The Financial Conduct Authority (“FCA”) have launched a consultation that would require Personal Investment Firms (“PIFs”) to quantify and set aside capital resources for “potential redress liabilities” connected to designated investment business. Designated investment business includes regulated activities like advising on investments, advising on the conversion or transfer of pension benefits and arranging deals in investments. Potential redress liabilities mean “unresolved” redress liabilities i.e. when a consumer has made a complaint, where this complaint may give rise to a liability and a decision is pending e.g. from the Financial Ombudsman Service (“FOS”) and “prospective” redress liabilities – any future exposure that may give rise to a claim by the consumer.
Determining the capital requirement
PIFs that are subject to this new requirement (that excludes sole traders and partnerships) are required to undertake the following steps:
- Step 1 – Estimate the redress amount
Estimate the amount of funds needed to provide redress to each customer if the liability crystallised (reflecting any professional indemnity insurance in place) Estimating the redress amount.
- Step 2 – Aggregate the redress amount for each customer
Add together the amounts calculated in step 1 to calculate the PIF’s total potential redress liabilities to all customers.
- Step 3 – Calculate the potential redress liabilities
Apply a probability factor (the FCA have suggested a probability factor of 28%.) to adjust the figure calculated in step 2. The PIF will report this figure as its capital deduction for redress and deduct it from its regulatory capital.
When the application of the capital deduction results in regulator capital lower than the minimum regulatory capital requirement PIFs are subject to an asset retention requirement which would apply until the PIF has remedied this breach. During the period of the breach the PIF will be prevented from undertaking transactions outside the ordinary course of business i.e. disposing of, withdrawing, transferring, dealing with or diminishing the value of any of its own assets (e.g. the payment of dividends etc).
The reporting to the FCA of additional redress liabilities is intended to be on a 3-month or 6-month basis depending on the size of the PIF and current reporting requirements. The FCA aim to publish a policy statement in the second half of 2024 with implementation of the rules in first half of 2025.
PIFs are subject to capital requirements which are:
- A minimum capital resources requirement of £20,000.
- An income-based requirement. For the majority of PIFs this is 5% of the annual investment business income earned in the previous year.
The capital resources requirement is the higher of the two requirements above. The above capital requirements are not risk based but with the introduction of new rules the FCA is moving minimum capital requirements for PIFs to be closely aligned with the risk that the business undertakes – that is no different to other firms e.g. banks and insurers that require risk based capital requirements as part of prudential regulation.
PIFs will need to undertake a review of the liability of each transaction with the consumer including an estimate of the redress liabilities. Congruent through the Congruent Calculations™ platform allows users to determine the redress liabilities for pension and investment advice in a cost-effective manner using our web-based client portal. The Congruent Calculations™ platform is an industry wide robustly tested platform which has been used to perform many 10,000’s redress calculations for users in the settlement of consumer complaints.