FCA to double capital resource requirements for investment firms

Under a new income based requirement, PIFs would be required to hold capital resources that are at least equal to a percentage of the relevant annual income amount earned in the previous year. This will be set at 5% for most PIFs, but could reach 10% for PIFs which have permission to trade as principal, hold client money or manage portfolios.

The new requirements will not commence until 30 June 2016. Then there will be a 12 month transitional period during which the minimum requirement will be £15,000, before reaching £20,000 by 31 December 2017.

Principle 45 of the FCA’s Handbook requires that PIFs must maintain adequate financial resources. Most PIFs keep surplus capital resources to meet business expenses, unforeseen events, and pay legitimate redress. However, the FCA have said that the current minimum capital resources requirement of £10,000 is insufficient for that purpose.

In the consultation paper, the FCA said:

"Although the majority of PIFs do not hold client money, they have significant potential to cause damage to consumers’ finances, either through providing poor advice or by inadvertent mistakes. Our proposals seek to ensure that all PIFs hold a proportionate and consistentlycalculated level of capital resources, to absorb routine losses and redress claims against them.

"The aim remains to require a proportionate level of capital resources for PIFs to absorb routine losses and legitimate redress claims against them, as well as to provide time to make appropriate arrangements in the case of market exit.

"A PIF, holding the current minimum capital resources and a PII policy with a £5,000 per claim excess, which then experienced two legitimate claims, would have insufficient capital. We do not want compliant PIFs to fail unexpectedly under normal operating conditions."

In its annual report for 2013/14 the FSCS noted that there had been a 15% increase in claims in the life and pensions sector (mostly for SIPP related activity) and this was the most significant increase in claims activity across the categories they cover. The average compensation paid to consumers of failed firms was approximately £11,000. PIFs are the dominant channel (51%) for distribution of these products.

The consultation paper said that achieving a better balance of capital resources requirements could, under normal business conditions, lead to a reduction in the impact of failures and by doing so reduce the need for FSCS involvement.

The FCA added:

"However, we believe that it is valid to attempt to reduce the cost of mutualised failure by changing the distribution of capital, through a change to an income-based size metric as well  as the introduction of a higher flat minimum capital resources requirement.

"The cost of failure has to be funded in some way if consumers are to be adequately protected. We suggest that introducing a consistent approach to the setting of capital resources for PIFs as an ex-ante requirement is fairer than simply relying on FSCS alone as an alternative protection. Furthermore, if PIFs can settle legitimate compensation claims without failing then delays and distress caused to consumers should be reduced."

The FCA has committed to a funding review of the FSCS, by the end of 2016.