sPIFfing! New capital requirements for Personal Investment Firms
Can the PIF pay? Personal Investment Firms (PIFs) are advisory firms responsible for around half of all regulated investment and pension sales.
Last month the FCA published Consultation Paper CP15/17 on capital resources requirements for PIFs which are designed to ensure that PIFs are able to pay redress to customers who complain.
While most PIFs will not need to change the amount of capital they hold as a result of the new proposals (some larger PIFs will even be able to make reductions), some smaller PIFs with low incomes will need to increase their capital by an amount which may be significant in comparison to their income. The FCA expects a small number of PIF firms to be forced to amalgamate or to join networks, despite the FCA's recent regulatory clampdown on that sector.
Proposed capital requirements
There are approximately 5,000 PIFs regulated by the FCA and subject to the capital requirements set out in the FCA Handbook's Interim Prudential sourcebook for Investment Businesses (IPRU (INV)) Chapter 13.
In short the FCA is proposing a new minimum capital resources requirement of the higher of £15,000 from 30 June 2016 and £20,000 from 30 June 2017 or 5% of the PIF's income for the year from designated investment business as reported in the PIF's RMAR.
The £20,000 own funds requirement would replace the current £10,000 minimum own funds requirement which the FCA argues has been in place for 20 years and is no longer sufficient. The FCA believes that the increase is reasonable as it matches inflation and is comparable to the €25,000 capital requirement that applies to many PIFs which also fall within the scope of the Insurance Mediation Directive (IMD).
The FCA decided to move from the current expenditure based requirement because this reduced incentives for firms to invest in their business, including extra staff such as para-planners and, significantly, compliance staff. It has also dropped the exemption for firms with fewer than 26 advisors as it decided that the 'cliff-edge' effect that this exemption created favoured certain business or employment models over others.
The FCA states that the 5% of income requirement equates to 2.6 weeks of annual income and is similar to the current requirement of 4/52 of expenditure. It is also the same requirement placed on insurance intermediaries that hold client assets under the Mortgage and Home Finance Firms and Insurance Intermediaries (MIPRU) rules which reflects the comparable prudential risks of the two activities.
Certain PIFs which are currently subject to other prudential regimes may face higher capital requirements under the new rules- for example PIF firms that also have permission to deal as principal, hold client money or manage portfolios. The FCA is proposing a capital resources requirement for these firms of the higher of £15,000 from 30 June 2016 and £20,000 from 30 June 2017 or 10% of the PIF's income.
Firms which conduct MiFID business must comply with capital requirements mandated in the Capital Requirements Directive (CRD) and the FCA has proposed that these MiFID firms must maintain the higher of the CRD requirements for own funds or PII or an equivalent mix or the new general capital requirements for PIFs.
Finally, PIFs which are also SIPP operators will be able to apply the current capital requirements until 31 August 2016. From 1 September 2016 their capital requirements will be the sum of the capital requirements for PIFs and the new capital regime for SIPP operators set out in PS14/12.
Impact on PIFs
In its cost benefit analysis the FCA concluded that the new proposals would impose limited costs on the PIF sector. The FCA said most PIFs already hold capital resources in excess of the proposed new requirements and the overall capital resources requirement for the largest group of PIFs will reduce under the new proposals. The FCA believes that collectively the PIF industry holds eight times more capital resources than the current regulatory minimum (£935 million against a new £187 million minimum).
Most PIFs with income over £400,000 will see their capital resources requirement decrease because 5% of income is lower than 3 months of expenditure. However, the FCA believes that 499 firms with annual incomes of below £200,000 will have to raise additional capital resources and the FCA expects a small number to amalgamate or migrate to network membership. The ARs in networks are not subject to the FCA's new rules and their principals may apply lower requirements on their ARs, making the network option a viable alternative for firms unable to raise sufficient capital to meet the new requirements.
It seems odd that the FCA might leave PIFs with no choice but to join networks given that the FCA has a lukewarm attitude to the AR model. In recent years it has placed advisory networks under such intense regulatory scrutiny that many in the industry question the longevity of the model. The FCA has also announced in this year's business plan that AR arrangements in the general insurance market will form part of its market-focused work programme.
For those firms concerned about their future capital requirements, the FCA has provided a handy calculator.