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Mid-sized advice firms face dramatic cap-ad leap


Medium-sized advice firms face a dramatic jump in the amount of capital they must hold within months, experts are warning.

Following concerns that firms facing the biggest increase are being given the shortest amount of time to make changes, trade bodies are urging the regulator to rethink its capital adequacy proposals.

In May the FCA proposed new income-based capital adequacy rules and delayed their introduction by six months. The regulator had been due to bring in expenditure-based requirements in December, but experts warned the rules – originally devised in 2009 and delayed three times – incentivised risky business models.

The latest consultation, which closed last week, proposes requiring firms to hold 5 per cent of the annual investment business income earned in the previous year.

The minimum capital requirement will increase from £10,000 currently to £15,000 on 30 June 2016 and £20,000 on 31 July 2017.

From 30 June 2016, firms must hold the income measure or the minimum, whichever is higher. The same applies to networks, and final rules are expected by the end of this year.

Currently firms with up to 25 advisers pay the minimum. Those with more than 25 advisers must hold four weeks’ expenditure, or 13 weeks’ expenditure for networks.

20-fold increase

Apfa argues that firms with 10 to 25 advisers which currently pay the minimum will see their capital requirements increase drastically from next year.

It says a firm with an income of £2m would see its requirement jump from £10,000 to £100,000.

Apfa says in its consultation response that the requirements should be staged for these firms as well as for those paying the minimum.

The trade body proposes a level of 3 per cent of income by 30 June 2016, rising to 5 per cent by 31 July 2017.

Apfa director general Chris Hannant says: “Overall, we feel the proposals are sensible. But mid-sized firms will feel the biggest increase and it does not seem right that those with the furthest to go are only given a year to get there.”

Norwich-based Almary Green has 15 advisers and currently holds the minimum level of £10,000.

Managing director Carl Lamb says the firm will have to hold £200,000 under the latest proposals, but is well prepared for the change.

He says: “Under the previous proposals we would have had to hold £500,000, and we have been keeping that in the bank in case the FCA did not amend its plans. Comparatively, the latest proposals give us a lot more flexibility on how we deal with our reserves.

“A £10,000 minimum is totally inadequate in today’s market.”

Managing risk

OAC Actuaries and Consultants senior manager Geoff Spencer says it is logical for the FCA to focus on mid-sized firms.

He says: “Mid-sized firms will be impacted the most, but that is because under the existing rules there is a massive jump for firms with more than 25 advisers, which is crazy.

“Small firms of up to five advisers tend to be low risk as they are tight knit and everyone knows what everyone else is doing.

“As you get up to 25 advisers, the risk management becomes more challenging. But large firms with over 25 advisers will have a full-blown compliance department, which brings the risk down again.”

Others believe an increase in the capital requirements is long overdue to prevent firm collapses.

The FCA says in its consultation paper: “An average redress claim for a pension or investment-related failure settled by the FSCS is £11,000. A personal investment firm, holding the current minimum capital resources and a professional indemnity policy with a £5,000 excess, which then experienced two legitimate claims, would have insufficient capital.”

Regulatory consultant and former FSA head of retail policy David Severn says: “The purpose of this paper was to make sure firms could absorb losses and meet redress claims.

“So if these new rules prevent some firms going into default that must be good news for the well-run IFAs which would otherwise have to pick up the compensation bill.

“I am not sure why Apfa is moaning about the timetable. These new requirements were originally canvassed years ago by the FSA as part of the RDR. If some firms have been burying their heads in the sand hoping they would just go away then that’s their look out.”

But Spencer says even though firms have had plenty of warning, some will be a “victim of circumstance” and could exit the market.

He says: “If a firm has just had an unexpected compensation bill, or the cost of a new computer system was much higher than expected, they could find themselves in a difficult spot.”

Those struggling to meet the requirements may seek to rid themselves of underperforming advisers in an attempt to reduce their income, he adds.

The FCA says in the consultation paper that of 4,000 firms analysed, 684 will need to raise additional capital to meet the new requirements. But it says it expects exits of smaller firms to be “limited”, and that the proposals will not adversely prejudice any particular sub-sector of the market.

Another Keydata?

