IPRU-INV 13.12 FINANCIAL RESOURCES TEST 2 - EXPENDITURE-BASED REQUIREMENT

DEDUCTIONS FROM EXPENDITURE

(a)

staff bonuses;

(b)

employees' and directors' shares in profits;

(c)

interest charges in respect of borrowing made to finance the acquisition of its readily realisable investments;

(d)

shared commissions paid which are directly related to commissions received;

(e)

emoluments of directors, partners or a sole trader;

(f)

a firm must not deduct any exceptional expenditure.

FIRMS CATEGORY B1

Calculation of Assets

ASSETS

ADJUSTMENTS

(1) Land and Buildings

Exclude in full. (A loan secured by a charge on land and buildings may be deducted from liabilities in accordance with item (14) of Part II of this table.)

(2) Investments

Include any net long position in any fixed or current asset investment (including shares in any connected company)

(a) valued at its current bid price (or, in the case of a with-profits life policy, at its surrender value), and

(b) discounted by the applicable percentage specified in table 13.12.3A.

A firm which acts as a market-maker in second-hand life policies must comply with the relevant requirements in respect of secondhand life policies held by the firm and include such a policy.

(a) valued at its surrender value at the date on which the firm acquired it, or its latest available surrender value if different.

(b) where a life office whose policy is held by the firm has altered adversely the basis on which it calculates surrender values, the firm must revise its valuation of the second-hand policy as soon as practicable after becoming aware of the alteration.

(3) Investments subject to Repurchase, Reverse Repurchase, Stock Borrowing or Stock Lending transactions

Include investments for which the firm has entered as principal into a repurchase, reverse repurchase, stock borrowing or stock lending transaction on its own behalf, after making (I) a deduction in accordance with item (2), and (II) a deduction calculated by computing its exposure (the difference between the market value of the securities and the loan or collateral (including accrued interest) where that difference is not in the firm's favour, after adjusting for any excess collateral).

(4) Debtors relating to Unsettled Securities Transactions Cash against Documents

Include debtors where the firm has entered into a transaction on its own behalf in securities or units in collective investment schemes on a cash against documents basis, and the transaction remains unsettled, after deducting an amount calculated by

(a) computing the difference between the agreed settlement price for those investments and their current bid price where that difference is not in the firm's favour, and

(b) multiplying that difference by the applicable percentage specified in table 13.12.3B.

(5) Debtors relating to Unsettled Securities Transactions Free Deliveries

(a) Include the full amount due to the firm from debtors if a firm has delivered securities or units in collective investment schemes before receiving payment for them, or paid for such investments before receiving certificates of good title for them, so long as not more than three days have passed since delivery

(b) If more than three days have passed since delivery, exclude in full.

(6) Regulated collective investment schemes

Include an amount owing in respect of a transaction in units in a regulated collective investment scheme only if the amount has been due and unpaid for 30 days or less after the settlement date of the transaction to which it relates.

(7) Loans secured on investments

If the firm holds client title documents as security for

(a) the repayment of money it has lent; or

(b) money due to the firm in connection with the purchase for or sale to another person of those investments, which the firm has for genuine commercial reasons agreed to postpone, the firm may include as an asset the lower of the following:

(i) the total amount due;

(ii) the market value of the investments multiplied by the appropriate rates set out in table 13.12.3A.

(8) Trade debtors

Include amounts owing only in respect of

(a) (i) commission;

(ii) investment management fees;

(iii) other fees earned in connection with the firm's investment business, which are due from other authorised or EEA firms, recognised investment exchanges or recognised clearing houses and have been due and unpaid for 30 days or less;

(b) (i) investment management fees; or

(ii) pensions administration which have been due from its customers and unpaid for 30 days or less.

(c) All other trade debtors must be deducted in full.

(9) Prepayments

Include prepayments which relate to goods or services to be received or performed within 90 days.

(10) Accrued income

(a) Accrued income relating to investment management fees not yet due and payable may be included if the fees relate to services provided within the previous six months.

(b) Other accrued income may be included if it relates to interest on marketable debt instruments or on deposits included in item (11).

(11) Deposits

The following may be included:

(a) cash and balances on current accounts and on deposit accounts with an approved bank or National Savings Bank which can be withdrawn within 90 days;

(b) money on deposit with a UK local authority which can be withdrawn within 90 days;

(c) money deposited and evidenced by a certificate of tax deposit.

(12) Other Debts

(a) Amounts owing in respect of

(i) interest on investments;

(ii) repayments of marketable debt instruments at maturity or call;

(iii) dividends declared by authorised or not EEA firms or by companies in respect of shares listed on a recognised or designated investment exchange;

which have been due and unpaid for 30 days or less may be included.

(b) Other amounts due from UK government bodies may be included if they are agreed and due within 30 days.

