06/14. Implementing MiFID for Firms and Markets. Addendum Capital/Professional Indemnity Insurance (PII) requirements. Financial Services Authority

Transcription

1 Consultation Paper 06/14 Financial Services Authority Implementing MiFID for Firms and Markets Addendum Capital/Professional Indemnity Insurance (PII) requirements July 2006

2

3 Introduction As indicated in paragraph 11.4 of CP06/14 Implementing MiFID for Firms and Markets, published on 31 July 2006, this Addendum provides our draft Handbook text and the new capital adequacy reporting requirements that reflect our proposals to implement MiFID s capital/pii requirements for exempt CAD firms. We propose a new chapter 9 in the Interim Prudential Sourcebook for Investment Businesses (IPRU (INV)) for the financial resources requirements for an exempt CAD firm which is currently subject to chapter 3, 5 or 10. Such a firm will remain subject to its current IPRU (INV) chapter for other requirements since these differ between chapters. We propose to add the MiFID requirements to IPRU(INV) chapter 13 for personal investment firms (PIFs) that choose to give up their Article 3 exemption to use the MiFID passport.

4 INTERIM PRUDENTIAL SOURCEBOOK FOR INVESTMENT BUSINESSES (EXEMPT CAD FIRMS) INSTRUMENT 2006 Powers exercised A. The Financial Services Authority makes this instrument in the exercise of the following powers and related provisions in the Financial Services and Markets Act 2000 ("the Act"): (1) section 138 (General rule-making power); (2) section 156 (General supplementary powers); and (3) section 157(1) (Guidance). B. The rule-making powers listed above are specified for the purpose of section 153(2) (Rule-making instruments) of the Act. Commencement C. This instrument comes into force on 1 November Amendments to IPRU(INV) D. The Interim Prudential Sourcebook for Investment Businesses (IPRU(INV)) is amended in accordance with Annexes A and B to this instrument. Amendments to MIPRU E. The Prudential Sourcebook for Mortgage Firms and Insurance Intermediaries (MIPRU) is amended in accordance with Annex C to this instrument. Amendments to the Glossary F. The Glossary is amended in accordance with Annex D to this instrument. Amendments to SUP G. The Supervision Manual (SUP) is amended in accordance with Annex E to this instrument. Citation H. This instrument may be cited as the Interim Prudential Sourcebook for Investment Businesses (Exempt CAD firms) Instrument By order of the Board [ ] October 2006

5 Annex A Amendments to the Interim Prudential Sourcebook for Investment Businesses In this Annex, unless otherwise indicated, underlining indicates new text and striking through indicates deleted text. Amendments to the Contents page: Chapter. 9 Exempt CAD firms Amendments to Chapter 1: R Table This table belongs to IPRU(INV) R Professional firm Chapters 1 and 2 Securities and futures firm (which is not an ISD a MiFID investment firm) or a category D firm (as defined in IPRU(INV) 10 App1) Securities and futures firm (which is an exempt BIPRU commodities firm) Securities and futures firm (which is an exempt CAD firm and which was subject to the requirements of Chapter 3 before 1 November 2007) The Society of Lloyd's (in relation to underwriting agents) and members advisers Investment management firm (which is not an exempt CAD firm) Investment management firm (which is an exempt CAD firm) Chapters 1 and 3 Chapters 1 and 3 Chapters 1, 3 and 9 Chapters 1 and 4 Chapters 1 and 5 Chapters 1, 5 and 9

6 Service company Chapters 1 and 6 Securities and futures firm (which is also an ISD a MiFID investment firm) or a category D firm (as defined in IPRU(INV) 10 App1) which falls within the definition of "local firm" in Article 3.1P of the BCD) Securities and futures firm (which is an exempt CAD firm other than a firm which was subject to the requirements of Chapter 3 before 1 November 2007) Chapters 1 and 10 Chapters 1, 9 and10 Personal investment firm Chapters 1 and 13 Amendments to Chapter 3: 3-1 R This chapter applies to a securities and futures firm if which: (a) (b) (c) it is not an MiFID investment firm or a category D firm; or is an exempt CAD firm which was subject to the requirements of this chapter before 1 November 2007; or it is an exempt BIPRU commodities firm. 3-6 G The financial resources rules for an exempt CAD firm are set out in IPRU(INV) chapter 9. As such, rules 3-61 to do not apply to an exempt CAD firm unless it carries on any regulated activity other than MiFID business (see IPRU(INV) 9.2.3R). An exempt CAD firm remains subject to the non-financial resources rules (rule 3-10 to rule 3-41(9)) contained in this chapter. 3-10(2) R A firm must keep accounting records in such a manner that they are sufficient to show and explain the firm's transactions and commitments (whether effected on its own behalf or on behalf of others) and in particular so that these records: (a) (b) demonstrate whether or not the firm is or was at that time complying with its financial resources requirement or, in the case of an exempt

7 CAD firm, its obligations under IPRU(INV) 9; and 3-60 Firms to which Rules 3-61 to apply Exempt CAD firms 3-60(8) R Rules 3-61 to do not apply to an exempt CAD firm, unless it carries on any regulated activity other than MiFID business (see IPRU(INV) 9.2.3R). Appendix 1 Glossary of Terms for IPRU(INV) 3 category D firm means a firm, the only core investment service for which it has permission is receiving and transmitting on behalf of investors orders in relation to one or more of the instruments listed in Section B of the Annex to the ISD, and whose permission is subject to a limitation or requirement preventing it from holding client money or clients assets and for that reason may not at any time place itself in debit with its clients, which benefits from the freedom of establishment or to provide services under Articles 14 or 15 of the ISD;... Amendments to Chapter 5: 5.1.1(1)(a) R TABLE 5.1.1(1)(A) APPLICATION OF CHAPTER 5 ISD FirmsExempt CAD firms OPS Firms (see Note 1 below) Non-OPS Life Offices and Non- OPS Local Authorities Individuals admitted to membership collectively Financial resources rules 5.2.1(1) to 5.2.7(5) YesNo (see note 3 below)

