not change the FCA’s regulatory powers. It is, though, a warning to any owner of a regulated business to ensure that acquisition and debt structures reflect longer-term client outcomes
Joyce adds: “Rates are higher than we’d like, sure, but they’re nowhere near the peaks we’ve seen before, so new deals can still make sense as long as the integration, growth and operational upside comfortably outweigh the cost of the borrowing.
“The real danger sits with firms that gorged on acquisitions just because debt was cheap. Those deals done five-plus years ago where the numbers only stacked up in a near-zero-rate world, that’s where big debt piles could come back to bite.”
Brian Hill, M&A adviser at Pathfinders, agrees: “The buy-and-build model isn’t dead yet, but it’s definitely hobbling a bit. High interest rates have turned debt from a growth engine into a handbrake and, for some, a rusty one.
“If an acquirer’s plan depends on stripping cash out of regulated firms to feed parent debt, they’re walking straight into a consumer duty tripwire.
“If loan repayments start driving advice decisions or pushing firms towards in-house products, that’s a flashing neon red sign.”
What the FCA examined
For the review, the FCA examined groups acquiring IFAs and wealth managers providing discretionary investment management and advice. It assessed debt structures, organisational frameworks, regulatory consolidation, treatment of group risk, governance, resourcing, and acquisition and integration approaches.
The regulator said: “Well-managed acquisition and integration can create real value for clients, employees, buyers and sellers of regulated entities.”
However, it identified several practices that could increase harm.
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Lack of prudential consolidation. Some groups were not prudentially consolidated, making it harder to identify and manage group-level risks, including those linked to debt and goodwill.
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Debt weakening regulated entities. Some regulated firms transferred cash to unregulated parent companies or guaranteed holding-company debt, exposing them to wider financial and operational risks.
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Governance not keeping pace. Rapid acquirers often failed to expand compliance and governance infrastructure in line with their growth.
Double leverage concerns
While acknowledging the benefits of debt funding, the FCA warned that financing equity investments through debt (double leverage) can weaken a regulated firm’s resilience, especially where there is pressure to upstream cash to service borrowing.
It added: “This arrangement can cause us particular concern where debt is guaranteed by, or secured on the assets of, the regulated entities within the group.
“This can transfer the credit risk of the lender to the regulated entities and result in client interests being subordinated to the interest of the lender in the event of default on that debt.”
Anthony Turner, corporate partner at Farrer & Co, notes the FCA’s concern that regulated entities may be used to service or guarantee group debt, undermining resilience in stress scenarios.
However, he says upstreaming cash to service acquisition debt is a long-standing market practice.
He adds: “In our experience, debt finance is typically structured such that regulated entities (and their consolidation groups) do not provide security/guarantees or, if they do, regulatory capital is carved out. These carve-outs may however not allay any FCA concerns on operational resilience.
“Debt is not a dirty word: indeed, the FCA recognises the potential benefits of debt-funding. That said, the FCA is focused on specific practices around debt and security, which could weaken the financial resilience of regulated entities.
“The FCA’s review should not materially impact upon current levels of debt used as part of regulated transactions. The FCA is not setting new expectations here.
“Rather, we expect market participants will need to focus more critically on specific practices such as stress-testing, refinancing strategies, and over-reliance on regulated assets when structuring transactions.”
Client handover risks
Consolidation is often driven by adviser retirement, but clients expect continuity. Gillian Hepburn, head of adviser solutions at Vanguard — Europe, says client handovers must be managed carefully, and the FCA should have full visibility over debt and guarantees before approving changes of control.
Hepburn adds: “Handover of a client to a new business structure, and perhaps adviser, can also be important from a client detriment perspective in other ways. For example, is the client being moved to a new platform, investment proposition or adviser charging structure?
“If so, to what extent is this driven by the consolidator and in turn the debt structure levers, should this come under pressure. Other considerations could be around any sales incentives and the extent to which in-house funds [are] being used.”
The FCA also highlighted good practice:
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Risk monitoring. Strong groups monitored debt and related risks closely, using early-warning indicators and regular board reviews.
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Sustainable financing. Groups ensured regulated entities remained well-capitalised relative to overall group debt.
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Protective debt structures. Some regulated firms provided no guarantees or security for group debt, limiting client exposure.
Where improvement is needed
But several areas required improvement:
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Weak group-level resilience. Some consolidated financial statements relied on goodwill for solvency and included limited stress testing and short-term refinancing strategies.
