A new survey shows that 86%of brokers fear the costs of FSA compliance will see their numbers greatly reduce in the next 18 months. Michelle Hannen reports on the expense of CP174.

Many brokers could be pushed into the red or forced to sell up in 2004 as a result of a massive cost hit required to comply with the proposals in the FSA's latest broker consultation paper, snappily titled CP174:Prudential and other requirements for mortgage firms and insurance intermediaries.

A new survey by accountancy firm Mazars and Biba said that regulation is one of the key reasons why 86%of brokers think that the number of brokers will greatly reduce in the next 18 months.

Owner of Scottish broker EH Ranson, Simon Bolam, says that brokers should already be reserving funds to cover the hit.

"The bills are all going to come at once, "he says. "I think it is a very foolhardy firm that is not accruing for these costs at the moment. "

The Broker Network managing director Grant Ellis is also urging brokers to start planning now. He says that if CP174 prevents brokers from drawing commission before it is received, as proposed, brokers will be hit with a one-off deferment of commission as they change accounting methods from accrued to received.

"Every broker who takes his commission like this is going to have to go without for six weeks, "Ellis says. "So my recommendation to brokers is to change now. "

PI concerns Smart and Cook managing director Paul Meehan said the impact of changing accounting systems will be significant: "That's going to be a flood of cashflow that we're going to have to find. "

Brokers are also concerned about the professional indemnity (PI)cover proposals outlined in CP174. The FSA is proposing that brokers have PI cover equivalent to the higher of either £680, 000 or three times annual income, to a limit of £10m.

Stuart Alexander joint managing director Stuart Reid said he is concerned about capacity in the PI market. "I can understand why they're doing it but I just don't think there's the capacity in the market for it. " Layton Blackham chief executive Chris Blackham agrees, saying:"They might not even be able to get cover. "

Meehan says that he is "90%sure "that concerns about the cost and availability of PI cover will force him into a captive. But Ellis said that the PI requirement is conservative. "I think they've underdone the PI. I think it's a bit weak, "he says.

Brokers have also expressed concerns about the FSA's proposed rules for principal and appointed agents. Bolam says:"It is an easy route, but the rules on what the appointed agents can do are so limited that I just wonder if it will work in practice. "

He is sceptical that larger brokers will be interested in becoming principal agents. "It could easily be unprofitable and perhaps more hassle than it's worth, "Bolam says.

Reid agrees:"I don't think it's going to be what the FSA wants, because I don't think larger brokers want to do it. "Ellis describes the current appointed agent regime as "unworkable ". "You can't become involved in any way shape or form in the claims process, " he says.

Reid warns that the smaller, currently unregulated brokers will be hardest hit by CP174. "It's a frightening document for a small broker, "he says.

Bolam agrees:"Some of the financial targets will greatly affect smaller firms, certainly those that are not regulated at the moment. "

In warning fellow brokers not to underestimate the impact of CP174 on their businesses, Bolam says:"I am spending at the moment probably 60%of my time on this. It is just so important to get this right. "

Blackham agrees that brokers should make understanding CP174 a priority:"This will have a monumental effect on the industry. "

What brokers face under CP174

  • Client money must either be contractually guaranteed by insurers or held in segregated client accounts under a trust. Brokers will be prevented from drawing commission before client funds are received

  • Brokers that don't handle client money will need o have solvency reserves of the higher of either £5, 000 or 5%of annual net brokerage income

  • Brokers holding client money will be required o have solvency reserves of the higher of either £10, 000, 5%of annual income or 5%of the average client money balance

  • Financial Services Compensation Scheme will be extended to cover insurance brokers. Consumers and small businesses would receive 100%of he first £2, 000 of the claim and 90%of the rest

  • Brokers will need to have compulsory professional indemnity cover equivalent o the higher of either £680, 000 or three times annual income, to a maximum of £10m.

    • The costs facing brokers based on proposals in CP174

  • A six-week deferment of commission to prevent brokers from drawing commission from client funds before they are received, and the associated cost of moving from accrued to received accounting systems

  • Cost of establishing and maintaining segregated client accounts under a trust, as proposed for all brokers who hold client money

  • Cost of reserving for proposed solvency requirements, which could be as high as 5%of annual income

  • Cost of a levy to fund the extension of the Financial Services Compensation Scheme (FSCS)to cover brokers

    • Cost of higher professional indemnity (PI) premiums to meet the FSA's proposed minimum PI cover of £680, 000 or three times annual income, whichever is higher, to a limit of £10

  • Cost of rising PI premiums if capacity struggles to keep pace with the increased demand.

  • On top of these costs will be those associated with meeting the FSA's competency and training requirements, which will be revealed when its consultation paper on these issues is released in April, and costs associated with the FSA's proposals in CP160, in particular the cost of administering all commercial clients with turnover of less than £1m per year as individuals.

  • In addition to the FSA-related costs, those brokers who are registered with the GISC will also simultaneously face ongoing regulatory costs under the GISC regime until it is wound down.

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