OAC's response on CP23/24

OAC have today issued our response to the FCA’s consultation on capital deduction for redress: personal investment firms (CP23/24).

The proposed new regulations have been labelled the ‘polluter pays proposals’, initially by the FCA, and enthusiastically adopted by others.  Whilst a pithy moniker, it is somewhat unhelpful.  In reality, what the proposals will do is help personal investment firms (PIFs) get a better handle on the risks they have and understand better the potential for the amounts of redress they may need to pay in the future.  This can only help improve the governance within these firms.

By requiring PIFs to reserve for these liabilities, for many the proposals will introduce a level of resilience into the firms that has not existed to date.  Alongside the wider suggested improvements in governance, when viewed as an overall package, the proposals are to be welcomed.

We do have significant concerns, though. 

·        We feel that the FCA has underestimated the effort that will be required from PIFs to implement the reforms and the hurdles some may need to overcome.  For many years the FCA has recognized that many redress calculations are complex and require the involvement of an actuary.  The proposals contained in CP23/24 add a new layer - an estimate of an underlying complex calculation.  If the expectation is that a PIF will be able to do this without advice, we fear that this is somewhat optimistic.  Many will need to seek advice from an actuary and will likely need to do so on at least an annual basis.  The consultation does not reflect this in its cost-benefit analysis.

·        PIFs will face significant data issues to be able to estimate the reserves they need to hold.  Our experience is that for many PIFs, the data is not readily available in an easily transferable electronic format.  The firms will need to undertake an exercise to decide on the data they need to collate and put this into a format that can be used for the calculation of the reserve.  PIFs should not underestimate the amount of time this may take.

·        The reserve that PIFs will be required to hold under the proposals will be volatile in nature.  Redress, in essence for many products, is the difference between two large numbers.  Quarterly market movements can lead to large changes in the reserves being proposed.  For other entities needing to reserve against future liabilities it is standard practice to add a resilience reserve to help protect it against such risks.  The proposals in CP23/24 do not take this approach which could lead to PIFs being exposed to material market-related risks.  If the FCA does not look to build in this level of protection in its final rules, PIFs would be well advised to consider doing so themselves to better insulate themselves from the vagaries of the market.

To help PIFs prepare, OAC have developed an 8-point plan for them to follow over the next few months ahead of implementation.

1.      Assess whether you have any unresolved redress or prospective redress liabilities.  For the latter, consider whether you need help or advice from a specialist compliance expert.

2.      Understand your PII cover.  In particular, understand the excess limits and how these apply across your book of business.

3.      If you need to calculate a reserve, find out the data that you, or an adviser, will need to calculate the reserve.  Carry out a GAP analysis against this.  You will need to be able to gather this data into a form that can be easily used for your reserve calculations.  OAC have a data schedule you can use for this purpose.

4.      If you don’t feel you have the necessary expertise to carry out the calculations yourself, appoint an actuary to do this for you.  Redress is a complex area so make sure that they have the required experience to help you.

5.      If the FCA does not mandate a resilience reserve, consider whether you want to add one yourself to better insulate yourself against market risks.  If you have appointed one, instruct your adviser to do so.

6.      Consider how frequently you will update your reserve.  Consider the sensitivity of your reserve to market conditions to help set the parameters that might trigger the need for an updated figure.

7.       As part of your governance requirement, you will be pro-actively monitoring your business to identify any new potential redress liabilities.  If these arise, you will add these to the data you will use for future reserving calculations.  You will need to make a decision on the materiality of any new potential liabilities and decide on whether this warrants an updated reserve calculation.

8.      Embed the process and reporting requirements into your BAU.

OAC have developed the tools and modelling to help you with the data and reserving requirements under these proposals.  With 30 years history as a specialist provider of redress advice, we can help PIFs navigate the complexity of the new rules.  We will be able to provide you with a report, signed by an actuary and subject to the actuarial profession’s standards, with the calculation of your liabilities.  The ‘actuarial stamp’ will give you, and others, the confidence that the figures produced are in line with the FCA’s rules.  If you want to know more, get in touch.