Let me give you a simplified example. Firm A is very much old style. It has £500,000 annual turnover split between six advisers. It has an administrator to submit business and check commission. There is no back-office system. Advisers are paid commission, getting up to 80 per cent of what they produce. Most of their business is up-front, with minimal trail income of £72,000 a year.
Firm B is a financial planning firm. It also produces £500,000 annual turnover. It has two financial planners and four other full-time employed staff, including two paraplanners. It uses an outsourced compliance firm to monitor the quality of advice and adherence to treating customers fairly. It uses sophisticated back-office and financial planning software. Much of its income – £300,000 – is on an ongoing fee or trail basis.
Which firm poses the higher consumer risk? Which is worse placed to cope with a downturn and meet its liabilities? Can I suggest the answer to both questions is Firm A?
What is the effect of the proposed capital adequacy requirements? The heart of this is what is, and is not, included in the calculation. In essence, pure commission-only remuneration is excluded from the cost calculation but salaries are not.
For Firm A, it is going to be 13/52 of expenses after the salespeople have been paid. In simple terms, this means 25 per cent of around £60,000 hard costs. This amounts to about £15,000, rising to £20,000 in 2012.
From my experience, it is reasonable to assume Firm B makes around £200,000 a year in gross headline profit before tax, owners’ remuneration and so on. Working on the same basis as Firm A, the capital adequacy requirement will be 13/52 of the hard costs, that is 25 per cent of £300,000, amounting to £75,000.
Yet Firm B has monthly income of £25,000 which is enough to pay ongoing obligations without requiring any additional capital. Why does this firm need to tie up an extra £65,000 (£75,000 minus £10,000) than it does today to address a concern that does not apply to that particular business model?
The answer is that, oddly, the FSA regards this income stream as nothing more than goodwill, so it cannot be included in the calculations.
It is all very well to say that Firm B should have this extra capital anyway. This ignores the fact that capital has a cost and it is the low-risk firm that is being required to pay this cost. There is also the very real concern that this requirement will act as a barrier to entry in this market and a barrier to change. These changes will hit firms looking to transition their model and new financial planning start-ups the hardest.
Phil Billingham is a director at Perception Support