The Navigator: perspectives on financial services M&A

Of all the financial services M&A trends that we predicted in our first issue of The Navigator, the one that is most relevant to retail banks in this quickly evolving GenAI era is partnering.

In the EY-Parthenon Q2 2023 Generative AI in Retail and Commercial Banking Survey, decision-makers said they believe GenAI will enhance profitability and efficiency, with benefits including higher levels of tailored products and services and improved operational speed. But they are also worried about:

• Lack of internal expertise
• Regulatory ambiguity and volatility
• Cost and budget constraints
• Data privacy and security
• Accuracy and reliability

To stay relevant, banks will need to overcome these challenges and reimagine their future with GenAI, while watching out for the following:

Identifying optimal GenAI applications amid case noise

Most decision-makers reported approaching GenAI in the same way as legacy automation capabilities, which will lead to missed opportunities. Survey respondents expressed apprehension about the viability of GenAI in the front office, and 67% said they are waiting for further developments and testing before prioritizing front-office use cases. Instead, enhancements are concentrated in the back office, with risk and operations projected to capture the largest efficiencies. By focusing on back-office priorities, banks risk losing out on strategic opportunities for new products, new markets and market differentiation.

To help identify optimal GenAI applications, banks should review the lessons learned from blockchain, where many wound up funding poor use cases. Given the high costs and challenges of GenAI, banks need to assess whether GenAI, legacy technology or a combination is the right solution.

Establishing infrastructure and tech talent

Only 32% of survey respondents reported having a team focused solely on GenAI. Thirty-seven percent do not have confidence in their institution’s technological infrastructure — which in banking tends to be outdated and heavily customized — or in their tech staff’s capabilities to implement GenAI use cases. Banks will have to make investing in infrastructure and talent a top priority or risk getting left behind.

Leveraging acquisitions, partnerships and ecosystems

Given the novelty of GenAI and in-house technology limits, 51% of respondents surveyed preferred partnerships as their go-to-market approach. To deliver new capabilities to market and transform their business models, banks should explore pursuing acquisitions or building partnerships and ecosystems with GenAI technology providers. Developing an ecosystem has the added benefit of outside-in perspectives that can uncover lagging practices, guide investments and facilitate successful implementation.

Novel risks and challenges of GenAI

When exploring investment opportunities (i.e., targets) in the GenAI space or to bolster GenAI capabilities internally, more parallels can be drawn from blockchain, such as how the absence of regulatory clarity and risk management became the culprit for investment losses. Evolving technology can lead to additional risks. For GenAI, this includes, but is not limited to:

• Intellectual property (IP) (ownership of IP rights, potential infringements and ongoing litigation)
• Data quality, privacy and security (scrutinizing data acquisition methods, privacy compliance and security measures)
• Regulatory environment (compliance with fast-evolving regulatory requirements)

In the wealth management advice space, we continue to hear about two goals:

• Expanding white-glove services
• Scaling to cater to the masses

At face value, these two goals are in conflict. By offering key white-glove services, the scale element remains elusive. On the other hand, scaling an offering makes it difficult to bolt on adjacent catered services. For the innovator who can square this circle, the upside is enormous, given the looming transfer of wealth from boomers to their Gen X and millennial children. But disrupting this space is no easy task.

Five years ago, registered investment advisors (RIAs) worried that robo-advisors would be a game changer, only to discover that most clients prefer to entrust their financial assets to a human advisor. Clients continue to look for the personal connection that no robo-advisor can currently provide. While robo-advisory offered up one of the aspirations — scale —it wasn’t enough to disrupt.

So who can actually provide white-glove service at scale? We believe PE firms, with their existing M&A and investment model, are in the best position to reach this apex.

Their M&A and investment model allow PE firms to invest in several RIAs at once, in a range of areas that include tax planning, estate planning and GenAI. This creates an attractive package of advisors, distribution channels and key white-glove services, all in the same portfolio. Over the last five years, more than 150 PE firms have invested in RIA portfolio companies, according to EY analysis. Of these, 33 have crossover in at least five other wealth service portfolio companies.

For independent RIAs, PE portcos have the advantage of value creation. They can help RIAs improve their pricing and upscale their distribution channels. And they can recommend bolt-on M&A and partnership opportunities to further expand into white-glove services. Meanwhile, many independent RIAs are feeling the burden of overhead costs in technology, human resources and strategic planning, leading them to seek out investments and guidance from PE firms.

We have yet to see a PE firm pursue white-glove service at scale as a holistic wealth management strategy. But we predict the one that does will upend legacy advisory services and will be poised to take full advantage of the coming generational wealth transfer.