In unveiling their new “polluter pays” proposal at the end of November 2023, the FCA has opened up a highly topical and contentious discussion.
The intention behind the proposed policy is to reduce the Financial Services Compensation Scheme (FSCS) levy and instead force advice firms to hold extra capital to cover compensation claims.
Up to 1,550 firms expected to have to set extra capital aside to meet compensation costs
According to CityWire, between 750 and 1,550 firms are expected to have to set aside extra capital to meet compensation costs, equating to around a third of UK advice firms.
Meanwhile, another 150 firms may face asset retention orders.
The new proposal forms part of an ongoing effort to reduce the FSCS levy, that funds claims against failed businesses.
According to the CityWire report, between 2016 and 2022, the FSCS paid out £760 million of compensation due to bad advice – with 95% of this generated by just 75 firms.
In effect, the new rules would require advice firms to:
- Calculate their potential redress liabilities at an early stage
- Set aside enough capital to meet them (this amount must equal at least 28% of the liabilities they face, based on three years of uphold rates related to pension and investment advice)
- Report potential redress liabilities to the FCA.
4 key steps to FCA’s framework
The “polluter pays” policy can be divided into four key steps.
1. Identify where you may need to pay redress in the future
This can be done by monitoring customer outcomes under Consumer Duty.
2. Quantify any liabilities
Firms must estimate what funds would be needed to pay redress for:
- Unresolved complaints
- Future redress from recurring or systemic issues and foreseeable harm.
This will be calculated for each impacted customer and form a firm’s potential redress liabilities.
With this calculation made, firms will be able to offset this amount by factoring in professional indemnity (PI) insurance and applying a prescribed probability factor, which recognises that not all complaints are upheld and that once investigated, not all issues lead to a redress payment.
3. Set capital aside to meet potential redress liabilities
This deduction should be built into the regulatory return on a firm’s capital resources.
4. Automatic asset restriction
This would offer some protection to those firms without enough capital to redress liabilities, and means that firms can only make payments in the ordinary course of business.
The FCA hopes that this will cause firms to build up their capital levels over a period of time and prevent them from dissipating assets to avoid liabilities.
Providing proactive redress and reducing the wait
With these four steps, the FCA believes more firms will be better able to provide proactive redress to consumers and, over time, reduce the amount of time consumers have to wait between the initial complaint and receiving redress.
The FCA also hope that the proposed framework will lead to fewer firms failing when they can’t meet their redress costs. And, consequently, lessen the burden on the Financial Services Compensation Scheme (FSCS).
With FSCS compensation capped at £85,000, the regulator also expects consumers will have fewer uncompensated losses.
Ultimately, the policy should incentivise firms to provide good advice and avoid causing harm from the outset.
As our managing director John Bull told Professional Adviser, “The FCA says new rules on setting aside extra capital to cover claims will not see a significant number of firms fail or ‘exit the market’. However, the rules may require capital to be put aside even when a complaint is being defended and no finding of fault has been determined.”
The concern is that, for some, this could prove to be a prohibitive cost.
Where will exemptions apply?
FTAdviser reports that the FCA has said “that those who are subject to higher standards, differing credential regimes, will be exempt”.
In addition, the FCA proposed that around 500 sole traders and unlimited partnerships would also be excluded from the asset retention rules. As they don’t feel it would be appropriate to automatically apply the new rules to the personal assets of such firms.
So, while all 5,500 firms need to read the FCA’s consultation paper, around 625 firms could expect to qualify for some level of exemption.
It would be unwise to simply hope for the best and assume that you’ll be automatically exempt. As such, we strongly recommend that you take the time to read the consultation paper and share your comments by 20 March 2024.
Don’t miss the chance to have your say
It is good news that this highly contentious issue is being addressed and the FCA are keen to hear your thoughts.
Having extended the consultation period to mid-March 2024, the regulator is actively encouraging people to share their views.
With many conflicting opinions – and plenty of opportunity for the resultant policy to be flawed – let’s hope that the FCA take views on board to evolve a policy that will truly help advice firms flourish and deliver good outcomes for their clients.
Get in touch
If you’d like to discuss how the FCA’s new “polluter pays” policy could affect your business or to find out more about how we could help you resolve a complaint, please get in touch.