Changes to prudential rules for personal investment firms (retail advisors and arrangers)
On 29 November 2023, the FCA published CP23/24 : Capital deduction for redress: personal investment firms (PIFs) which introduces their proposals to increase capital and apply 'IFPR like' rules to PIFs.
The FCA flag some key facts in the consultation paper which helpfully set the scene:
- There are approximately 5,000 PIFs authorised in the UK today.
- 75 firms caused 95% of the £757m FSCS costs for PIFs exiting between 2016 and 2022.
There are two main elements of the consultation:
The first is a requirement for PIFs to set aside capital resources for both ‘unresolved redress liabilities’ and ‘prospective redress liabilities’ and where they are not holding enough capital to meet potential redress liabilities, to comply with an asset retention requirement.
The second is essentially applying an 'IFPR lite' set of requirements (including risk management /ICARA elements).
In our view, the approach the FCA are looking to take under 1 is specific and logical, based on the underlying issue of FSCS redress costs. However, we suspect it will be difficult to implement and supervise. For instance, identifying and quantifying potential liabilities is a complex and often contentious task. If firms are inaccurate and claim not to have any liabilities, only to later identify complaints, well, the “capital cat” may have strolled out of the proverbial bag...
In respect of point 2, this is not unexpected. With many different types of firms and reporting requirements, it seemed inevitable that the FCA would want to apply a similar level of scrutiny to those on a more simplified prudential regime.
The existing prudential requirements for PIFs combine minimum capital requirements and the requirement to hold appropriate professional indemnity cover. PIFs are currently not subject to specific liquidity requirements. At present, their capital resources requirements are based on their income, without reflecting the scale of assets that they give advice on, specific risks that they face or their activities.
The FCA are concerned that these prudential requirements may not be suitable for all and are looking to introduce a more comprehensive regime which will include a combination of the following elements:
• regulatory rules around capital and liquidity adequacy
• risk management, governance and credit and loss provisioning requirements
• wind down planning requirements
• professional indemnity insurance
• reporting and disclosure requirements
In our experience, most PIFs struggled to understand the 'simple' requirements under RMAR, and we strongly suspect they will struggle to apply these rules properly.
It is going to be a big change and require major adjustments for many PIFs who have spent a decade working on the 'COBS' side of the business (getting the advice, documentation, and controls right) but less time on risk/prudential controls.
Also, the proposals don’t seem to recognise that many PIFs do not give advice, they just arrange, and this regime does not seem suited for them. We hope responses to the consultation paper make this clear and that industry bodies work with the FCA to make changes as proportionate as possible.
What’s next?
The consultation period for these proposals has been extended to 16 weeks and responses are due by 20 March 2024. The FCA plan to run a pilot data collection during the consultation period so that they can consider the results of this alongside the responses and will publish their findings and response in the 2nd half of 2024. It is expected that any changes will take effect in the 1st half of 2025.
We recommend any firms likely to be affected review the paper and get in touch if you have any questions. If you’d like to submit a response, make sure this is done by 20 March.