On November 29 2023, the Financial Conduct Authority announced proposals to require personal investment firms, otherwise known as investment advisers, to set aside capital to cover compensation costs.
The proposals would require firms to calculate the cost of rectifying mistakes in the event of a customer being adversely impacted (known as redress liabilities), set aside enough capital to meet these costs, and report these incidences, where compensation is required, to the FCA.
We urge firms to engage with their industry association to ensure involvement in coordinated responses.The proposed changes are part of the FCA’s drive to create good consumer outcomes and ensure that the fair treatment of customers is central to corporate culture.
If this phrase sounds familiar, it should, as it is a key element of the watchdog’s consumer duty, which goes hand in hand with these proposals as part of the regulator’s wider consumer investment strategy.
Where the consumer duty addresses the adequacy of products, these proposals assess the adequacy of advice as part of the FCA’s aim to ensure good outcomes are being provided at every point of the retail investment value chain.
Advisers are no doubt pouring over the detail of the FCA’s suggested capital reforms, but to minimise concern about more regulatory change coming down the tracks, we recommend taking into account the following five considerations as firms prepare to respond to the proposals and, ultimately, manage implementation.
1. Read the consultation paper and Dear CEO letter
It sounds simple, but getting into the weeds of the changes to the prudential regime will act as a reminder to personal investment firms of their existing responsibilities, as well as explain the approach the FCA is taking to ensure consumers are treated fairly.
These proposals are a high priority for the regulator and, once implemented, will work in conjunction with other reforms to the advisory market, including the consumer duty and the advice guidance boundary review.
It is therefore paramount these proposals are put in front of the right internal stakeholders to ensure they understand the FCA’s direction of travel and the standards they, and the wider business, will have to adhere to.
2. Assess the scope to be on the front foot
The industry is working with draft proposals at this point in time, but complacency now will only cause difficulties down the line when the regulatory reforms come into force.
Firms should therefore be well prepared and take the time now to conduct high-level analysis to determine how the proposals apply to the business and if any exemptions can be afforded.
The firms in scope mainly provide advice and arrange deals in retail investment products and are exempt from Mifid regulation – although the FCA estimates that in reality only one-third of the market would have to set aside capital.
However, it is worth noting that the FCA is already monitoring firms that are applying to cancel or take new permissions in an attempt to work around these new rules.
So, this part of the process is particularly important to ensure firms and individuals are on the right side of the regulator come implementation.
3. Allocate responsibilities and ensure IT systems are in check
Complying with the requirements will necessitate additional reporting to the FCA on an ongoing basis, and this is really important to remember.
Systems, controls and measures will need to be enhanced to provide the required oversight and ensure potential redress situations are properly quantified and reported.
However, before this step can be taken, responsibilities must be allocated among senior managers to oversee the process. IT systems must also be reviewed and updated if necessary, to ensure the business has the right tech infrastructure to support implementation.
4. Leverage your consumer duty framework
As previously stated, the capital redress requirements go hand in hand with the consumer duty as part of the FCA’s consumer investment strategy.
Therefore, to create efficiencies, firms should be leveraging their management information and data on consumer outcomes, obtained when complying with the consumer duty.
This data, if collated properly, will include indicators of future payments for unresolved complaints and/or redress payments in instances where advice led to a poor consumer outcome.
From this information, firms will need to calculate the capital required to pay redress for unresolved complaints, or future redress from recurring or systemic issues and foreseeable harm.
However, the interwovenness between the consumer duty and the capital redress proposals can do more than simply create efficiencies when implementing the latter regulatory change.
From these two regulatory requirements, firms can gain a clear picture of the FCA’s direction of travel, which is to encourage greater proactivity, amongst personal investment firms, to ensure customers are treated fairly and receive good outcomes.
So, follow the advice of the regulator and take the initiative now to be ahead of implementation and prepared when that day comes.
Also, central to these proposals will be the classification of vulnerable customers. According to a More2Life vulnerability report, 30 percent of advisers have clients classified as vulnerable.
This figure is up from 15 per cent in 2021, but with the FCA focusing firms on recognising vulnerability, we would expect the number to increase further.
These are individuals who, due to their personal circumstances, are especially susceptible to harm, particularly when a firm is not acting with appropriate levels of care.
According to the FCA, this could include: individuals with poor health; those undergoing life events, such as new caring responsibilities; and those with low resilience to cope with financial shocks.
The consumer duty should have improved the process of identifying vulnerabilities in customers among the adviser community, but the adequacy proposals will, again, shine a light on this as the FCA works to ensure firms can recognise customers displaying characteristics of vulnerability and make sure they experience the same quality of outcomes.
5. Engage with the consultation
The FCA is welcoming feedback by March 20 2024, so now is the time to voice concerns and thoughts on the proposals.
We would therefore urge firms to engage with their industry association to ensure involvement in coordinated responses, particularly those that provide views on the proportionality of the rules – a specific point the FCA will be looking at closely.
As part of the proportionality discussion, firms should be providing feedback on the extent to which these proposals will take focus away from providing good consumer outcomes for the sake of getting internal infrastructure – ie systems and processes – prepared for implementation. Because, when it comes down to it, the regulator wants firms to be concentrating on creating a well-run business that puts customers first.
No doubt the proposals may be daunting to some, particularly with the financial requirements attached, but, as stated previously, the best advice that can be heeded at this point is prepare, prepare and prepare some more.
The work that is put in now will only reap rewards upon implementation and ensure firms remain out of the red, which, in this instance, will involve the FCA stepping in with automatic restrictions on the sale of products and services.
Linda Gibson is head of regulatory change, EMEA at BNY Mellon Pershing
