Recent comments from the Financial Conduct Authority that the current level of the Financial Services Compensation Scheme levy is unsustainable may be seen by some as no more than confirmation of the blatantly obvious, but for others, a senior representative of the regulator making such a strong statement may be something of a watershed moment.
Either way, the issue of meeting the liabilities of failed businesses and capital resource requirements look to be back on the regulatory agenda.
That is no bad thing considering the FSCS levy for 2021-22 is expected to top £1bn – a 48 per cent increase on last year – of which investment advice companies will contribute £240m.
The increase is attributed to a rise in complex pension cases, further self-invested personal pension provider failures and an expected increase in business failures because of the Covid-19 pandemic.
There will be no increase in the total amount paid by investment advice companies in 2021-22 as the class will breach its limits for the second successive year.
That total, however, if spread across a smaller number of companies, may result in each being asked to pay more individually. So, a debate about improving the system, as the FCA put forward in its September 2020 Call for Input, is welcome.
The objective of a CRR should be two things: to provide a capital buffer to enable a business to wind-up in an orderly manner (often conflated with working capital but not the same thing); and to ensure there are sufficient resources to meet liabilities to customers after it has failed.
Pre-Retail Distribution Review, there were three tests that businesses were required to meet. Test 1, the own funds requirement, set a minimum of £10,000 of available funds and Test 1A, adjusted net current assets, required positive net current assets after the deduction of certain items.
Most significant for larger businesses was Test 2, the expenditure-based requirement. Only networks and companies with 26 advisers or more were subject to this, which required them to hold a proportion of their annual expenditure (with a per adviser minimum).
This ranged from 13/52 (three months’ money) for networks down to 4/52 (one month) for standalone businesses.
The calculation of the EBR was set out in detail and there were some flaws involving the treatment of depreciation and amortisation of goodwill. Clawbacks and claims provisions in networks and self-employed models (where part of the provision due from an appointed representative or adviser was not automatically allowable) were an issue too.
Several businesses ended up successfully applying for waivers as a result. Some groups organised into multiple regulated entities, each one of which was maintained below the 26-adviser threshold to ensure they were not subject to the EBR at all.
Despite the drawbacks, the exclusion of smaller companies and 4/52 not being sufficiently large, the EBR had the virtue of being related to the costs of a business, thereby meeting the need to provide a capital buffer enabling it to wind-up in an orderly manner.