(13) All other a ssets

Exclude in full.

FIRMS IN CATEGORY B1

Calculation of Liabilities

LIABILITIES

ADJUSTMENTS

(14) Secured Liabilities

Include in full, except the amount of the liabilities secured by a charge on land and buildings which may be reduced by the smallest of the following amounts:

(a) the aggregate amount of the firm's secured liabilities which are due more than one year after the balance sheet date;

(b) (if the land and buildings have been valued by an independent professional valuer within the past 18 months) 85% of the amount certified by the valuer as their market value;

(c) 85% of the net book value of the land and buildings.

(15) Subordinated loans

Include in full, except any short-term subordinated loan in the standard form prescribed by the

FSA

which may be treated as capital up to the limits specified in rules 13.12.5 and 13.12.5A.

(16) Commission on indemnity terms from the sale of life policies or pension contracts

Include as a liability a provision for repayment, in the event that premiums cease within the indemnity period, which must equal or exceed 2.5% of the commissions the firm has received on indemnity terms during the previous twelve months. This provision must be reasonable having regard to its circumstances and, in particular, its previous lapse ratio.

(17) Short Positions

Include a net short position

(a) valued at its offer price and

(b) increased using the applicable percentage rate in table 13.12.3A.

(18) Deficiency in subsidiary

Include as a liability the amount by which the liabilities of any subsidiary (excluding its capital and reserves) exceed its tangible assets. This requirement applies only to the extent that the firm has not already made such a provision elsewhere in its financial statements.

(19) Liability for tax

Include as a liability a provision for taxation on the whole of the profits of the firm's business up to its balance sheet date.

(20) Creditors relating to Unsettled Securities Transactions - Cash against Documents

Include creditors where the firm has entered into a transaction on its own behalf in Securities or units in collective investment schemes on a cash against documents basis, and the transaction remains unsettled, after adding an amount calculated by

(a) computing the difference between the agreed settlement price for those investments and their current market value where that difference is not in the firm's favour, and

(b) multiplying that difference by the applicable percentage specified in table 13.12.3B.

(21) Creditors relating to Unsettled Securities Transactions - Free Deliveries

Include an amount for creditors where (acting on the firm's own behalf) the firm has delivered certificates of title for securities or units in collective investment schemes before receiving payment for them, or where a firm has bought such investments before receiving certificates of good title for them, as follows:

(a) (if the firm has paid for them and not more than 3 days have passed since the payment was made) include in full:

(b) (if more than 3 days have passed since the payment was made) include the full value of the securities at their current offer price.

(22) Over the counter derivatives

If the firm holds positions in derivatives on its own behalf must

(a) make the adjustment in item (17) of this table, and

(b) deduct the credit equivalent of those positions computed in accordance with table 13.12.3C. In addition, bought OTC options and covered warrants will be subject to table 13.12.3D.

(23) Contingent Liabilities

A firm must include a provision for any contingent liabilities which exist at its balance sheet date that must be made.

(24) Redeemable Preference Shares

Include as a liability any redeemable preference shares which fall due within two years. If shares are not redeemable by the shareholder within 2 years, they must be treated in accordance with rules 13.12.5 and 13.12.5A.

(25) Foreign currency risk

If the firm holds positions on its own behalf in foreign currencies or has assets or liabilities denominated in foreign currencies, the firm must calculate a provision to cover the risk in accordance with table 13.12.3D and include the amount as a liability

(26) All other liabilities

Include in full.

FIRMS IN CATEGORIES B2 AND B3

(except low resource firms)

Calculation of Assets

ASSETS

ADJUSTMENTS

(1) Land and Buildings

Include land and buildings which are not subject to any charge only if they have been valued either

(a) at 60% of their net book value, or

(b) ( if valued by an independent professional valuer within the past three years) at 60% of the amount certified by the valuer to be the market value.

(2) Motor vehicles

(a) Include motor vehicles acquired less than 12 months ago valued at 50% of their cost

(b) Include motor vehicles acquired within the past 24 months (but more than 12 months ago) valued at 25% of their cost

(c) Exclude in full any other motor vehicles.

(3) Investments

Include any net long position in any fixed or current asset investment (including shares in any connected company)

(a) valued at its current bid price (or, in the case of a with-profits life policy, at its surrender value), and

(b) discounted by the applicable percentage specified in table 13.12.3A.

(4) Debtors relating to Unsettled Securities Transactions Cash against Documents

Include debtors where the firm has entered into a transaction on its own behalf in securities or units in collective investment schemes on a cash against documents basis, and the transaction remains unsettled, after deducting an amount calculated by

(a) computing the difference between the agreed settlement price for those investments and their current bid price where that difference is not in the firm's favour, and

(b) multiplying that difference by the applicable percentage specified in table 13.12.3B.

