Sale of client banks to trigger ‘reverse due diligence’

The FCA’s new guidance for firms selling client banks creates an interesting role reversal in the world of M&A. A purchaser has always needed to carry out due diligence on a seller – both for commercial reasons as well as legal and regulatory risk. But in some cases the FCA now expects the seller to conduct its own review on the purchaser.

In a somewhat muted announcement in December 2023, FCA updated its firm pages on expectations for the treatment of client banks. The regulator’s definition of a client bank in this context is a list of clients or accounts maintained by someone who provides financial services. The client bank is often a vital asset, representing a list of accounts that contribute to a firm’s business success.

The FCA acknowledges that client banks may be sold for legitimate reasons – for example, to merge with another firm or so that an adviser can retire. But it is also careful to point out that the acquisition or sale of a client bank requires consideration and adherence to regulatory guidelines to avoid potential risks. In some cases, firms have been found selling client banks without acknowledging or detecting redress liabilities. This could lead to regulatory action.

Regulatory requirements

A firm selling or transferring a client bank must comply with the FCA Principles and the Consumer Duty. Amongst other requirements, firms must act in good faith, act to deliver good outcomes for retail customers, and avoid causing foreseeable harm. The FCA expects firms to assess and set aside adequate financial resources to meet potential redress liabilities, as outlined in their framework (FG20/1).

In November 2022, the FCA reiterated its focus on firm failure and phoenixing in the financial advice sector. This emphasis is reflected in its consultation paper (CP23/24) on changes to the prudential regime for Personal Investment Firms and a Dear CEO letter outlining immediate actions for firms.

As the FCA views a client bank as a firm’s asset, it is crucial for firms intending to sell or transfer their client bank to consider whether the FCA should be notified in line with SUP 15 notification.

Due diligence over the purchaser

The FCA states in its new guidance “We encourage a selling firm to carry out due diligence to ensure the firm buying the client bank can provide the same level of service – e.g. regarding ongoing servicing”.
It will also closely scrutinise arrangements with employees or third parties to prevent risks to effective supervision and regulatory compliance.

This due diligence of the purchaser will require the selling firm to satisfy itself, and the regulator, that the purchaser, has the resources, personnel, and skills to continue to meet the needs of its client bank. This is quite a departure from previous standard practice and should have both a positive impact on the clients themselves, but also discourage a selling firm from trying to off-load their book to a purchase who may not have the competence, capability, or willingness to treat customers fairly.

Additional measures

To further mitigate risks, the FCA may propose measures for both selling and purchasing firms. For selling firms, this may include a voluntary asset retention requirement and an undertaking to maintain an increased level of capital until permissions are cancelled. Purchasing firms may be asked to agree to restrictions on benefits from the sale or assume liabilities through a deed poll.

It’s clear that firms looking to sell or transfer a client bank should exercise all due skill, care and diligence in selecting a purchaser. This should include its expertise and market reputation. Firms should also consider the capital and credit rating of the purchaser. And once a decision has been made on whether the purchaser is appropriate it should be carefully recorded alongside the grounds for that decision.

How we can help

The FCA outlines specific circumstances that may prompt regulatory action. This includes firms attempting to sell client banks to evade redress liabilities, compromising with customers on redress values, transferring client banks to holding companies, or selling below market value without independent valuation.

We can play a crucial role in assisting firms with due diligence during client bank sales or transfers. Our expertise allows us to guide firms through regulatory requirements, ensuring compliance with FCA principles and rules. We have staff with the appropriate knowledge and expertise to perform (and review) a thorough examination of a potential client bank acquisition, assessing risks, identifying any redress liabilities that may exist, and recommending further actions where necessary. This work can include the following:

  • Reviewing a sample of files which contain products which could be a concern, working with you to agree a suitable sample size. We can review these using our own file assessment methodology which has been developed to ensure it meets the FCA’s expectations.
  • Highlighting where remedial actions are needed to demonstrate suitability and what steps could be taken to achieve this, and prepare a clearly structured report, outlining our observations and common themes, general strengths and weaknesses, and providing specific recommendations where relevant.
  • Designing and implementing a redress programme to mitigate risks where required.
  • Providing guidance on whether a SUP 15 notification could be required and assisting with it.