CP174 definition of capital excludes goodwill, consultant says

Independent brokers looking to acquire may be hamstrung by the FSA regulatory proposals, according to a leading industry consultant.

Tony Cornell of Cornell Consulting said that the definition of capital as it relates to the proposed solvency margin requirements in CP174 excludes intangible assets.

The largest intangible asset on most brokers' balance sheets is goodwill - the difference between the price paid for a business and the value of its fixed assets, such as buildings and equipment.

Broking firms, which do not tend to have many fixed assets, are largely valued according to goodwill, which is calculated based on the size and quality of the business they write.

Cornell said: "We could have 1,500 brokers coming on to the market in the next 18 months and independent brokers won't be able to buy them."

Cornell said the FSA has resorted to using the old Insurance Brokers Registration Council rules, where the value of goodwill was excluded when calculating solvency margins. As a result, brokers were forced to set up holding companies to house goodwill and associated debt, and use these holding companies to make acquisitions.

But under the GISC, goodwill is accounted for using recognised accounting standards, and, therefore, can be carried on brokers' balance sheets and brokers can borrow funds against it. Cornell said that as a consequence, many brokers who have been involved in acquisitions or who have conducted MBOs over the past few years are carrying substantial amounts of goodwill, and associated debt, on their balance sheets.

But Cornell said that under the proposals in CP174, this debt will be counted as a liability. "If brokers are in that situation, technically, according to the FSA, they're insolvent because their liabilities exceed their assets," he said.