8 Note 2 Note 3 The financial resources rules for an exempt CAD firm are set out in IPRU(INV) chapter 9. However, rules 5.2.1(1) to 5.2.7(5) apply to an exempt CAD firm for the purpose of calculating its own funds requirement (see IPRU(INV) 9.2.7R(2)(a)) and if it carries on any regulated activity other than MiFID business (see IPRU(INV) 9.2.3R). An exempt CAD firm remains subject to the non-financial resources rules (rule 5.3.1(1) to rule 5.5.1(1)) contained in this chapter (1) R A firm must ensure that it maintains adequate accounting records and must prepare and submit such reports as are required by the FSA in a timely manner. A firm's records must: (1) (2) enable the firm to demonstrate its continuing compliance with its financial resources requirements or, in the case of an exempt CAD firm, its obligations under IPRU(INV) 9; and Amendments to Chapter 10: 10-B R This chapter applies to a securities and futures firm which is: (1) an exempt CAD firm (which was not subject to Chapter 3 before 1 November 2007); or (2) a MiFID an investment firm, and to a category D firm which falls within the definition of "local firm" in Article 3.1P of the BCD). G 10-D G The financial resources rules for an exempt CAD firm are set out in IPRU(INV) chapter 9. However, rules to apply to an exempt CAD firm for the purpose of calculating its own funds (see IPRU(INV) 9.2.7R(2)(b)) and if it carries on any regulated activity other than MiFID business (see IPRU(INV) 9.2.3R). An exempt CAD firm remains subject to the non-financial resources rules (rule to rule 10-12(6)) contained in this chapter.

9 10-10(2) R A firm must keep records in such a manner that they are sufficient to show and explain the firm's transactions and commitments (whether effected on its own behalf or on behalf of others) and in particular so that these records: (a) (b) demonstrate whether or not the firm is or was at that time complying with its financial resources requirement or, in the case of an exempt CAD firm, its obligations under IPRU(INV) 9; and Category D firms Exempt CAD firms 10-60(2) R Rules to apply to an category D exempt CAD firm only for the purpose of calculating its own funds (see IPRU(INV) 9.2.7R(2)(b)) and if it carries on any regulated activity other than MiFID business (see IPRU(INV) 9.2.3R), except that a corporate finance advisory firm. which is a category D firm must instead comply with rules 3-60(3), 3-62, and (8) R A firm's initial capital must be: (a) (b) (c) for a category B firm: euro 125,000; or for a category C firm: euro 50,000; or. (d) for an category D firm: euro 50, (1) R A firm's The expenditure requirement for a MiFID investment firm which falls within the definition of "local firm" in Article 3.1P of the BCD must be: ¼ of its relevant annual expenditure calculated in accordance with (2) to (4) below. (a) (b) for a category D firm which is not responsible for its counterparties' performance: 6/52nds of its relevant annual expenditure calculated in accordance with (2) to (4) below; or for any other firm:

10 Appendix 1 Glossary of Terms for IPRU(INV) 10 category D firm means a firm, the only core investment service for which it has permission is receiving and transmitting on behalf of investors orders in relation to one or more of the instruments listed in Section B of the Annex to the ISD, and whose permission is subject to a limitation or requirement preventing it from holding client money or clients assets and for that reason may not at any time place itself in debit with its clients, which benefits from the freedom of establishment or to provide services under Articles 14 or 15 of the ISD; Amendments to Chapter 13: Chapter 13 generally Throughout Chapter 13, references to "Category A firm" are changed to "exempt CAD firm" R (1) This chapter applies to a firm which is a personal investment firm. (2) Sections 13.1 to 13.8 apply to For a personal investment firm which is an Category A exempt CAD firm the following apply: (a) (b) sections 13.1 and 13.1A; and sections 13.2 to 13.8 or (if prior to 1 November 2007 the firm was subject to sections 13.9 to 13.12) 13.9 to (see 13.1A.2). (3) (1) R (1) A firm must take out and maintain at all times professional indemnity insurance that is at least equal to the requirements of (2) to (15). (2) Paragraph (1) does not apply to an exempt CAD firm unless it chooses to comply with these rules (see 13.1A). Policy Terms (2) R

