FCA to require investment advisers to set aside funds for redress liabilities

The proposed rules (127-page / 1.69MB PDF) will apply to firms termed ‘personal investment firms’ 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. An accompanying ‘dear CEO’ letter (3-page / 165KB PDF) published by the FCA reminds these investment advisers of their ongoing responsibilities, including that they must not seek to avoid potential redress liabilities.  

Financial services regulation expert Venetia Jackson of Pinsent Masons described the proposals as a significant move from the FCA to ensure 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. 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,” she said. 

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.  

Financial regulation expert Hannah Ross of Pinsent Masons said that the FCA is taking a ‘polluter pays’ approach. It means that the regulator wants firms generating redress costs to be sufficiently financially resilient 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. According to the consultation paper, the FSCS paid out nearly £760m between 2016 and 2022 for poor services provided by failed personal investment firms. Around 95% of this was generated by just 75 firms. 

“In the long term this may foster a more robust and resilient industry and reduce the burden on the FSCS,” said Ross. 

The proposed measures come several months after the consumer duty came into force on 31 July 2023 and are consistent with the FCA’s consumer investments strategy.  

“The proposals bolster the FCA’s work on the consumer duty and ensuring good outcomes for consumers, as well as the FCA’s work in relation to its consumer investments strategy, to reduce harm, set higher standards and promote positive change,” she said. 

Under the existing requirement, personal investment firms 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. In-scope 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,” said Ross. 

Jackson added: “In-scope firms should also consider now their processes for identifying and addressing potential liabilities which will be the basis for their capital requirements calculations if these rules are adopted.  In doing so, they should be mindful of the requirements under the consumer duty around proactive addressing of foreseeable harm.” 

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. 

The 16-week consultation period will end on 20 March 2024. In the meantime, in its associated Dear CEO letter, the FCA has warned that it will act against firms seeking to change their corporate structures in light of its ongoing consultation proposals, or otherwise seeking to avoid potential redress liabilities and complaints responsibilities. For example, it will subject applicants to significant additional scrutiny where it perceives this risk.