(5) Debtors relating to Unsettled Securities Transactions Free Deliveries

(a) Where the firm has delivered securities or units in collective investment schemes before receiving payment for them or paid for such investments before receiving certificates of good title for them include the full amount due to a firm from debtors so long as not more than 3 days have passed since delivery.

(b) Exclude in full if more than 3 days have passed since delivery.

(6) Regulated collective investment schemes

Include an amount owing in respect of a transaction in units in a regulated collective investment scheme only if the amount has been due and unpaid for 30 days or less after the settlement date of the transaction to which it relates.

(7) Debts of group or connected companies

Include amounts due from group or connected companies (which do not relate to trade debts) where a firm has no reason to doubt that repayment will be made in full on demand.

(8) Trade debtors

Include amounts due from trade debtors (including group or connected companies) which have been due and unpaid for less than 90 days.

(9) Prepayments

Include prepayments which relate to goods or services to be received or performed within 90 days.

(10) Accrued income

(a) Include accrued income not yet due and payable in respect of fees earned in the performance of investment management services that is receivable within six months.

(b) Include any other accrued income receivable within 90 days.

(11) Deposits

The following may be included:

(a) cash and balances on current accounts and on deposit accounts with an approved bank or National Savings Bank which can be withdrawn within 90 days;

(b) money on deposit with a UK local authority which can be withdrawn within 90 days;

(c) money deposited and evidenced by a certificate of tax deposit.

(12) Other amounts due from Government bodies or local authorities

Include other amounts due from UK Government bodies or local authorities if they are agreed and due within 90 days.

(13) All other assets

Exclude in full.

FIRMS IN CATEGORY B1

(except low resource firms)

Calculation of Liabilities

LIABILITIES

ADJUSTMENTS

(14) Secured Liabilities

Include in full, except the amount of the liabilities secured by a charge on land and buildings which may be reduced as follows:

(a) If the liabilities secured exceed 85% of the value of the land and buildings, then the excess is treated as a liability;

(b) If the land and buildings have been valued by an independent professional valuer within the past three years, the value of the land and buildings is the amount certified by the valuer as their market value; otherwise it is their net book value.

(If 60% of the value of the land and buildings which are subject to a charge exceeds the liabilities secured, then the amount of that excess may be treated as an asset.)

(15) Subordinated loans

Include in full, except any short-term subordinated loan in the standard form prescribed by the FCA which may be treated as capital up to the limits specified in rules 13.12.5 and 13.12.5A.

(16) Commission on indemnity terms from the sale of life policies or pension contracts

Include as a liability a provision for repayment, in the event that premiums cease within the indemnity period, which must equal or exceed 2.5% of the commissions the firm has received on indemnity terms during the previous twelve months. This provision must be reasonable having regard to its circumstances and, in particular, its previous lapse ratio.

(17) Short Positions

Include a net short position

(a) valued at its offer price, and

(b) increased using the applicable percentage rate in table 13.12.3A.

(18) Deficiency in subsidiary

Include as a liability the amount by which the liabilities of any subsidiary (excluding its capital and reserves) exceed its tangible assets. This requirement applies only to the extent that the firm has not already made such a provision elsewhere in its financial statements.

(19) Liability for tax

Include as a liability a provision for taxation on the whole of the profits of its business up to its balance sheet date.

(20) Creditors r elating to Unsettled Securities Transactions - Cash against Documents

Include creditors where the firm has entered into a transaction on its own behalf in securities or units in collective investment schemes on a cash against documents basis, and the transaction remains unsettled, after adding an amount calculated by

(a) computing the difference between the agreed settlement price for those investments and their current market value where that difference is not in the firm's favour, and

(b) multiplying that difference by the applicable percentage specified in table 13.12.3B.

(21) Creditors r elating to Unsettled Securities Transactions - Free Deliveries

Include an amount for creditors where (acting on its behalf) the firm has delivered certificates of title for securities or units in collective investment schemes before receiving payment for them, or where a firm has bought such investments before receiving certificates of good title for them, as follows:

(a) (if the firm has paid for them and not more than 3 days have passed since the payment was made) include in full:

(b) ( if more than 3 days have passed since the payment was made) include the full value of the securities at the current offer price.

(22) Over the counter derivatives

Include as a liability an amount for any positions the firm holds on its own behalf in such derivatives calculated by computing the credit equivalent of those positions in accordance with table 13.12.3C. In addition, bought OTC derivatives and covered warrants will be subject to table 13.12.3D.

(23) Contingent Liabilities

A firm must include a provision for any contingent liabilities which exist at its balance sheet date that must be made.

(24) Long term li abilities

Include as a liability any amount which falls due more than 3 years from the balance sheet date and is due to connected persons, in accordance with rules 13.12.5 and 13.12.5A.