11 Limits of Indemnity IMD insurance intermediary or an exempt CAD firm (b) if the firm is an IMD insurance intermediary or an exempt CAD firm that maintains professional indemnity insurance under 13.1A.3(1)(b), appropriate minimum limits of indemnity per year, which are, if the firm is an IMD insurance intermediary,: (i) (ii) euro 1,000,000 for a single claim against the firm; and euro 1,500,000 in the aggregate; [Note: Article 67(3) MiFID and Article 7 CAD (see also rule 13.1A.3)] (c) if the firm is both an IMD insurance intermediary and an exempt CAD firm that maintains professional indemnity insurance under 13.1A.4(1)(b), appropriate additional limits of indemnity to (2)(b) per year are: (i) (ii) euro 500,000 for a single claim against the firm; and euro 750,000 in the aggregate. [Note: Article 67(3) MiFID and Article 8 CAD (see also rule 13.1A.4)] Limits of Indemnity Non-IMD insurance intermediary Other firms (c) (d) if the firm is not an IMD insurance intermediary or an exempt CAD firm, then the following limits of indemnity apply: (i) The following text is all new and is not underlined. After section 13.1 insert section 13.1A as follows: 13.1A Financial resources requirements for an exempt CAD firm Application 13.1A.1 R This section applies to a personal investment firm which is an exempt CAD firm. Initial capital and professional indemnity insurance requirements 13.1A.2 R The financial resources requirement for a personal investment firm which is an exempt CAD firm is the higher of:

12 (1) the requirement that is applied by section 13.1A; and (2) (a) the requirement that is applied by sections 13.2 to 13.8; or (b) (if prior to 1 November 2007 the firm was subject to sections 13.9 to 13.12) the requirement that is applied by those sections (but reading references to Category B firm as references to the firm)). 13.1A.3 R (1) A firm which is not an IMD insurance intermediary must have: (a) (b) (c) initial capital of euro 50,000; or professional indemnity insurance at least equal to the requirements of (2)(b) and (3) to ; or a combination of initial capital and professional indemnity insurance in a form resulting in a level of coverage equivalent to (a) or (b). [Note: Article 67(3) MiFID and Article 7 CAD (see also rule (2)(b))] (2) If a firm chooses to comply with either (b) or (c) above, it must nevertheless have initial capital of at least [ 5,000/ 10,000]. 13.1A.4 R (1) A firm that is also an IMD insurance intermediary must have professional indemnity insurance at least equal to the limits set out in (2)(b) and in addition has to have: (a) (b) (c) initial capital of euro 25,000; or professional indemnity insurance at least equal to the requirements of (2)(c) and (3) to ; or a combination of initial capital and professional indemnity insurance in a form resulting in a level of coverage equivalent to (a) or (b). [Note: Article 67(3) MiFID and Article 8 CAD (see also rule (2)(c))] (2) If a firm chooses to comply with either (b) or (c) above, it must nevertheless have initial capital of at least [ 5,000/ 10,000]. Ongoing capital requirements 13.1A.5 R (1) A firm must, at all times, maintain own funds, calculated in accordance with (2), in excess of its initial capital requirement. (2) The firm's own funds must be calculated in accordance with R.

13 Initial capital 13.1A.6 R A firm's initial capital consists of the sum of the following items: (1) ordinary share capital; (2) non-cumulative preference share capital; (3) share premium account; (4) reserves excluding revaluation reserves; (5) audited retained earnings; (6) externally verified interim net profits or current account; (7) partners' capital account; and (8) eligible LLP members' capital (in accordance with the provisions of IPRU(INV) Annex A). Preference share capital 13.1A.7 R A firm may include preference share capital in the calculation of its initial capital only if: (1) there is an agreement between the firm and the holders of those shares which provides that redemption of the shares may not take place, if after such redemption the firm would be in breach of the requirements in R; and (2) the firm notifies the FSA in writing before issuing any preference shares of its intention to do so. Non-cumulative preference share capital 13.1A.8 R A firm may include preference share capital in initial capital only where the dividends are not cumulative. Audited retained earnings 13.1A.9 R When calculating initial capital, a firm may include its audited retained earnings only after making the following adjustments: (1) a firm must deduct any unrealised gains or, where applicable, add back in any unrealised losses on cash flow hedges of financial instruments measured at cost or amortised cost; (2) in respect of a defined benefit occupational pension scheme, a firm must derecognise any defined benefit asset; (3) a firm must not include any unrealised gains from investment

14 property (these should be reported as part of revaluation reserves); (4) where applicable, a firm must deduct any asset in respect of deferred acquisition costs and add back in any liability in respect of deferred income (but excluding from the deduction or addition any asset or liability which will give rise to future cash flows), together with any associated deferred tax. Externally verified interim net profits or current account 13.1A10 R A firm may include interim net profits or current account when calculating initial capital to the extent that they have been verified by the firm's external auditor and are net of any foreseeable charge, dividend or proprietor's drawings. 13.1A.11 R When calculating initial capital, a firm may include its partners current accounts figure only after making the following adjustments: (1) a firm must deduct any unrealised gains or, where applicable, add back in any unrealised losses on cash flow hedges of financial instruments measured at cost or amortised cost; (2) in respect of a defined benefit occupational pension scheme, a firm must derecognise any defined benefit asset; (3) where applicable, a firm must deduct any asset in respect of deferred acquisition costs and add back in any liability in respect of deferred income (but excluding from the deduction or addition any asset or liability which will give rise to future cash flows), together with any associated deferred tax. Defined benefit pension scheme: defined benefit liability 13.1A.12 R For the calculation of initial capital, a firm may substitute for a defined benefit liability the firm's deficit reduction amount. The election must be applied consistently in respect of any one financial year. 13.1A.13 G A firm should keep a record of and be ready to explain to its supervisory contacts in the FSA the reasons for any difference between the deficit reduction amount and any commitment the firm has made in any public document to provide funding in respect of a defined benefit occupational pension scheme.

