An old, established industry can still thrive if it embraces change.
Encompassing much more than simply creating financial plans and running portfolios, the European wealth management business has long thrived on complexity. Because it also coordinates retail banking, money management, estate planning, and tax and legal advice in a highly personalized fashion, the industry has been able to protect itself against structural changes. It has prospered on the hefty fees banks charge its customers due to high barriers of entry, ample “gray money” pouring into Europe, as well as holes in local taxation systems. High capital market returns—driven by high interest rates and buoyant equity markets—contributed to lifting margins. And charging fees based on a percentage of assets under management is a lucrative fee structure.
These good times are still reflected today in valuations of banks’ wealth management units. According to a study by Deutsche Bank and the consulting firm Oliver Wyman on global wealth management, leading players with combined AUM of $11 trillion accounted for 37% of banks’ valuations, compared with 16% before the financial crisis in 2007. This compares to a 28% share of revenue, the study says.1
This high-margin business, however, faces challenges to the core of its business model. Several factors are contributing to the erosion of margins: increasing regulatory pressure; rising compliance costs; the advent of new, disruptive technologies that have bred new competitors; and ultimately, the loss of client trust due to poor investment returns during the financial crisis.
These factors could be compounded by less benign capital markets. With equity valuations stretched and the continuation of the multiyear bond bull market unlikely, asset performance as a growth factor for wealth managers is under question. The base-case assumption of the Deutsche Bank/ Oliver Wyman report sees AUM growth of 5% annually through 2020, down from 7% in the past five years. (The bear-case scenario sets AUM growth at only 2% to 3% annually.)
This article will explore the industry’s challenges. These can be summed up in three key aspects: regulation, trust, and technology. While our focus lies on European wealth managers, these factors confront wealth managers globally. While disruption arguably will lead to the consolidation of the industry, it need not only be seen as a threat. Change and challenges offer opportunities for innovative and flexible incumbents.
Regulation: An Important Driver of Transparency
After the financial crisis, waves of regulatory measures hit the banking industry. In Europe, the Markets in Financial Instruments Directive, known as MiFID II, is expected to have a sweeping impact on the financial-services industry. The far-reaching rules, which are set to start in 2018, cover investor protection, fee transparency, internal and external controls, and market structure.
Fee transparency is the Achilles’ heel of the wealth management industry, which has thrived on cost opaqueness (and correspondingly cost insensitivity on the behalf of investors). It is expected that fees levied by wealth managers will now come under scrutiny. According to a survey of high-net- worth investors by Oliver Wyman, 75% of the European respondents said they are willing to switch wealth managers if offered a 20% discount, compared with only 25% of U.S. investors surveyed.2
“The extent of the problem may even be understated,” the authors say, “given almost half of all surveyed respondents…aren’t really aware of the price they are paying, which impending regulation will start to change.”