The Broker Protocol – What Lies Ahead?

by PwC AM on January 22, 2018

By Arjun Saxena and Jay Remis

First one major firm, then a second one and then a third: three months and three major retail brokerage players have all exited the Broker Protocol. Two are major wirehouses — with $4 TRILLION of AuM between them – plus a major bank. Ostensibly, the idea is to reduce recruiting costs and focus on organic growth and retaining current advisors. But does that make sense from the wealth managers’ perspective? Could this trickle to the exit become a flood?

The answers are yes and maybe. But before we explain why, a little history to help put this into context.

Prior to 2004, advisors who left their firms faced legal restrictions which made it difficult for them to bring existing clients to a new firm. But then along came the Protocol for Broker Recruiting (aka “Broker Protocol”) which then allowed advisors leaving one firm for another to take basic client contact information to their new firms.  One phone call and a meeting later, the advisor in theory at least could persuade the client to transfer funds to the advisor’s new base of employment.

One of the major unintended beneficiaries of the Broker Protocol has been the RIA industry.  Many financial advisors believe RIA firms offer them a more flexible platform versus full-service brokerages and the Broker Protocol has made it easier for FAs to leave.  The past decade has witnessed consistent growth in the RIA sub-sector, with total AuM increasing from $1.7 trillion to $4.2 trillion between 2006 and 2016 (a 9.2% CAGR, compared to a 7.7% CAGR for the S&P500). Several trends have driven the migration of FAs to the RIA model and the growth of the RIA Industry:

  • TAMPs and RIA platform vendors provide technology services and outsourcing capabilities which reduce barriers to entry and make it very easy for financial advisors to start up new RIAs
  • Large RIA platform providers continue to see significant benefits from scale – they have established a virtuous cycle where growth allows them to fund investments to improve tools, products and service offerings and continue attracting breakaway FAs [IT budgets at the two largest RIA platform providers are now comparable to those at wirehouse firms]
  • A low interest rate environment and availability of financing have significantly offset the traditional scale advantages enjoyed by wirehouses

Net result: During the past decade, independent RIAs and hybrid RIAs have continued to increase market share (see Fig. A).

Fig. A – Market Share by Business Model / Channel (% of Advisor-Managed AuM)*

The continued uptrend across markets (US equities, debt, emerging markets) over the last 9 years has allowed the larger full-service players to enjoy strong revenue growth and pre-tax income margins from their Wealth Management units, despite the steady leakage of advisors to the RIA model. So if everyone in the equation is making money – from the firms to the advisors to, presumably, the client – why upend the system? Why pull out of the Broker Protocol?

Recent developments explain the change – the prospects for continued go-forward growth in markets from current levels are mixed at best. Also, the DOL Fiduciary Rule has caused the entire wealth management industry to shift attention to more fee-based business models which are customary for RIAs versus commission-based business historically associated with full-service brokerage firms. It has also shifted bargaining power away from FAs and towards firms by severely curtailing sign-on bonuses for lateral hires, and by making any move of retirement accounts across firms subject to fiduciary requirements. To protect and grow their franchises further, several wirehouse firms have decided to exit the Broker Protocol in order to:

  • Eliminate hiring practices which offered large upfront payouts (e.g., sign on bonuses of ~250-300% of trailing 12-month revenue) to FAs switching from another firm, thus reducing operating costs
  • Free up resources to invest in digital capabilities to enhance client experience and increase financial advisor productivity
  • Retain and incentivize existing advisors, rather than on lateral hiring

At firms where we have run the analytics, we estimate that the impact of lowering advisor attrition and reducing AuM outflow for departing financial advisors by 20% can add ~2 percentage points to pre-tax margins. For a typical wirehouse firm, this corresponds to $200-400MM more in annual pre-tax income impact.

Within weeks of the exit decisions, the industry witnessed FAs with $10 Bn+ in Assets under Management (AuM) transitioning away from the two wirehouses – we believe this pace of FA departures is likely to slow significantly given the increased risk to FAs considering such a move going forward. In our experience, advisors who switched firms after introduction of the Broker Protocol were able to take ~90% of client AuM to their new firm (versus only ~70% of client AuM prior to the Broker Protocol coming in place) – the risk of a 20 percentage point drop in AuM (and therefore income!) along with potential litigation risk present could be a significant deterrent to any FA considering such a move.

Some strategic and operational considerations for other wealth management firms:

  1. What is likely to be the competitive response from RIA platform players, and from Independent Broker Dealer players, which have traditionally espoused the flexibility they offer FAs as part of their pitch to wirehouse FAs?
  2. Given the exit of three firms from the Broker Protocol, what should be the appropriate course of action for other full-service brokerages:
    • Does continuing membership leave them disadvantaged versus the firms which have left?
    • How should they weigh the benefit of protecting the existing franchise versus being able to continue attracting lateral hire FA talent?
    • How can acquisitions and joint ventures be leveraged to drive growth?
  3. If they choose to exit (and hence become significantly less attractive to lateral hire FA talent), how can they reinvigorate organic growth – increasing share of wallet and attracting flows from existing clients, and new advisor hiring / training programs?
  4. What should be their one-time and ongoing messaging to FAs and clients, to consistently communicate why firms are going down the path they choose?

Those are our thoughts. Tell us yours.

The authors would like to acknowledge analytical and research support from Andrew Knowlton, Michael Gildner, Peter LiVolsi and Leean Saveker.

Source: Public securities filings; Cerulli; PwC |Strategy& client experience and analysis

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