Others have questioned whether the new proposals will be effective in easing the pain of rising FSCS bills.

The Wealth Management Association argues the FCA has provided little evidence to show the rules will result in fewer firms falling on the FSCS.

In its response to the consultation, the trade body says: “No evidence is presented in the consultation paper to indicate why the proposed level of capital requirements meets the stated aim to ensure there is a proportionate level of capital.

“For example, no evidence is presented as to what costs arise in the event of an orderly wind down of a personal investment firm.”

The WMA says the majority of its members are subject to the EU Capital Requirements Directive IV and therefore tougher capital requirements. However, its members are grouped into the same FSCS investment intermediation class as advice firms.

WMA director of regulation Ian Cornwall says: “We are concerned that the vast majority of personal investment firms have much lower capital requirements than our firms, in many cases conducting comparable business, within the same compensation class.

“Firms need to hold sufficient capital to manage an orderly wind down and sustain complaints in the reasonable course of events.

“It is not clear why the FCA has based its assumptions on firms receiving two FSCS claims. We have asked the regulator: if there was another Keydata-style collapse, would the FSCS be able to recover the money it needs from advisers?”

Adviser views

Martin Bamford, managing director, Informed Choice

The proposed changes to capital adequacy requirements are sensible and generally affordable for well-managed firms. However, I remain unconvinced that the changes will do anything to reduce the growing burden of the FSCS. When firms fail, in practice their capital is used up and they breach this regulatory condition before compensation to their customers can be calculated and paid. We continue to have a system where firms pay three times for consumer protection: by holding capital adequacy, funding FSCS levies and having PI insurance in place.

Tim Page, director, Page Russell

There is always going to be one sector that is hardest hit, but medium-sized firms would have been even more adversely impacted under the old proposed rules. The cap ad rules have been going round for years and we have finally got to a reasonable outcome so we should just get on with it.



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There are 7 comments at the moment, we would love to hear your opinion too.

  1. Our business commenced in 2003, and the capital adequacy requirement was £10,000 then – 12 years ago. An increase is long overdue, and whilst some firms may struggle, one must question how they run their business if 5% of their turnover would have such a dramatic effect. Would they be able to cope with a reduction in fees/income of 5% caused by a market correction?

  2. 2 thoughts:
    As Carl Lamb rightly identifies in the article firms should previously have been basing their medium-term business plans on the original expenditure-based cap ad requirements, which were much more onerous; so if any have been ignoring this then perhaps questions should be asked as to how they feel qualified to advise clients on long-term financial planning if they themselves cannot? Is this just a repeat of those advisers who felt the FSA (as then was) would not go through with the Level 4 qualification threshold in the run-up to RDR?
    Secondly, many have expressed reservations that a firm that might be doing something wrong would run down their cap ad account prior to going bust and so still dump all the liabilities on the FSCS and other advisers, before the FCA could identify it was happening. So why not explore the idea that these funds have to be placed in some sort of special bond or escrow-type account that cannot be accessed in the same way as a normal bank account?

  3. 2 thoughts here too-
    With an increase in cap ad this year and a lead in time of 16 weeks until FCA authorisation this is yet another barrier to new entrants into our business.
    Not every firm has 15-25 advisers and there are still single IFA businesses for which an additional £5k in reserves PLUS a 30%+ increase in fees may be the difference between running their own business and deciding to work elsewhere

  4. or go and do something else Alistair.

  5. I don’t know what the Wealth Management Association are banging on about, I would suggest that the vast majority of advisers would raise a cheer if they were segregated into another fee band, after all in the past few years, it is their members that have been the main source of claims on the FSCS.

  6. @Neil Duthie, Kevin Neil & Soren Lorenson; “We continue to have a system where firms pay three times for consumer protection: by holding capital adequacy, funding FSCS levies and having PI insurance in place”.

  7. The FCA says in its consultation paper: “An average redress claim for a pension or investment-related failure settled by the FSCS is £11,000. A personal investment firm, holding the current minimum capital resources and a professional indemnity policy with a £5,000 excess, which then experienced two legitimate claims, would have insufficient capital.”

    This suggests that the FCA are happy for us to pay redress claims out of Capital Adequacy. Not quite sure that’s how its supposed to work!

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