The Financial Conduct Authority (FCA) has proposed a shake-up to investment advice compensation rules which will see firms set aside capital under a "polluter pays" framework.

The regulator set out its plans in a consultation paper, Capital deduction for redress: personal investment firms, and a Dear CEO letter today (29 November).

It said the proposals mean firms will be required to set aside capital so that they can cover compensation costs and "ensuring the polluter pays when consumers are harmed". 

It explained the plans would mean personal investment firms - otherwise known as investment advisers - would need to calculate their potential redress liabilities "at an early stage", then set aside enough capital to meet them and "report potential redress liabilities to the FCA".

It added that any firm not holding enough capital would be subject to "automatic asset retention rules to prevent them from disposing of their assets".    

FCA executive director of markets and international Sarah Pritchard said: "We want to see a thriving financial advice market to make sure consumers can access the support they need from financially resilient advice firms that want to do the right thing. 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. 

"We want to hear from industry and consumer groups on our proposals. Please do let us know what you think so that we can reform the way the current framework operates to ensure that those polluting the sector pay." 

FSCS levy burden

The FCA pointed out that the Financial Services Compensation Scheme (FSCS) paid out nearly £760m between 2016 and 2022 for poor advice provided by failed personal investment firms.

It said that 95% of this was generated by just 75 firms. 

It said its proposals wanted to ensure that the "polluter pays for the redress costs they generate".

The FCA said it would be those who provide "bad advice who will be responsible for setting aside enough capital to compensate for it".

It added that in turn, the proposals would create a significant incentive for firms to provide good advice in the first place and to right wrongs quickly.

"This will benefit consumers given the important role investment firms play in the decisions people make for their long-term financial future," the watchdog added.

It said the proposals were designed to be "proportionate, building on existing capital requirements".

The measures would exclude around 500 sole traders and unlimited partnerships from the automatic asset retention requirements. Firms that are part of prudentially supervised groups, which assess risk on a group-wide basis, would also be excluded. 

The FCA urged affected businesses to share their views on the plans and said due to its importance the consultation would run for 16 weeks and be supplemented by an extensive programme of industry outreach.

It said it expected to publish the next steps in the joint review of the Advice Guidance Boundary which it is conducting alongside the government in the coming weeks.

The FCA said it would run an extensive programme of outreach to the industry and consumer groups as part of the consultation which runs until 20 March 2024.