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Keep capital adequacy simple

Bruce Wilson
Bruce Wilson

One of the hottest topics in the run-up to the RDR is capital adequacy which has been thrown back into the spotlight recently as the FSA is looking at it in relation to wrap platforms – something that has not happened before.

I welcome this subject being back on the agenda as it is essential to IFAs and any business. Businesses need to be mak-ing money or their future looks bleak and this is especially true for IFAs in the current situation.

There is a football analogy to describe the current financial situation of IFAs. IFA firms are like football clubs – they hire their star players (advisers) who make a good living and a good amount of money. But the IFA firms themselves are broke. In order to keep these star players, we have to pay them more than we can afford while dealing with the spiralling cost of bureau-cracy and regulation. This all adds up to the fact there are few IFA firms making any money. Good players inevitably mean good turnover but I think it is essential that IFAs should be forced to retain more capital.

IFAs are starting to realise the importance of having a strong balance sheet – if nothing else, it is reassuring to know we will not be closed down if there is another downturn.

But although capital adequacy is a fundamental business principle, I fear that the FSA could push things too far to the other extreme.
I have noticed that quite often, measures brought in by the FSA to make things work better have had the opposite effect.

Good firms are looking for a regulatory payoff rather than more regulation.

For example, when the FSA introduced depolarisation, it managed, in my opinion, to polarise the market more effectively than pretty much anything that had gone before it.

Now we are seeing business consultants such as Ernst &Young taking the view that restricted advice may be the best option for many in the advice sector. If they are right, this will mean further haemorrhaging of IFA numbers.

So while capital adequacy is an important part of our industry, I hope that this is something that is kept simple and is not overcomplicated.

It is inevitable that many IFAs will be pushed out of the advisory arena – as with any crisis, the good will survive while the poor will not.

These are challenging times for everyone and steps must be taken to prevent the good from going to the wall, simply because they have failed to meet an arbitrary level of capital.

Bruce Wilson is managing director of Helm Godfrey


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There are 9 comments at the moment, we would love to hear your opinion too.

  1. One wonders whether Mr Wilson actually read DP07/4, FS08/2, CP08/20 CP09/20 and PS09/19 before penning this piece. This debate is over with the new rules set to start taking effect in a little over 4 months.

    That said, his footballing analogy is absolutely spot on – IFAs are getting paid at “star player” levels that is clearly unsustainable, particularly on a risk-weighted basis. “Good” firms are those that are realising this and are doing something about it before they melt down financially.

  2. A good and thought-provoking article, Bruce.

    The new capital adequacy requirements have of course been pushed back until the end of 2011 before their phased introduction, but they still require planning from forward-thinking IFA firms.

    Individual approved persons should be looking carefully at the published accounts for their ‘host’ company and thinking carefully about their involvement with loss making organisations. There are sadly too many of these around; probably more to do with the chosen business model (stack ’em high, sell ’em cheap) than the cost of regulation, etc.

    Turnover is a rubbish measure of success in retail financial services, but unfortunately something of an obsession.

  3. Realist – youre right, but rules CAN still be changed if sufficient common sense momentum to change them is generated.
    Bruce: “it is essential that IFAs should be forced to retain more capital”. FORCED is the word i dont like. We all know its good sense, but there are occasionally business cycles when turnover falls, maybe we even want to BORROW money to expand, maybe we nee/want a month long holiday and we might dip £10 below the limit while we’re away….etc…
    My real beef with the capital adequacy issue is that it simply DOESNT WORK to achieve what its meant to. All it leads to is a HIGHER level of money than Zero, which if you breach it means you will still cease trading (presumably, or whats the point?). So, the firm is more likely to cease trading sooner (and clients lose their IFA sooner) and the money supposedly for capital adequacy will still be owed to landlords, HMRC, staff, etc (for whom capital adequacy is irrelevant if you are still a solvent business) so the money will still disappear. Additionally, we cant borrow or take risks to fund growth if we want to, even though it appears the country as a whole is crying out for businesses to be able to borrow to get things moving again. Measured risk taking is not in itself a business sin after all! Why IFAs alone are singled out for this restriction no one has ever explained. Do any other “advice only” businesses have the same business restrictions and obligations to tie up money doing nothing??

  4. Great analogy Bruce – you find a lot of us using it in the next few months.

    The big problem I have is that the FSA promised a consultation over the calculation of the Expenditure Based Requirement – which most of us will be caught by. I haven’t see it yet and – as Realist says – the clock is ticking….

  5. Martin says “Turnover is a rubbish measure of success in retail financial services, but unfortunately something of an obsession.”

    Turnover is Vanity — Profit is Sanity !!!!

    PS I hope Bruce Wilson doesn’t become the chairman of my football club or we will have another Portsmouth on our hands. Any business that is stupid enough to pay out more than their profit and not realise it, ( – there seems to be masses of them – not just in financial services) deserve their eventual demise. Unfortunately, we the survivors will have to pick up the tab for their FSCS/FOS claims.

  6. The sad thing is that they will not work. Capital Adaquacy is something the accountants create on paper in accordance to established principles. In reality the firms with adaquacy problems have long since lost any cash since the first thing that goes is the money to be replaced by loans or overdrafts. The debtors then have to be chased and in reality the cost of chasing can be more than the money recovered. Finally the assets are usually over-inflated especially at a time of forced sale.
    The idea of CA is fine, but these rules will not stop the disreputable and will penalise good well financed and properly run firms. Sadly it will also push employees onto less secure contracts.

  7. Sam Caunt has alluded to the irony of the proposed CA rules. As they currently stand the EBR (Expenditure Based Requirement) calculation encourages firms to take on self-employed advisers instead of employees. It penalised firms that have invested in decently staffed back offices to deliver a proper service.

  8. “It is inevitable that many IFAs will be pushed out of the advisory arena – as with any crisis, the good will survive while the poor will not”

    Maybe some will simply choose not to.
    It may be that some will say ” we have had enough of this mad dictator of a regulator who when we have no bread says “then let them eat cake”

  9. Until the PIA and FSA started regulating everything under the sun by hindsight to shift the blame for their own regulatory failures onto those they claim to regulate, capital adequcy was never an issue, was it? But now, in the wake of the huge increase in PII claims and, as a result, policy excesses, a couple of claims against a small firm could wipe it out almost overnight.

    What’s worse is that most DR IFA firms will probably never be able to get back the money the FSA is forcing them to set aside now. As a result of the FSA’s (illegal) denial of the 15 year longstop, the prospect of this capital having to be raided to meet the excess on some PII claim at some determinate point in the possibly far-distant future means that the FSA will probably never allow it to be accessed.

    So, in effect, the FSA is dictating that IFA’s are going to have stump up a probably never-recoverable £20,000 just to be allowed to continue to trade.

    What does Hector Sants have to say about this, other than spouting the usual vacuous platitudes about consumer protection? My guess is that he’s completely unconcerned about the fate of small IFA’s and that this is just another step in the FSA’s concerted and sustained campaign to eradicate them.

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