15 Appendix 13(1) Defined terms for Chapter 13 initial capital means the initial capital of a firm calculated in accordance with 13.1A.6. In the following text underlining indicates new text and striking through indicates deleted text. Amendments to Chapter 14: R Subject to rule 14.12, consolidated supervision and this chapter apply to a firm which is a member of a group if: (1)... (b) a securities and futures firm, subject to the financial rules in Chapter 10, unless the firm is an category D firm exempt CAD firm; or

16 Annex B Amendments to the Interim Prudential Sourcebook for Investment Businesses In this Annex, all the text is new and is not underlined. Insert the following new chapter as Chapter 9 of IPRU(INV): Chapter 9: Financial resources requirements for an exempt CAD firm 9.1 Application R This chapter applies to an exempt CAD firm which is: 9.2 General requirements (1) an investment management firm; or (2) a securities and futures firm G For an exempt CAD firm, the rules contained within this chapter replace the rules in respect of financial resources contained within Chapter 3, 5 or 10, as applicable. However, an exempt CAD firm must continue to comply with the requirements of Chapter 3, 5 or 10, as applicable, for its non-financial resources related requirements and to the extent it is referred to Chapter 3, 5 and 10 by a rule in this chapter R A firm must: (1) have and maintain at all times financial resources of the kind and amounts specified in, and calculated in accordance with, the rules of this chapter; and (2) be able to meet its liabilities as they fall due R The financial resources of an exempt CAD firm that carries on any regulated activity other than MiFID business must be the higher of: (1) the requirement which is calculated by reference to this chapter; and (2) the requirement which is calculated by reference to the financial resources rules of the chapter of IPRU(INV) to which the firm is otherwise subject (Chapter 3, 5 or 10). Initial capital and professional indemnity insurance requirements firms that are not IMD insurance intermediaries R (1) A firm which is not an IMD insurance intermediary must have: (a) initial capital of euro 50,000; or

17 (b) (c) professional indemnity insurance covering the whole territory of the EEA or some other comparable guarantee against liability arising from professional negligence, representing at least euro 1,000,000 applying to each claim and in aggregate euro 1,500,000 per year for all claims; or a combination of initial capital and professional indemnity insurance in a form resulting in a level of coverage equivalent to (a) or (b). [Note: Article 67(3) MiFID and Article 7 CAD] (2) If a firm chooses to meet the requirements of either (b) or (c) above, it must nevertheless have initial capital of at least [ 5,000/ 10,000]. Initial capital and PII requirements firms that are also IMD insurance intermediaries R (1) A firm that is also an IMD insurance intermediary must always have professional indemnity insurance equal to the requirements set out in rule 9.2.4(1)(b) and in addition has to have: (a) (b) (c) initial capital of euro 25,000; or professional indemnity insurance covering the whole territory of the EEA or some other comparable guarantee against liability arising from professional negligence, representing at least euro 500,000 applying to each claim and in aggregate euro 750,000 per year for all claims; or a combination of initial capital and professional indemnity insurance in a form resulting in a level of coverage equivalent to (a) or (b). [Note: Article 67(3) MiFID and Article 8 CAD] (2) If a firm chooses to meet the requirements of either (b) or (c) above, it must nevertheless have initial capital of at least [ 5,000/ 10,000]. Comparable guarantee R (a) If another authorised person which has net assets of more than 10 million provides a comparable guarantee, a firm can treat it as an alternative to effecting or maintaining professional indemnity insurance pursuant to rules 9.2.4(1)(b) or 9.2.5(1)(b), or both. (b) If the firm is a member of a group in which there is an authorised person with net assets of more than 10 million, the comparable guarantee must be from that person.

18 (c) A comparable guarantee means a written agreement on terms at least equal to those required by rule to finance the claims that might arise as a result of the breach by the firm of its duties under the regulatory system or civil law. Own funds R (1) A firm must, at all times, maintain own funds, calculated in accordance with (2), in excess of its initial capital requirement. (2) (a) If the firm is an investment management firm its own funds must be calculated in accordance with the rules in IPRU(INV) 5.2.1(1) to 5.2.7(5). (b) If the firm is a securities and futures firm (subject to either Chapter 3 or Chapter 10) its own funds must be calculated in accordance with the rules in IPRU(INV) 10.61(1)(B) to Calculating Initial capital Initial capital R A firm's initial capital consists of the sum of the following items: (1) ordinary share capital; (2) non-cumulative preference share capital; (3) share premium account; (4) reserves excluding revaluation reserves; (5) audited retained earnings; (6) externally verified interim net profits or current account; (7) partners' capital accounts; and (8) eligible LLP members' capital (in accordance with the provisions of IPRU(INV) Annex A) Preference share capital R A firm may include preference share capital in the calculation of its initial capital only if: (1) there is an agreement between the firm and the holders of those shares which provides that redemption of the shares may not take place, if after such redemption the firm would be in breach of rule 9.2.2; and

