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How capital adequacy rules could catch you out

How capital adequacy rules could catch you out

Directly authorised advice firms have been warned they need to take a second look at new capital adequacy requirements. amid concerns they have been misled by the £20,000 headline figure.

Tenet Select has contacted directly authorised advisers to inform them of their options when the transitional period for capital adequacy comes to an end this month.

From 30 June it is a regulatory requirement that firms will need to hold the higher of £20,000 or 5 per cent of their investment business income in order to meet new capital adequacy rules.

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Martin Greenwood, chief executive of Tenet Group, said this could create challenges for smaller directly authorised advice firms.

Mr Greenwood said: “We are supporting directly authorised firms to ensure they know the facts and are able to weigh up their options before the impending increase takes place.

“Not all assets contained within a firm’s balance sheet will be allowable under the regulatory definition.

“Moreover, if a firm’s professional indemnity policy includes high excesses and exclusions, their capital adequacy requirement may well have to increase.

“This is an area that firms need to manage very closely and they should not be misled by the £20,000 headline figure.”

Before the FCA took action, the capital adequacy requirement was £10,000 for firms with 25 advisers or less and the greater of £10,000 or an expenditure-based requirement for those with more than 25 advisers.

For the past year the FCA has been implementing a transitional requirement of £15,000 but from the end of this month it will increase again to £20,000 or 5 per cent of income.

Mr Greenwood said this is a “substantial amount” in its own right but also reminded firms of additional criteria surrounding the figure.

This means it must be made up of the “right type” of allowable assets, eliminating most non-liquid assets such as the firm’s business premises or intangible assets such as goodwill.

It must be readily realisable, meaning it can be turned into cash within 90 days.

Meanwhile £20,000 is the minimum which must be maintained at all times, not just the date when firms draw up their balance sheet for regulatory reporting.

Mr Greenwood added: “If a firm is unable to raise or maintain the required capital, they need to consult with their accountant, professional indemnity insurer and support service provider to review their options.

“There are a number of potential solutions including taking out a subordinated loan, sacrificing their own income from the business in order to increase retained profits or cancelling their permissions and becoming an appointed representative of a network.”

He added that the Financial Conduct Authority has suggested it plans to increase the focus on smaller directly authorised firms following its suitability review.

Published last month, the review found restricted firms and network members were doing better at giving suitable advice and making clear how much they charge for their services.