Anything to declare?

Andrew Tjaardstra: The Financial Services Authority is seeking an industry-led answer to its concerns over commission disclosure and has given more than a hint that it will mandate if any industry solution is not acceptable. How much of a problem do you think this it likely to be?

John Needham: When you look at more detailed and complex sorts of commissions or remuneration structures for brokers, it is going to be a bit of a nightmare if you have to disclose absolutely everything. Then again, it would probably be fine, as it can be quite easily system-driven if you were forced down that route.

Paul Samways: It isn't an issue for the brokers or the clients. The people that have an issue with it are the regulators and insurers. You wouldn't go into a supermarket and ask how they arrive at the price they charge for a tin of beef. There certainly is the freedom of choice there and a big difference is that the products we sell are not investment products. I mean, if I was buying a pension and the whole of the first-year premium was going to my adviser for the advice that had been given, I ought to know that. When we sell a policy to a client, they have full cover from the day we set up the policy and the benefit of that policy. So, I see them as two totally different issues and the two have got confused.

Mark Grice: It seems to me that the FSA is driving it for its own reasons.

Chris Blackham: The FSA has been pressurised into it because it is not a level playing field, due to the issues with the bigger brokers that, to save their own skins, had to make public declarations that all went too far. I have little doubt that they, plus a few international insurers that are in the same situation, are putting pressure on the FSA rather than anybody else - certainly not the consumer. I can't see where the consumer benefit is. In fact, it confuses things because the level of commission does not reflect the quality of the product, the price or the service.

Derek Findlayson: The whole issue has been blown out of perspective. I don't see the real need for commission disclosure, commissions are only a reflection of what work is actually carried out by different parties. The commission levels that are paid are only sustainable based on the results and the degree of work transfer that takes place in an arrangement. So, my personal view is there is a need, specifically with insurance, to segregate out that element of the proposition. The customer is going to pay a price that they believe is adequate for what they receive. Provided the broker is happy that what they do in that equation is reflected in the contribution they make to the service that is being provided, I don't think it is the issue that it has been made out to be over the last two to three years.

Chris Blackham: There is also a dichotomy in that everybody is talking about commission disclosure for commercial customers, when surely we should be first protecting the personal lines customers, where there are enormous commission rates payable in certain circumstances, particularly to property owners, household contents and warranties outside the FSA. In fact, it is the commercial customers who are the educated customers, so the whole thing is upside down.

Janice Deakin: For me, the debate should be driven by what customers want. It happened in the life industry and it hasn't necessarily changed behaviour. So, it is looked at as a way of potentially changing the playing field but I am not sure that it will necessarily do so, even if we end up with full disclosure. It has to be driven from what is right for the customer.

Steve White: In the work the FSA has done, it has found three problems. First, it found that intermediaries were not identifying and managing the potential conflict of interest that arises when you have an agency arrangement with a customer and get remunerated by the insurer.

Well, there are now guidance notes on how to identify and manage conflicts of interest. The last output we saw from the FSA featured some concerns around firms' use of management information to prove that what they have put in place with regard to the management of conflicts is actually happening. So, the ball is on our side of the net on that one.

Second, it (the FSA) also expressed some concerns that firms did not have in place the processes to fully disclose remuneration, if asked. It is no defence to say 'I am never asked, therefore, I don't need a process'. You may never get a complaint, but you still have a complaints process.

An accepted wisdom about how to manage, for example, a profit share agreement is don't tell the placing staff that you have it. That means it does not influence the placing staff decision as to which market the risk goes to. What you need is a process where the placing staff, if they are asked what their remuneration is, don't just tell the customer the element they know about, the request goes to the back office for the answer to be given. That is why we talk about a process around disclosure.

Third, the FSA is concerned with commercial customers not asking about remuneration. It does smack a bit of a nanny state gone mad - and why are we getting so wound up in protecting the risk manager at ICI? He is a professional buyer and is capable of asking the question himself. The BIBA Terms of Business Agreements wording reminds the customer that we will tell them annually that they have a right to ask about our earnings, and that the customer can ask at any stage what the earnings are. If all of those elements are being done, the argument to mandate disclosure should reduce dramatically.