19 (2) the firm notifies the FSA in writing before issuing any preference shares of its intention to do so. Non-cumulative preference share capital R A firm may include preference share capital in initial capital only where the dividends are not cumulative. Audited retained earnings R When calculating initial capital, a firm may include its audited retained earnings only after making the following adjustments: (1) a firm must deduct any unrealised gains or, where applicable, add back in any unrealised losses on cash flow hedges of financial instruments measured at cost or amortised cost; (2) in respect of a defined benefit occupational pension scheme, a firm must derecognise any defined benefit asset; (3) a firm must not include any unrealised gains from investment property (these should be reported as part of revaluation reserves); (4) where applicable, a firm must deduct any asset in respect of deferred acquisition costs and add back in any liability in respect of deferred income (but excluding from the deduction or addition any asset or liability which will give rise to future cash flows), together with any associated deferred tax. Externally verified interim net profits or current account R A firm may include interim net profits or current account when calculating initial capital to the extent that they have been verified by the firm's external auditor and are net of any foreseeable charge, dividend or proprietor's drawings R When calculating initial capital, a firm may includes its partners current accounts figure only after making the following adjustments: (1) a firm must deduct any unrealised gains or, where applicable add back in any unrealised losses on cash flow hedges of financial instruments measured at cost or amortised cost; (2) in respect of a defined benefit occupational pension scheme, a firm must derecognise any defined benefit asset; (3) where applicable, a firm must deduct any asset in respect of deferred acquisition costs and add back in any liability in respect of deferred income (but excluding from the deduction or addition any asset or liability which will give rise to future cash flows), together with any associated deferred tax.

20 Defined benefit pension scheme: defined benefit liability R For the calculation of initial capital, a firm may substitute for a defined benefit liability the firm's deficit reduction amount. The election must be applied consistently in respect of any one financial year G A firm should keep a record of and be ready to explain to its supervisory contacts in the FSA the reasons for any difference between the deficit reduction amount and any commitment the firm has made in any public document to provide funding in respect of a defined benefit occupational pension scheme. 9.4 Policy terms for professional indemnity insurance Insurers whose professional indemnity insurance policies can be used R A firm that has professional indemnity insurance in accordance with this chapter must take out and maintain professional indemnity insurance that is at least equal to the requirements of rule from: (1) an insurance undertaking which is authorised to transact professional indemnity insurance in the EEA; or (2) a person of equivalent status in: (a) (b) a Zone A country; the Channel Islands, Gibraltar, Bermuda or the Isle of Man. Terms to be incorporated in the insurance R The contract of professional indemnity insurance must incorporate terms which make provision for: (1) cover in respect of claims for which a firm may be liable as a result of the conduct of itself, its employees and its appointed representatives (acting within the scope of their appointment); (2) the minimum levels of indemnity per year as set out in rules and 9.2.5; (3) appropriate cover in respect of legal defence costs; and (4) cover in respect of Ombudsman awards made against the firm G In relation to rule 9.4.2(1), a firm should be aware that it is responsible for the conduct of all of its employees. The firm's employees include, but are not limited to, its partners, directors, individuals that are selfemployed or operating under a contract hire agreement and any other individual that is employed in connection with its business.

21 9.4.4 G In relation to rule 9.4.2(1), a firm should be aware that it is responsible for the conduct of all of its appointed representatives. Policies in other currencies R If a professional indemnity insurance policy is denominated in any currency other than euros, a firm must take reasonable steps to ensure that the limits of indemnity are, when the policy is effected and at renewal, at least equivalent to those required for the purposes of rules and Conditions and exclusions R A professional indemnity insurance policy must not be subject to conditions or exclusions which unreasonably limit the cover provided for in rules and (whether by exclusion of cover, by policy excesses or otherwise). APPENDIX 9(1) (INTERPRETATION) Glossary of defined terms for Chapter 9 Note: If a defined term does not appear in the glossary below, the definition appearing in the Handbook Glossary applies. initial capital means the initial capital of a firm calculated in accordance with section 9.3. own funds means the own funds of a firm calculated in accordance with rule verified means checked by an external auditor who has undertaken at least to: (a) (b) (c) satisfy himself that the figures forming the basis of the interim profits have been properly extracted from the underlying accounting records; review the accounting policies used in calculating the interim profits so as to obtain comfort that they are consistent with those normally adopted by the firm in drawing up its annual financial statements and are in accordance with the relevant accounting principles; perform analytical procedures on the result to date, including comparisons of actual performance to date with budget and

22 with the results of prior period(s); (d) (e) (f) discuss with management the overall performance and financial position of the firm; obtain adequate comfort that the implications of current and prospective litigation, all known claims and commitments, changes in business activities and provisioning for bad and doubtful debts have been properly taken into account in arriving at the interim profits; and follow up problem areas of which he is already aware in the course of auditing the firm's financial statements, and a copy of whose report asserting that the interim net profits are reasonably stated has been submitted to the FSA.

23 Annex C Amendments to Prudential Sourcebook for Mortgage Firms and Insurance Intermediaries (MIPRU) In this Annex, underlining indicates new text and striking through indicates deleted text. 3 Requirement to hold professional indemnity insurance R Application (5) In relation to all the activities in (2), this section does not apply to: (c) (d) a firm to which IPRU(INV) (1) (Financial resource requirements for personal investment firms: requirement to hold professional indemnity insurance) applies.; or an exempt CAD firm to which IPRU(INV) 9.2.5R (Initial capital and PII requirements firms that are also IMD insurance intermediaries) applies.

24 Annex D Amendments to the Glossary In this Annex, underlining indicates new text and striking through indicates deleted text. exempt CAD firm (1) (except in IPRU(INV), MIPRU and SYSC) has the meaning set out BIPRU R (Types of investment firm: exempt CAD firm) which is in summary an investment firm that satisfies certain specified conditions. (2) (in IPRU(INV), MIPRU and SYSC) a firm in (1) whose head office is in the United Kingdom (or, if it has a registered office, that office). Note for consultation: the changes underlined are made to the amended definition of "exempt CAD firm" contained in CP 06/3 "Strengthening Capital Standards 2", which will take effect on 1 January 2007.

