Outlining the capital adequacy requirements

The Financial Conduct Authority (FCA) introduced the new capital resources rules in December 2015, and they took effect from June 2016.

They require all personal investment firms (PIFs) to set aside enough capital to cover any potential contingency.

According to the FCA, capital adequacy rules are part of the regulator’s consumer protection and integrity objectives.

On page 33 of its May 2015 consultation paper document, the FCA wrote: “When PIFs fail and leave a redress legacy, this cost is then mutualised by the Financial Services Compensation Scheme (FSCS) by way of ongoing regular levies and, occasionally by interim levies.

“We realise these levies are often seen as unfair to PIFs that have not failed and have not caused consumer detriment.”

PIFs that are also home finance and/or insurance intermediaries are also required to calculate their capital resource requirement under Mipru Linda Todd

In a nutshell, according to Keith Richards, chief executive of the Personal Finance Society, the requirements, which came into force in June this year, will require PIFs to set aside the higher of:

■ £20,000, replacing the current minimum requirement of £10,000.

■ An income-based requirement. For the majority of PIFs, this will be 5 per cent of the annual investment business income earned in the previous year.

In other words, the amounts will be calculated at 5 per cent of the annual income generated from a firm’s investment business, or a minimum of £20,000 a firm, whichever is the higher.

The income-based requirement, Linda Todd, head of Bankhall operations adds, also “replaces the expenditure-based requirement which previously applied to larger category B3 firms - (those with 26 or more advisers).

The table below shows the breakdown of ‘prudential’ advisory categories as set out by the regulator:

Although the requirements came into force on 30 June 2016, Mr Richards clarifies: “From this date onwards, there will be a 12-month transitional period where the new minimum capital resources requirement will be £15,000, which will switch to £20,000 from 30 June 2017.”

Who is affected?

Directly-authorised PIFs will come under the scope of the FCA’s capital resources requirements. According to the FCA’s policy statement from December 2015, PS15/28: Capital Resources Requirements for Personal Investment Firms - Feedback on CP15/17 and Final Rules, all PIFs should review the changes.

In the policy statement, the City watchdog wrote: “PIFs provide financial advice to retail consumers on investment products, generally without holding client money.

“This includes, but is not restricted to: pension planning, investment product selection, and income and estate protection. There are approximately 5,000 directly authorised firms in the PIFs sector and 9,000 appointed representative firms.

“PIFs provide both restricted and independent advice. Our rule changes relate only to directly authorised PIFs.”

Firms which form part of a network or come under the auspices of a national adviser do not have to worry about the rule changes.

The need to hold a cash buffer against an emergency has been in place long before the FCA or the then Financial Services Authority even existed. The old capital resources rules dated back to 1994, and were replaced on 31 December 2015 by the rules originally made by the Financial Services Authority (FSA) in its 2009 Policy Statement 09/19.

The new policy statement explains: “Although most PIFs do not hold client money, they can cause damage to consumers’ finances either by providing poor advice or by making an inadvertent mistake.

“Our policy proposals seek to ensure all PIFs hold a proportionate and similarly calculated level of capital resources to help absorb routine losses and meet redress claims made against them.”

Other firms

There are PIFs which are classed as Capital Adequacy Directive (Cad) exempt under the Markets in Financial Instruments Directive (Directive 2006/49/EC).

For these, according to Bankhall’s Ms Todd, their capital resource requirement will be the higher of:

(a) Their CRD requirement (€50,000 for firms that are not IMD insurance intermediaries, or €25,000 for firms which are Insurance Distribution Directive insurance intermediaries (or an equivalent mix of capital and PI insurance);

(b) The higher of (i) £15,000 (£20,000 from 30 June 2017) (i) 5 per cent of annual investment income.

There are others for whom the capital adequacy bell tolls - it is not just investment advisers facing the need for good capital adequacy - although the rules are different to those facing directly authorised PIFs.

Our proposals seek to ensure all PIFs hold a proportionate and similarly calculated level of capital resources to help absorb routine losses and meet redress claims made against them FCA

Ms Todd explains: “PIFs that are also home finance and/or insurance intermediaries are also required to calculate their capital resource requirement under rules governing mortgage and home finance firms and insurance intermediaries (Mipru), but ignoring the minimum requirement under these rules.

“This means these firms will also have to calculate 2.5 per cent, or 5 per cent if they hold client money for insurance mediation purposes, of their annual income from home finance and / or insurance mediation activities.

“Their capital resource requirement will then be the higher of (a) £15,000 (£20,000 from 30 June 2017) or (b) 5 per cent annual investment income + 2.5 per cent (or 5 per cent if applicable) of annual income from home finance and/or insurance mediation activity.”