Is there a vertical integration conspiracy?

RG246’s silence on the issue of vertical integration has led some to conclude that this cannot be accidental. Is there an unofficial policy to encourage vertical integration of the wealth management industry?

When I started in the industry (too many) years ago, vertical integration was a bit of a joke. The only vertically integrated players were the banks and insurers, and in most cases the components – asset management and advice in particular – were not exactly market leading quality. A fast growing industry actually encouraged fragmentation – the boutique boom in asset management being one symptom.

Fast forward to 2013 and things look rather different:

– The rise of platforms from the mid-1990s created strong incentives to vertically integrate, in particular by acquiring adviser businesses for distribution, and adding a multi-manager asset management engine. We now have an industry where the majority of retail distribution is institutionally owned, and diversified funds management is dominated by in-house asset managers.

– A decelerating industry has driven waves of consolidation, particularly through the for-profit parts of the industry, and the competitors still standing are hungry to harvest margins that they see (or think they see) in other parts of the value chain.

– As regulation has squeezed the for-profit business model, vertical integration has often proved an easier option than drastic changes of strategy – think of the ban on dealer group rebates as a good example. It eliminated large swathes of the independent planner channel, which found it easier to sell than restructure.

So some vertical integration which has already occurred is really down to the evolution of the industry. This is normal – as industries mature and growth slows, it’s common for big players to grow via vertical integration.

Some is unintended consequences. We have seen a lot of super and wealth management policy in recent years which has not fully thought through the second round impacts, FoFA being a good example. Much regulation of the past 5 years has pushed the industry towards further vertical integration as a response.

This still leaves open the question as to whether this government actually has a preference for a more vertically integrated industry. Well it clearly wants a more consolidated industry with fewer and larger players, which can be seen in:

– Formal policy, such as the scale tests in MySuper, which although not exactly stringent, point the way.

– Measures such as auto-consolidation, which while it’s not an overt consolidation policy, clearly reduce the scope for marginal super funds to maintain their independence.

Consolidation is not necessary vertical integration. But in the absence of structural separation of banking and wealth in Australia, more consolidation tends to mean more vertical integration. This then forces pure super incumbents such as the large not-for-profits to consider following.

With strong market and regulatory forces at work, you don’t need to make a case for a vertical integration conspiracy theory. But the government does not appear particularly worried about it either. Why the insouciance?

Clearly vertically integrated businesses are not getting a free ride, as conflicted remuneration measures and recent enforceable undertakings demonstrate. But you could argue that Storm-type financial scandals are less likely to occur in large vertically integrated financial institutions, which are now very risk and reputation sensitive. Compared to a fragmented industry, such institutions are going to be easier to police, and in the event of a Storm, to hold to account, and secure compensation from.