25 Annex E Amendments to the Supervision Manual In this annex all of the text is new and is not underlined. The location of the new text is described. Insert the following new forms after form FSA030 in SUP 16 Annex 24R

26 FSA031 Capital Adequacy Exempt CAD firms Subject to IPRU (INV) Chapter 9 Regulatory Capital ( Investment Management firm which is an exempt CAD firm ) Part 1 (References to "Items" refer to Items of capital in Part I of IPRU (INV) Table 5.2.2(1)) Tier 1 1 Paid up share capital (excluding preference shares) (Item 1) 2 Eligible LLP Members' Capital 3 Share premium account (Item 2) 4 Reserves (Item 3) 5 Non-cumulative preference shares (Item 4) 6 Less: Investment in own shares (Item 5) 7 Intangible assets (Item 6) 8 Material current year losses (Item 7) 9 Material holdings in credit and financial institutions (Item 8) 10 Tier 1 Capital 11 Tier 2 12 Revaluation reserves (Item 9) 13 Fixed term cumulative preference share capital (tem 10) 14 Long term subordinated loans (Item 11) 15 Other cumulative preference share capital and debt capital (Item 12) 16 Qualifying arrangements (Item 13) 17 Own Funds

27 Part 2 (Securities and Futures Firm which is an exempt CAD firm) 18 Initial capital 19 Less: Investments in own shares 20 Intangible assets 21 Material unaudited losses 22 Original own funds 23 Non-fixed term cumulative preference shares 24 Fixed term cumulative preference shares (50% of tier one original own funds) 25 Non-fixed term long term subordinated loan 26 Fixed term long term subordinated loan 27 Revaluation reserve 28 Less the sum of material holdings in credit and financial institutions and material insurance holdings 29 Own Funds Regulatory capital test 30 How do you meet your regulatory capital requirement? (Drop down box choice of Capital / PII / Combination) 31 Capital resources requirement 32 Own Funds requirement 33 Other FSA own funds requirement (if applicable) 34 Surplus / (deficit) Professional Indemnity Insurance 34 Does your firm hold a Comparable Guarantee in lieu of PII or is it otherwise exempt from PII? Yes/No 35 Does your firm conduct insurance mediation activities? Yes/No 36 Limit of indemnity required : Single 37 : Aggregate 38 Limited of indemnity obtained : Single 39 : Aggregate

28 40 Annual premium 41 Policy excess 42 Start date 43 Renewal date 44 Insurer's name 45 Length of PII contract

29 FSA032 Capital Adequacy Exempt CAD firms PIFs subject to Ch 13 IPRU (Inv) which choose to carry out European -wide activities Regulatory Capital Own Funds 1 Paid up share capital (excluding preference shares redeemable by shareholders within 2 years) 2 Eligible LLP Members' Capital 3 Share premium account 4 Audited reserves (excluding revaluation reserves ) and verified interim net profits 5 Non-cumulative preference shares (if not redeemable by shareholders within 5 years) 6 Balances on proprietor's or partners' capital accounts 7 Balances on proprietor's or partners' current accounts 8 Less: Investments in own shares 9 Intangible assets 10 Material current year losses 11 Material holdings in credit and financial institutions 12 Excess of current year's drawings over current year profits 13 Revaluation Reserves 14 Cumulative preference share capital ( if not redeemable by shareholder within 5 years) 15 Long-Term subordinated loans 16 Preference share capital (if not redeemable by shareholders within 2 years) and debt capital 17 Own Funds [1to7-(8 to12)+(13to16)] Adjusted net current assets 18 Net current assets (from balance sheet) 19 Less: Long term assets adjustment 20 Connected persons adjustment 21 Investments adjustment 22 Adjusted Net Current assets [18 - (19 to 21)]

30 Regulatory capital test 23 How do you meet your regulatory capital requirement? ( Drop down box choice of Capital/PII/Combination) Capital requirement 24 Own funds requirement 25 Additional own funds requirement for PII (if applicable) 26 Other FSA capital / own funds requirements (if applicable) 27 Own Funds [17] 28 Surplus / (deficit) [27-(24to26)] Adjusted net current assets 29 Adjusted net current assets requirement (if applicable) 30 Adjusted net current assets (if applicable) [22] 31 Surplus / (deficit) (if applicable) [30-29] Professional Indemnity Insurance 32 Does your firm hold a Comparable Guarantee or equivalent cover in lieu of PII or is it otherwise exempt Yes / No from holding PII? 33 If your firm does not hold a Comparable Guarantee or equivalent cover and is not exempt does the firm Yes / No currently hold PII? 34 Does your firm conduct insurance mediation activities? Yes / No 35 Firms should state their limit(s) in Euros 36 Limit of imdemnity required : Single 37 : Aggregate (If also conducting IMD scope activities, 1.5m for IMD activities plus 750k for MiFID scope or 25 k capital (or mix) 38 Limit of indemnity obtained : Single 39 : Aggregate Euros 40 Has your firm renewed its PII cover since the last reporting date? Yes/No 41 If your policy excludes all business activities carried on prior to a particular date (I.e. a retroactive start date), then insert the date here. If not insert N/A.