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Guarantees by regulated entities. In some cases, regulated firms guaranteed holding-company debt or had debt secured against their assets, reducing resources available to clients in a failure.
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Short-term financing reliance. Heavy use of short-term borrowing created refinancing risk, especially where regulated entities supported group debt.
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Stress testing. The FCA found heavy reliance on cash from regulated entities to service debt, with some groups lacking contingency plans: “While some firms transfer cash via dividends, many built up intra-group receivables which may not be realisable in a stress.”
Market impact
According to Hill, multiples are softening for acquirers that are over-leveraged or under-governed, as lenders increasingly question whether clients are indirectly funding acquisition debt.
“We’ve seen this where buyers push sellers to hike fees just before a deal closes which, whilst commercially prudent, doesn’t always sit well with sellers,” Hill says.
“If they want headroom to reinvest in service, compliance, and culture, acquirers need to keep debt sensible. For most, that means [earnings before interest, tax, depreciation and amortisation] multiples in the six to eight range. Beyond that, unless there’s a clear strategic reason, they’re potentially in nosebleed territory.”
Hill adds that deal pricing should use normalised profits rather than adjusted ebitda, which often includes amortisation of past acquisitions and other one-offs.
He concludes: “Aggressive roll-ups are starting to look, to me, like yesterday’s playbook. The new game is sustainable integration and resilience.”
Debt as a consumer duty risk
Joyce says investors increasingly recognise that leverage can create consumer duty risks if it triggers cost-cutting or product bias.
He adds: “It’s always a risk when businesses target profits over quality of service, because while short-term cost-cutting or fee-raising can produce immediate financial improvements, it won’t create long-term success.
“In people-driven industries in particular, that success can only be sustainable by delivering exceptional customer satisfaction, which creates loyalty and drives cross sales, referrals and so on, becoming a self-sustaining, virtuous circle of success.
“As consumer duty is designed to protect the customer from what is effectively poor or negligent service, prioritising customer outcomes is the less risky approach from both a financial and a compliance perspective.”
Joyce says lenders are now asking tougher questions, especially at the lower end of the market.
“But it’s not a fire sale market,” he adds. “The capital’s still there, it’s just that lenders are a bit more cautious. You tend to see investors pricing in lower leverage, doing a bit more modelling and keeping a closer eye on covenants, and ensuring due diligence has a real focus on the quality of client service and the stickiness of the book.
“What’s really happening is a split: the standout businesses are still attracting strong valuations, while the more generic or ‘run-of-the-mill’ ones are having a tougher time. The bottom quartile that could raise money easily a few years back might find it far harder now, and that’s where we’re seeing the biggest hits to valuation.”
Monitoring debt-related client risk
To identify when debt pressure is affecting clients, Andy Peterkin, financial services partner at Farrer & Co, says he would expect the FCA to spot rising complaints or to bring issues to the surface through thematic reviews.
Peterkin adds: “Proactive monitoring of debt pressure is going to be a more important regulatory element as opposed to a purely financial concern.”
He notes that the FCA already requires disclosure of acquisition finance as part of the change-of-control process and can ask detailed questions about debt structures.
“So, the FCA should already be getting a good picture of what debt is being placed on the wider structure. Put another way, in our view, they already ask for transparency,” he says.
“The [Mifid Prudential sourcebook] rules give the FCA oversight over an ‘investment firm group’. This can include unregulated UK parent companies above any FCA-regulated entities, and we have seen this extend quite far up a group structure.
“Ultimately, the FCA also has power to require a group with two or more FCA investment firms to establish a UK parent company, which will give the FCA greater supervision rights. This power is rarely used, but the FCA may lean on this power more in the future.”
Warning shot to consolidators?
While many PE-backed firms continue to pursue buy-and-build strategies, the FCA’s findings may serve as a warning shot across the consolidation landscape.
Turner notes that private equity is not the only driver of activity; trade buyers and other capital providers are also active.
Turner says: “The consolidation review does not change the FCA’s regulatory powers. It is, though, a warning to any owner of a regulated business to ensure that acquisition and debt structures reflect longer-term client outcomes.
“The FCA’s message is that the consolidator’s financial and operational rigour needs to be fit for purpose. Investors should be alive to the renewed focus on robust capital structures, strong governance processes and disciplined integration.”
Ima Jackson-Obot is deputy features editor of FT Adviser
