Standard Life and Aberdeen Asset Management have agreed terms of a recommended all-share merger.
The firms announced the plans to the Stock Exchange this morning, confirming reports of a deal over the weekend.
Shares in Standard Life jumped nine per cent at the open, while Aberdeen's stock was up six per cent.
Aberdeen shareholders will receive 0.757 new shares in exchange for each Aberdeen share. Standard Life said this arrangement values Aberdeen's issued share capital at a total of £3.8bn.
The combined group, which will be headquartered in Scotland, will "harness the talent in both companies to optimise the benefits for clients and shareholders".
Keith Skeoch, chief executive of Standard Life, and Martin Gilbert, chief exec of Aberdeen, will become co-chief executives of the new company.
Both the Standard Life and Aberdeen brands will continue to operate.
"We have always been clear that it is Standard Life's ambition to become a world-class investment company and that this would be achieved through continued investment in diversification and growth, coupled with a sharp focus on financial discipline," said Skeoch.
"We are therefore delighted that this announcement marks another important step towards achieving that ambition.
The combination of our businesses will create a formidable player in the active asset management industry globally.
He added: "We strongly believe that we can build on the strength of the existing Standard Life business by combining with Aberdeen to create one of the largest active investment managers in the world and deliver significant value for all of our stakeholders."
Meanwhile, Gilbert said: "We believe this merger is excellent for our clients, bringing together the strong and highly complementary investment capabilities of each firm with a breadth and depth of talent unrivalled amongst UK active managers and positioning the business to meet the evolving needs of clients and customers.
"This merger brings financial strength, diversity of customer base and global reach to ensure that the enlarged business can compete effectively on the global stage."
In 2015, Gilbert quashed reports that Aberdeen was looking for a buyer after the firm was hit heavily by its exposure to emerging markets. And last year, the group was forced to drop a bid for bid for Italian bank UniCredit’s Pioneer fund unit because it couldn't afford the €3.5bn (£3bn) price tag.
Standard Life is being advised by Goldman Sachs, while JP Morgan and Credit Suisse are advising Aberdeen.