31 42 Is the cover compliant? 43 Annual premium 44 Policy excess 45 Increased excess(es) for specific business types : Business types 46 (Only in respect of business you have undertaken in the past or : Amount will undertake during the period covered by this policy) 47 Policy exclusion(s) for specific business types (Only in respect of business you have undertaken in the past or will undertake during the period covered by this policy) 48 Start date 49 End date 50 Insurer's name 51 Annual income as stated on the most recent proposal form 52 Amount of additional capital required for increased excess(es) (Where applicable, total amount for all PII policies) 53 Total amount of additional own funds required for policy exclusion(s) 54 Total of additional own funds required Total of readily realisable own funds 56 Excess / (deficit) of readily realisable own funds 55-54

32 Insert the following section after the guidance on FSA030 in SUP 16 Annex 25G FSA031 Capital Adequacy for UK exempt CAD firms subject to IPRU (INV) Ch 9 Introduction The purpose is to provide a framework for the collection of information required by the FSA as a basis for its supervision activities. It also has the purpose to help the FSA to monitor a firm's capital adequacy and financial soundness. Defined Terms Terms referred to in these notes where defined by the Companies Act 1985 or the provisions of the firm's accounting framework (usually UK GAAP or IFRS) bear that meaning for these purposes. The descriptions indicated in these notes are designed simply to repeat, summarise or amplify the relevant statutory or other definitions and terminology without departing from their full meaning or effect. the data item must comply with the principles and requirements of the firm's accounting framework, which will generally be UK GAAP (including relevant provisions of the Companies Act 1985) or IFRS the data item must be unconsolidated for a sole trader, only the assets and liabilities of the business should be included the firm is required to include a statement of material accounting policies the data item must be in agreement with the underlying accounting records accounting policies must be consistent with those adopted in the statutory annual accounts and must be consistently applied information required must be prepared in accordance with generally accepted accounting standards investments (other than investments in subsidiaries and related companies) must be included in the balance sheet at cost or market value (or the firm's estimate) the data item must not give a misleading impression of the firm. A data item is likely to give a misleading impression if a firm wrongly omits or includes a material item or presents a material item in the wrong way

33 Data element Row Number Guidance Regulatory capital This section has two parts. Each firm need only complete one part: Part 1 should only be completed by firms previously subject to the requirements of IPRU (INV) Chapter 5 Part 2 should only be completed by firms previously subject to the requirements of IPRU (INV) Chapter 3 or10 Initial capital 18 Initial capital includes ordinary share capital, noncumulative preference shares, share premium account, reserves excluding revaluation reserves, audited retained earnings, externally verified interim net profits or current account, proprietor's or partners' capital account and eligible LLP members' capital. Preference share capital can only be included in own funds, provided that there is an agreement in place, that redemption may not take place if it would take the firm into a deficit of own funds. Regulatory capital test How do you meet your regulatory capital requirement? 30 The rules allow a firm to specify the method in which it will meet the regulatory capital requirement. A firm can: use capital to meet the regulatory requirement; or use PII insurance to meet the regulatory requirement; or use a combination of capital and PII to meet the regulatory requirement.

34 Other FSA own funds requirements (if applicable) 33 Firms subject to a requirement under another chapter of IPRU(INV) should include that requirement to the extent it exceeds the own funds requirement in line with row 32. Professional Indemnity Insurance This section requires the firms to confirm it is in compliance with the prudential requirements in relation to professional indemnity insurance (PII). Data is required in relation to all PII policies that a firm has in place, up to a limit of ten (the firm will be prompted to submit data on all applicable policies). If a firm has more than ten policies, it should report only on the ten largest policies by premium. Does your firm hold a comparable guarantee in lieu of PII or is it otherwise exempt from PII? 34 This question will establish whether a firm is exempt from the requirements and so is not required to hold PII. If the firm is required to hold PII i.e. is not exempt from holding PII you should enter 'no' in the data field. A firm is NOT exempt from holding PII if: the firm has a group policy with an insurer; or the firm has permission for the regulated business that requires PII, but does not currently carry it out; or it is a personal investment firm meeting the exemption requirements for mortgage intermediaries and insurance intermediaries in PRU 9.2. Does your firm conduct insurance mediation activities? Limit of indemnity required single Limit of indemnity required aggregate Limited of indemnity obtained single 35 Insurance mediation activities are defined in the FSA Handbook glossary. 36 You should record here the required indemnity limits on the firm s PII policy or policies, in relation to single claims. This should be stated in Euros. 37 You should record here the required indemnity limits on the firm s PII policy or policies, in aggregate. This should be stated in Euros. 38 You should record here the indemnity limits on the firm s PII policy or policies obtained in relation to single claims. This should be stated in

35 Euros. Limited of indemnity obtained aggregate 39 You should record here the indemnity limits on the firm s PII policy or policies obtained in aggregate. This should be stated in Euros. Annual premium 40 This should be the annual premium that is paid by the firm, net of tax and any other add-ons. Policy excess 41 If the policy includes an excess(es) the amount(s) should be stated here. Insurer's name 44 The firm should select the name of the insurance undertaking or Lloyd's syndicate providing cover. If the PII provider is not listed you should select 'other' and enter the name of the insurance undertaking or Lloyd's syndicate providing cover in the free-text box. If a policy is underwritten by more than one insurance undertaking or Lloyd's syndicate, you should select 'multiple' and state the names of all the insurance undertakings or Lloyd's syndicates in the free-text box. Length of PII contract 45 You should record here the length of the PII contract in months.

