Capital inadequacy

19 November 2009

Tony Byrne IFA View

As if TCF, RDR and the pension-switching review were not enough to contend with, IFA firms are now being confronted with new capital adequacy rules.

The new requirement, to be phased in over the next four years, is for firms to have the equivalent of three months’ fixed expenditure in reserve, subject to a minimum capital adequacy requirement of £20,000. It remains to be seen what exactly is the FSA’s definition of fixed expenditure.

It appears the FSA is hell-bent on ridding itself of smaller IFA firms despite the fact that advice given by the IFA sector is considerably better than banks and insurance companies as shown by the fact that just 3 per cent of all complaints are made against IFAs, of which just 30 per cent are upheld. This is even more remarkable when you consider that IFAs control the lion’s share of the market.

The FSA is apparently concerned that smaller IFA firms represent a capital adequacy risk as most of them are not covered by Mifid. There are 5,000 personal investment firms authorised by the FSA. Most of them are small, 83 per cent have fewer than five advisers.

The vast majority of them do not handle client money, they maintain professional indemnity cover and hardly suffer any complaints. So where is the risk?

The current capital adequacy rules are already fundamentally flawed. Let me explain why. If, for example, an IFA firm wants to buy another firm for £100,000, the acquisition, even ignoring any borrowing, is immediately treated as a deduction against its reserves. The goodwill value is not recognised on the balance sheet because it is an intangible asset.

Assuming reserves of £50,000 before the acquisition, the reserves become negative to the tune of £50,000 after the purchase. The capital adequacy rules are broken and the IFA firm is now in trouble with the FSA.

The nonsense is that the firm is now bigger, stronger and more profitable, yet its balance sheet shows it to be weaker. What ludicrous rules.
Increasing the amount of money Pifs will be required to keep on deposit will exacerbate the problem.

Using the same example, let us say its fixed annual expenditure is £400,000. The firm will be required to keep £100,000 on deposit. This means it is denied the opportunity of buying the other firm anyway. The opportunity cost to the business of keeping such a large amount of money on deposit is huge.

IFAs who offer first-class service to their clients are continually being put under pressure by a Government quango, the FSA, which is heavily influenced and directed by the EU and the banks, so much so it threatens to ruin the future of the independent advice sector in the UK.

Tony Byrne is financial planning director at Wealth and Tax Management

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