UK Investment Advisers to Increase Capital Cover for Compensation Costs

Investment advisers in the UK are facing a new regulatory proposal that would require them to hold additional capital to cover compensation costs. The goal is to address the rising costs associated with bad advice and guarantee that the businesses responsible for it suffer the financial burden. In this post, we will look at the proposed changes and their possible effect on the investment advice business.

Background

Regulated enterprises in the United Kingdom are already required to contribute to the Financial Services Compensation Scheme (FSCS), which is regulated by the Financial Conduct Authority (FCA). This plan compensates customers who have incurred losses as a result of poor advice, with a maximum claim limit of £85,000 per claim.

The Growing Compensation Bill

Between 2016 and 2022, the FSCS paid out nearly £760 million for poor advice, and a significant portion of this cost was attributed to just 75 firms out of a market comprising approximately 5,000 firms. The rise in compensation claims has prompted regulators to take action.

The FCA is now proposing a “polluter pays” model, which means that firms responsible for providing poor advice should bear the financial consequences of their actions. This approach aims to create stronger incentives for advisers to enhance their standards and provide better advice to clients.

Sarah Pritchard, the FCA's executive director of markets and international, emphasized the need for change, stating, “Diligent advisers are having to compensate through the levy for the bad advice of their failed competitors. That needs to change. It is important that the polluter pays.”

Proportionate Approach

The proposed regulations are designed to be proportionate, building upon the existing capital requirements. Firms would be required to calculate the additional capital needed to cover potential redress liabilities. However, approximately 500 one-person advice firms, unlimited partnerships, and firms within group-wide risk assessments would be excluded from this requirement.

During the public consultation period, the FCA plans to conduct a pilot scheme to assess firms' ability to provide the necessary data demonstrating how they have determined the extra capital requirement. The results of this pilot data collection will be considered alongside consultation responses before finalizing the rules.

Compliance Costs

According to the FCA, the yearly compliance expenses for these new laws would be about £1,000. These regulations are set to take effect in the first half of 2025. Advisers must previously put aside a minimum of £20,000 in capital in order to function.

The proposed “polluter pays” model has received a positive response from industry representatives. PIMFA, a trade body for financial advisers, welcomed the concept but urged for a proportionate approach that does not discourage new entrants into the industry.

Conclusion

The proposed regulatory changes in the UK aim to hold investment advisers accountable for the quality of their advice and the financial consequences of poor decisions. By implementing a “polluter pays” model, the FCA intends to incentivize advisers to improve their standards and reduce the burden on diligent firms that have to compensate for the failures of their competitors. These changes are set to have a significant impact on the investment advisory sector, with the potential to enhance overall industry standards and protect the interests of clients.