(25) Redeemable Preference Shares

Include as a liability any redeemable preference shares which fall due within two years. If shares are not redeemable by the shareholder within two years, they must be treated in accordance with rules 13.12.5 and 13.12.5A.

(26) Net open foreign currency position

A firm must calculate its foreign exchange risk requirement in accordance with table 13.12.3D and include the amount as a liability.

(27) All other liabilities

Include in full.

DISCOUNTS FOR INVESTMENTS

The percentages in the table are applied to the market value (unless otherwise stated) or gross positions, i.e. both longs and shorts in each category; netting and offsetting are prohibited. The long or short position in a particular investment is the net of any long or short positions held in that same investment.

Investment

Discount

A. Debt

UK Government or local authority stocks:

- with less than one year to final redemption

2%

- with more than one year but less than five years to final redemption

5%

- with five years or more to final redemption

10%

Debt security:

- debt instruments issued or accepted by an approved bank with less than 90 days to final redemption

2%

- other debt instruments which are marketable investments with less than one year to final redemption

5%

- other debt instruments which are marketable investments with less than five years to final redemption

10%

- other debt instruments which are marketable investments

15%

- floating rate notes which are marketable investments:

- with no more than 20 years to final redemption

5%

- with more than 20 years to final redemption

10%

B. Equities

- other investments listed on a recognised or designated investment exchange

25%

- shares traded on a recognised or designated investment exchange

35%

- other shares for which there is a market maker in the UK

35%

C. Derivatives

- exchange traded futures

4 x initial margin requirement

- OTC futures

Apply the appropriate percentage shown in A and B to the market value of the underlying position

- Purchased options

Apply the appropriate percentage shown in A and B to the market value of the underlying position but the result may be limited to the market value of the option

- Contracts for differences

20% of the market value of the contract

D. Other Investments

- Unit linked bonds and units in authorised unit trust schemes (other than higher volatility funds and property funds) or regulated collective investment schemes

25%

- units in higher volatility funds and property funds

50%

- with profit life policies (only applicable to firms other than traded life policymarket makers)

20% of the surrender value of the policy

- shares in subsidiary companies and shares which are not readily realisable securities in connected companies

100%

- traded endowment policies:

where a traded life policy is held for resale by a firm which is a traded life policy market maker:

(a) for 3 months or less

0% of the surrender value of the policy

(b) for more than 3 months

10% of the surrender value of the policy

when a traded life policy is held by a firm which is a traded life policy market maker for investment

10% of the surrender value of the policy

- other

100%

UNSETTLED SECURITIES TRANSACTIONS

Number of business days

A

B

after due settlement date

%

%

0 - 15

0

0

16 - 30

25

0

31 - 45

50

25

46 - 60

75

50

61 or more

100

75

over 90

100

100

Note 1: Column A applies to a transaction in a debt or debt-related instrument (unless the debt instrument is settled through the appropriate UK settlement system), and

Note 2: Column B applies in all other cases (and, in particular, applies to equity and equity-related instruments).

OVER THE COUNTER DERIVATIVES

a . By attaching current market values to contracts (marking to market), obtain the current replacement cost of all contracts with positive values.

b. To obtain a figure for potential future credit exposure (except in the case of single currency "floating/floating interest rate swaps" in which only the current replacement costs will be calculated), the notional principal amounts or values underlying the firm's aggregate positions are multiplied by the following percentages:

Residual Maturity

Interest Rate Contracts

Foreign Exchange Contracts

One year or less

Nil

1%

More than 1 year

0.5%

5%

c. The credit equivalent is the sum of current replacement cost and potential future credit exposure.

FOREIGN EXCHANGE RISK

(a) A firm must deduct a foreign exchange risk requirement for all the following items which are denominated in a foreign currency:

(i)

all assets and liabilities, including accrued interest, denominated in the currency (all investments at market or realisable value);

(ii)

any currency future, at the nominal value of the contract;

(iii)

any forward contract for the purchase or sale of the currency, at the contract value, including any future exchange of principal associated with currency swaps;

(iv)

any foreign currency options at the net delta (or deltabased) equivalent of the total book of such options;

(v)

any non-currency option, at market value;

(vi)

any irrevocable guarantee;

(vii)

any other off-balance sheet commitment to purchase or sell an asset denominated in that currency.

(b) The requirement must be calculated as follows:

(i)

using the spot rate, convert the net long position and net short position in each foreign currency into the currency in which the firm's annual financial statements are reported;

(ii)

total the net open long positions and the net open short positions;

(iii)

the higher of (i) and (ii) above is its net open foreign currency position;

(iv)

multiply its net open foreign currency position by 10%;

(c) A firm may not include any future income or expense not yet accrued but fully hedged (subject to deduction of an appropriate risk requirement).