Friday was clearly a good news day for our business.
It was great to read reports that the Financial Conduct Authority (FCA) is delaying new capital adequacy rules for a two year period, also promising a ‘fundamental review’ of its proposed approach.
These new rules were due to come into force at the end of this year.
They would have resulted in our own business needing to increase its capital adequacy from £10,000 to around £120,000 in three steps over the next two years.
As a prudent and profitable business, we had already secured this capital, ready for the rule changes which were due to be phased in over three years from 31st December 2013.
However, it did rankle that we needed to set this money aside, rather than put it to work in the business.
For a small business like our own, £120,000 is a significant amount of capital to leave sitting in the bank earning a paltry rate of interest.
We had several concerns about the new rules for enhanced capital adequacy; concerns which will hopefully be addressed by the fundamental review carried out by the FCA.
It is likely that firms which go bust will spend this capital before they eventually collapse, making it effectively useless as a regulatory buffer.
Firms in financial difficulty are likely to breach capital adequacy rules rather than enter liquidation with tens or hundreds of thousands of pounds in the bank account.
Capital adequacy requirements are important, when set at reasonable levels, but duplicate the role played by Professional Indemnity insurance and the Financial Services Compensation Scheme (FSCS).
All authorised and regulated firms, such as our own, are required to hold Professional Indemnity insurance which covers their regulated activities. Such firms are also required to fund the FSCS which provides consumer redress in the event of valid claims against companies in default.
Both PI insurance and FSCS levies are expensive. The total cost of these represented some 4-5% of our turnover in 2012/13.
Why then does the regulator insist on piling expensive capital adequacy requirements on top of these two elements of consumer protection?
What we would prefer to see is capital adequacy requirements determined by reference to risk.
Riskier advice firms, engaged in esoteric investment schemes or cutting edge tax planning schemes, should be required to set aside higher levels of capital.
Firms which are loss-making or carry large amounts of debt should also be subject to a tougher capital adequacy regime.
Responsible firms such as our own – which is consistently profitable, has no debt and sticks to ‘vanilla’ advice areas – should be subject to a more modest capital adequacy requirement.
Instead, money that would be set aside in the bank could be used to enhance the delivery of services to our clients, pay for systems improvements and hire staff which would contribute towards a growing economy.
We look forward to seeing new proposals on this subject from the FCA once they have completed their review.
