FSA chief executive John Tiner has given the London market until the end of the year to come up with a workable solution to contract certainty.
The ultimatum was set at the insurance industry's meeting with Tiner last week, which representatives from the top London market brokers, insurers and trade associations attended.
A senior industry source said: "We have until the end of the year and if we haven't made any progress Tiner will get his stick out to beat the industry into shape."
A progress report must also be delivered after six months, added the source.
Lloyd's support of Kinnect as a solution to the problem of contract certainty is likely to cause friction in the discussions. One source said it would create divisions. and he would not opt for it.
"God knows we do not want that system, it is hopeless," he said.
Another broker source welcomed Tiner's tough approach. "Self regulation has not worked in any market," he said.
The industry group will now split into two working parties.
The Market Underwriters Review Committee will be made up of Lloyd's leading underwriters and brokers and will address complex rules.
The Lloyd's Reform Group will examine commodity risks.
Lloyd's slams FSA over commissions
Lloyd's chief executive Nick Prettejohn slammed the FSA for not making commission disclosure mandatory.
In a speech to the Insurance Institute of London on Monday Prettejohn said: "I believe they [the FSA] have got it wrong. I believe they have not gone far enough. In light of Spitzer there was a great opportunity to change the rules and they have missed that opportunity.
He called on the FSA to change its Conduct of Business regime from the current approach of 'disclosure on request' to mandatory disclosure.
An FSA spokesman replied: "The industry made it clear it did not wish to have mandatory disclosure. We will not be looking at the issue again."
The big fight: Nick Prettejohn v John Tiner
In the red corner: Nick Prettejohn
Punch:Chief executive of the world's oldest insurance market overseeing £13.7bn of capacity
Best move in the ring: Accusing the FSA of not going far enough on commission disclosure.
Fighting talk: "The FSA has got it wrong."
Big fight assessment: Has to dig deep to come up with more big punches
In the blue corner: John Tiner
Punch: FSA chief executive,
Best moment in the ring: Has put the London market on the ropes since his condemnation of a lack of contract certainty in the market.
Fighting talk: "If the market is not able to come up with a solution we have a number of tools at our disposal which can create tough incentives for them to get it right."
Big fight assessment: Looks to have Prettjohn in the corner. Could well achieve a knock-out