Chief executives say tighter governance will discourage all but the biggest M&A deals

An FSA report has warned leading brokers that the consolidator model must face stricter governance and controls or risk market failure.

The FSA’s Financial Risk Outlook 2010, published last week, warned brokers that acquisitions and mergers “can threaten the regulated entity if the integration is not successful or if the group fails to put adequate risk controls in place”.

To guard against these risks, the report said: “The increasing size of consolidators requires more sophisticated governance systems and controls.”

“The complexity of these groups raises the risk of failure and could impact other consolidators, especially if the consolidator model is perceived as a failure by investors and market participants,” it said.

A tightening of regulatory control over consolidation activity will lead to a smaller number of bigger players, chief executives have predicted.

Jelf’s chief executive, Alex Alway, said that tighter regulation would increase the level of resources brokers had to put into M&A.

“It’s going to raise the bar even higher and weed out people. There will be a smaller number of bigger players,” Alway predicted.

The Towergate-owned Broker Network Group’s executive chairman, Grant Ellis, agreed that greater regulation would heighten the barriers to entry for firms exploring acquisitions.

Bluefin’s chief executive, Stuart Reid, commented that tighter regulation could snuff out any revival of consolidation activity by mid-market companies.

The outlook report also raised concerns over brokers expanding into different areas of financial advice, in which they lack expertise, in order to compensate for declining commission and investment income.

And the report, which is an annual crystal ball-gazing exercise for the FSA, warned insurers that claims inflation is a “major risk” because many claims and underwriting staff have only worked in the relatively benign economic environment of the past decade.

“Early warning signals may not be noticed or may be ignored until too late,” said the report, recommending the establishment of robust monitoring systems.

The financial regulator also announced the establishment of a new joint consumer protection committee with the OFT and the Financial Ombudsman Service to scan new financial products for emerging risks.