36 FSA032 Capital Adequacy - Exempt CAD firms - PIFs subject to Ch 13 IPRU (Inv) which choose to carry out European-wide activities Introduction The purpose is to provide a framework for the collection of information required by the FSA as a basis for its supervision activities. It also has the purpose to help the FSA to monitor a firms' capital adequacy and financial soundness. Defined Terms Terms referred to in these notes where defined by the Companies Act 1985 or the provisions of the firm's accounting framework (usually UK GAAP or IFRS) bear that meaning for these purposes. The descriptions indicated in these notes are designed simply to repeat, summarise or amplify the relevant statutory or other definitions and terminology without departing from their full meaning or effect. the data item must comply with the principles and requirements of the firm's accounting framework, which will generally be UK GAAP (including relevant provisions of the Companies Act 1985) or IFRS the data item must be unconsolidated for a sole trader, only the assets and liabilities of the business should be included the firm is required to include a statement of material accounting policies the data item must be in agreement with the underlying accounting records accounting policies must be consistent with those adopted in the statutory annual accounts and must be consistently applied information required must be prepared in accordance with generally accepted accounting standards investments (other than investments in subsidiaries and related companies) must be included in the balance sheet at cost or market value (or the firm's estimate) the data item must not give a misleading impression of the firm. A data item is likely to give a misleading impression if a firm wrongly omits or includes a material item or presents a material item in a wrong way

37 Data element Row Number Guidance Regulatory Capital Paid up share capital (excluding preference shares redeemable by shareholders within 2 years) 1 Share capital which is eligible for inclusion as regulatory capital. Revaluation reserves 13 Revaluation reserves (unrealised reserves arising from revaluation of fixed assets) can only be included here if audited. Regulatory capital test(s). How do you meet your regulatory capital requirement? 23 IPRU(INV) Chapter 13 allows an exempt CAD firm to specify the method in which it will meet the regulatory requirement. A firm can: use capital to meet the regulatory requirement; or use PII insurance to meet the regulatory requirement; or use a combination of capital and PII to meet the regulatory requirement. Capital requirement Own funds requirement 24 The own funds requirement ( OFR ) should be calculated in accordance with section IPRU (INV) 13.1A.. Additional own funds requirement for PII (if applicable) Other FSA capital / own funds requirements (if applicable) 25 If the firm has any increased excesses or exclusions on its PII policies, the total of the additional capital requirements required by IPRU(INV) Firms subject to a requirement under IPRU(INV) or should include that requirement as calculated by reference to the firm's own funds calculated under IPRU(INV) 13.3 to the extent it

38 exceeds the own funds requirement in item 24. This excludes capital requirements in relation to PII. Surplus / (deficit) 28 This should show the amount of the firm s own funds in relation to its own funds requirement. A firm's own funds requirement, is the total of 24,25 and 26. So, such a firm should compare this requirement with the own funds calculated in 27 to compute the surplus/(deficit ) Adjusted net current assets The purpose of this test is to ensure that the firm has adequate working capital to be able to meet its liabilities as and when they fall due. It does this by taking the firm s net current assets (from the balance sheet), and applying the following actions: (1) excluding assets which cannot be realised or recovered within twelve months; (2) excluding amounts receivable from connected persons (to the extent that they are not properly secured, except certain allowable deposits); (3) valuing investments at current market value. Adjusted net current assets requirement (if applicable) 29 All personal investment firms except low resource firms should at all times have adjusted net current assets of at least 1. Low resource firms should enter n/a here. Adjusted net current assets (if applicable) Surplus / (deficit) (if applicable) 30 Adjusted net current assets should be calculated in accordance with IPRU (INV) This shows whether the firm s net current assets are positive. Professional Indemnity Insurance This section requires the firm to confirm that it is in compliance with the prudential requirements in relation to professional indemnity insurance (PII). Data is required in relation to all PII policies that a firm has in place, up to a limit of ten (the firm will be prompted to submit data on all applicable policies). If a firm has more than ten policies, it should report only on the ten largest policies by premium. Does your firm hold a Comparable Guarantee or 32 This question will establish whether a firm is exempt from the requirements and so is not required to hold PII.

39 equivalent cover in lieu of PII or is it otherwise exempt from holding PII? If the firm is required to hold PII i.e. is not exempt from holding PII you should enter 'no' in the data field. A firm is NOT exempt from holding PII if: the firm has a group policy with an insurer; or the firm has permission for regulated business that requires PII, but does not currently carry it out; or it is a personal investment firm meeting the exemption requirements for mortgage intermediaries and insurance intermediaries in PRU 9.2. Limit of indemnity required - single Limit of indemnity required aggregate Limit of indemnity obtained single Limit of indemnity obtained aggregate If your policy excludes all business activities carried on prior to a particular date (i.e. a retroactive start date), then insert the date here. If not insert N/A. 36 You should record here the required indemnity limits on the firm s PII policy or policies, in relation to single claims, as under IPRU(INV) (2) R. This should be stated in Euros. 37 You should record here the required indemnity limits on the firm s PII policy or policies, in aggregate, as under IPRU(INV) (2) R. This should be stated in Euros. 38 You should record here the indemnity limits on the firm s PII policy or policies obtained in relation to single claims, as in IPRU(INV) (2) R. This should be stated in Euros. 39 You should record here the indemnity limits on the firm s PII policy or policies obtained in aggregate, as in IPRU(INV) (2) R. This should be stated in Euros. 41 Required terms of PII are set out in IPRU(INV) Examples of a retroactive start date: (1) A firm has a retroactive start date of 01/01/2005 on its policy if: A client is advised by the firm to purchase an XYZ policy on 01/03/2004 (i.e. before the retroactive date) The client makes a formal complaint about the sale of the XYZ policy to the firm on 01/04/2006 (i.e. while this PII cover is still in