New 'polluter pays' proposals from the FCA - are these toxic?

The FCA has released a consultation paper (CP 23/24), proposing new measures for personal investment firms (PIFs) to set aside capital for potential redress liabilities at an early stage. These changes aim to address consumer harm caused and reduce the burden on the Financial Services Compensation Scheme (FSCS).

In CP23/24, the FCA proposes that PIFs set aside capital equivalent to at least 28% of the value of potential redress liabilities. However, some PIFs will be required to set aside more capital depending on their complaint history. PIFs are encouraged to calculate their potential redress liabilities at an early stage - this will comprise any unresolved complaints along with prospective redress that could arise from systemic problems or foreseeable harm (a term that readers will recognise as part of the Consumer Duty). PIFs can account for their professional indemnity cover while making these calculations.

PIFs failing to hold enough capital to cover their potential liabilities would be subject to automatic asset retention orders, preventing them from disposing of assets until they meet the necessary capital requirements.

Alongside CP 23/24, the FCA has issued a 'Dear CEO' letter to PIFs setting out its expectation that they should not seek to avoid their existing liabilities before any new rules are implemented. This stresses the need to act in 'good faith', one of the cross-cutting rules under the Consumer Duty.

The FCA is seeking feedback from industry participants and stakeholders during the consultation period, which concludes on 20 March 2024.  During this consultation period, the FCA will closely monitor PIFs applying to cancel or seeking new authorisations to prevent the avoidance of potential redress liabilities. The FCA will also conduct a pilot scheme to assess PIFs' ability to provide the necessary data for calculating additional capital.

If implemented, the proposals will heap further pressure on an already heavily regulated sector. The FCA refers to the impact that failing firms have on the FSCS levy, whilst noting that this has actually been 'falling overall recently'. They also note that, between 2016 and 2022, the FSCS paid out £760 million in compensation in respect of failed PIFs, but that just 75 firms accounted for 95% of the total. 

The FCA's proposals beg some difficult questions, in our opinion:

• How, precisely, will the FCA expect firms to quantify both unresolved redress liabilities (i.e. potential liabilities for complaints that have been made but which are unresolved) and prospective redress liabilities (i.e. potential liabilities for foreseeable harm or systemic problems that may give rise to an obligation to provide redress to a consumer)?  This, in our experience, is an extremely difficult and contentious area – both in terms of whether a future liability will arise at all (i.e. should a complaint be upheld / does a systemic issue requiring redress arise) and in terms of what the amount of that liability might be. 
• We therefore question what benefit there is to making an entire sector hold additional capital against complaints that will not have been upheld and which may never materialise (although the FCA estimates that only a third of the market will actually have to set aside capital). 
• The paper is (perhaps unsurprisingly) silent on the impact it could have on firms if significant capital is tied up against potential liabilities that never become payable. 'Productivity' is a popular word in economic discussions at present and it's hard to see how these measures would have a positive impact on it (despite the paper  seeking to explain how the proposals will benefit the FCA's growth objective). 
• The justifications for the measures include incentivising firms to resolve complaints quickly and to identify systemic or recurring issues - all admirable aims but this potentially loses sight of the fact that complaints or claims need to follow due process and there is often disagreement between the FCA / FOS and the advice firm on whether or not a complaint should be upheld (or whether a systemic issue requiring redress exists). 
• Actually quantifying potential future liabilities is always a very inexact science.  The recent redress scheme for transferring members of the British Steel Pension Scheme (BSPS) is a good example of this.  When initiating the scheme, the FCA forecast very large liabilities for providing redress, but subsequent movements in gilt yields have resulted in redress liabilities plummeting to comparatively low levels.  Had the FCA's proposed new capital retention rules been in place at the outset of the FCA's work on BSPS, many firms would likely have had to put aside very large amounts of capital for potential liabilities that, ultimately, did not materialise.  This in itself could have put firms out of business unnecessarily and resulted in more exposure for the FSCS.
• We also question whether requiring firms to set aside capital for potential liabilities in respect of claims already received or for systemic issues already identified will amount to closing the stable door after the horse has bolted.  In our experience, by the time firms receive large volumes of complaints or have identified any significant, systemic issues requiring large amounts of redress to be paid, the damage will already have been done and those firms without sufficient capital or PI cover at that point will likely fail anyway.  After all, by the time these issues are identified, no one will be willing to provide additional investment into such firms.
  
  Subject to the results of the consultation, the FCA proposes to publish a final Policy Statement in the second half of 2024, with the aim that any new rules will come into force in the first half of 2025.
  
  Anyone wanting to provide feedback on the proposals can do so here:  CP23/24 Online Feedback Form