Investment advisers in the UK are to be asked to set aside money to cover the cost of potential redress claims at an early stage, under Financial Conduct Authority (FCA) proposals to ensure the “polluter pays” when consumers are harmed.

The proposed rules will apply to firms termed “personal investment firms” (PIFs) under FCA rules, which are firms that mainly provide advice on and arrange deals in retail investment products and which are exempt from the UK implementation of the Markets in Financial Instruments Directive. There are approximately 5,000 PIFs authorised in the UK today.

An accompanying “dear CEO” letter published by the FCA reminds these investment advisers of their ongoing responsibilities, including that they must not seek to avoid potential redress liabilities.

The FCA proposals are aimed at ensuring that compensation is available to customers who may otherwise be left with proving their claims to the Financial Services Compensation Scheme (FSCS) when things go wrong.

This aligns with the FCA’s aim of being a more agile regulator, enabling action to proceed swiftly in these circumstances and builds on the steps we have already seen it take to secure assets for redress in relation to other compulsory redress schemes.

Hannah Ross, Senior Associate and Financial Services specialist, Pinsent Masons

Hannah Ross, Senior Associate and Financial Services specialist, Pinsent Masons

However, it will also require significant adaptation from advisers to ensure that they are looking ahead to calculate potential liabilities and do have the capital reserves to meet any liabilities that may exist.

The proposals require firms to quantify an overall amount for all the potential redress liabilities they have identified, and to set aside sufficient capital resources to cover these liabilities. If the investment advisers are not holding enough capital for potential redress claims, they will be required to retain assets.

It means that the regulator wants firms generating redress costs to be sufficiently financially resilient so that they can bear the responsibility for meeting them, without recourse to the FSCS.

The financial regulator said that it is seeing significant redress liabilities falling to the FSCS which paid out nearly £760 million between 2016 and 2022 for poor services provided by failed PIFs. Around 95% of this was generated by just 75 firms.

Under the existing requirement, PIFs must have and maintain minimum capital resources of at least £20,000 or 5-10% of a firm’s annual income from investment business, whichever is higher. The FCA estimates that the proposed rules will result in only a third of the market having to set aside extra money, with only 2% of the firms being required to retain assets. In addition, the estimated annual compliance cost for smaller firms is £1,000.

The proposals are designed to be proportionate, building on existing capital requirements. Firms not holding enough capital will be subject to automatic asset retention rules to prevent them from disposing of their assets. These firms should therefore start thinking about how they will ensure sufficient capital is held, if and when the FCA adopts these proposed rules.

The FCA has proposed certain limited exclusions to the automatic asset retention requirements which would exclude around 500 sole traders and unlimited partnerships. Firms that are part of prudentially supervised groups, which assess risk on a group-wide basis, would also be excluded.

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