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Guessing game as FSA keeps cap-ad clarity in reserve

The FSA’s lack of clarity on capital adequacy requirements is creating an air of uncertainty and means IFAs have less time to build up the necessary reserves, the industry has warned.

It has been over three years since the FSA first published a review into the prudential rules for personal investment firms and a year since it promised a consultation on the expenditure-based requirements to establish a level playing field for all firms.

Last November, the regulator announced all IFAs will have to hold capital worth at least three months of their annual fixed expenditure, with a minimum of £20,000.

The requirements will be phased in so firms will have to hold a minimum of one month’s fixed expenditure or £15,000 by December 31, 2011, going up to two months’ worth or £15,000 by December 31, 2012, and three months’ worth or £20,000 by the end of 2013.

The FSA planned to consult this year on how to apply these rules to all Pifs fairly but now says this will take place in 2011.

An FSA spokeswoman says: “We want to do a robust consultation on this and not just squeeze it in at the end of the year just because we said we expected to do it this year.”

In the meantime, firms are becoming increasingly anxious about what the impact of the capital adequacy requirements will be on distribution and if the rules will change between now and 2013.

Tenet distribution and development director Keith Rich-ards says the delay may be because the FSA does not know how to consistently apply the rules to all firms.

Richards says: “It is likely that the FSA underestimated the number of unintended consequences of its capital adequacy requirements and is having to take more time than originally expected to assess the effect on different firms and how to deal with any disproportionate impact, whatever the size of the business.”

Threesixty commercial dir-ector Phil Young says: “By foc-using on an expenditure-based amount, the rules are going to be punitive to the firms that have built up infrastructure and set up employed adviser models and will end up benefiting the one-man bands working out of a bedroom. That seems to be at odds with what the RDR is trying to achieve.”

Institute of Financial Planning chief executive Nick Cann says: “From our direct experience with the FSA, we are not comfortable that it has understood the nature of the businesses it is dealing with when it comes to capital adequacy. On the one hand, it is asking businesses to become more professional, but on the other hand it is penalising the businesses that make those changes.”

Cann argues that the regulator needs to come up with capital adequacy rules that are more relevant to new model businesses, such as taking into account recurring revenue.

He says: “The FSA says this does not count as the income has not been earned yet while the financial planning community would argue there are client agreements in place to provide an ongoing service which guarantee the money coming in. There has been an impasse on this issue which might be why there has been a delay.”

Lighthouse Group chairman David Hickey says the lack of clarity over capital adequacy comes at a time when IFAs are already uncertain about the future.

He says: “Many advisers are trying to figure out how their business is going to work to cope with the retail distribution review and that is taking up most of people’s time but there is an element of guesswork with that. If you then superimpose increasing capital adequacy requirements on top of what is already some guesswork on future business models you find yourself in a situation with a lot of uncertainty.”

Originally, the FSA had int-ended to bring in its increased capital adequacy requirements in December 31, 2012 but, after industry lobbying, the deadline was extended to the end of 2013.

Young says the decision to put back the requirements by a year allows the FSA and advisers to focus on the more pressing RDR deadline.

He says: “There is 12 months’ grace to deal with this particular issue but we have always felt this could be the main event and that it will have a more radical impact on the shape of IFA distribution than the RDR itself.

“The capital adequacy requirements could be more open to legal and European challenge than the RDR and we think this capital adequacy issue may be one the FSA has to handle with even more caution than the already controversial RDR.”

Hickey says that as time drags on without the consultation paper, it leaves less time to put aside capital.

He says: “Any business needs time to build reserves and if you are having to do that at a time when you are trying to significantly change your business model, it puts additional strain on the entity.

“On the one hand I have a lot of sympathy with where the FSA is trying to get to but I have a lot of sympathy for IFAs who may be facing a triple challenge of qualifications, the adoption of a new business model and somehow or other procuring the additional reserves needed to satisfy capital adequacy. It all adds up to a lot of pressure and a lot of stress.”

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