Derek Findlayson: Ultimately, the regulator is only interested in the customer being treated fairly but they have it in their heads that knowing how much you get out of a transaction is important. This isn't the case as no one is asking. I don't see how that would explain how it is quantified or how a broker earned his money from the elements of his commission. It is just a question of whether they can express it in a way that can be understood by the client.

Mark Grice: Obviously, if the firm can demonstrate that it is managing the conflicts that these arrangements will generate, then I don't think the FSA would have a problem with it.

Chris Blackham: If the FSA is moving to principles-based regulation, what we are talking about here would be a definite 'no, you can't do this,' which would be contrary to the current direction.

Janice Deakin: From NU's point of view, the internal governance processes it goes through are at least as robust as I would expect. Anything that came out on this would also be put in place.

Derek Findlayson: I very much endorse that. Groupama takes a very similar approach. It financially models any deal that it does to make sure that it reflects where the work is being done and where the value is being added.

Paul Samways: Ultimately, there is no point in the customer getting a cheap policy that the broker hasn't earned any money from if it is the wrong policy. You get the wrong policy and the wrong cover regardless of disclosing what the commission was.

Andrew Tjaardstra: I would like now to move onto the issue of goodwill and its abolition in January 2008. How will this change the way brokers do business?

Mark Grice: It is question of how much capital you have in the business. The FSA wants a minimum amount of capital. The FSA's view is that intangibles like goodwill don't count as an asset. So, if they are a smallish broker and have got goodwill, then they may have to leave money in the business or inject capital to meet the requirement. There are a lot of consolidators out there who have lots of goodwill on their balance sheet. That tends not to be the regulated entities as they are structured in a different way with a holding company at the top, where the goodwill is, which should not be a problem with the FSA as it doesn't look at goodwill on a group basis but on the regulated entity basis.

Andrew Tjaardstra: Is there any specific thing that brokers should be doing now in preparation?

Mark Grice: They should be going to the BIBA website. There is some balance sheet tidying up that you could do, if you are in a group situation and you have goodwill on your books, depending on how you bought the acquisitions, you could have that goodwill in several places, including a regulated entity. You can restructure and pass out to the holding company to get it off your balance sheet. The principal item, which is a problem for the small broker, is how much capital they have in the business? It either requires the broker to put more money in or take less out - or find another way of re-evaluating assets if there are some other assets. If it is a lifestyle business, there could be boats and yachts on the balance sheet.

Chris Blackham: Would you agree that one of the things that brokers have to be aware of - if it is using a holding company and is moving stuff into that holding company - is that if it is seen as trying to falsify the risk and if the company then goes under, then the broker will be held personally responsible by the FSA? Just moving stuff around may not solve the problem as far as it is concerned and they will pursue it at that point. So, if the company then goes down, they will try and hold that person or director responsible for the results.

Mark Grice: If you do go down the route of re-engineering to the holding company, effectively you are turning an intangible asset into an asset - a debt from the holding company. As a director of the company, you have to take a view as to whether that asset is allowable and recoverable. So, I can see why the FSA is taking that view. Although, if the holding company owns other businesses it may well be recoverable then. In any situation where a business goes bust, the directors are under investigation for having traded insolubly, for example.

John Needham: I don't think it is going to affect larger brokers because they have already thought about it or have acquired businesses and done deals in a structure whereby their goodwill is outside of the regulated entity, but setting up a new holding company is a relatively straightforward process. If it is a shell company though, you do run the risk of it being undercapitalised if there is any issue with the goodwill and again, it comes back down to the directors' responsibility. The FSA and other regulated entities do take into account other group companies as a matter of course, through the relationship of the group. It would not be unreasonable for it to look beyond that, but for this purpose it has said that it hasn't. The main issue may be for small brokers. If they are used to taking their profits out every year and declaring a large dividend every year, then they are not going to be able to do that for a while. So, it could be a personal sort of disbenefit rather than a corporate problem. On the smaller end of the scale, the amounts of goodwill are just not that large.

Andrew Tjaardstra: Do you feel it will inhibit new start-up businesses?

John Needham: Not really, no. If you are aware of the requirements, you can set up a new start-up relatively quickly and easily, as long as you structure it in the right way.

Janice Deakin: While it is another barrier of entry for broking compared with the barriers for starting up in other businesses, there are not a lot of barriers to entry into broking.

John Needham: There may be more sensitivity when you are actually borrowing to pay for the businesses that you are acquiring. So, if you have goodwill sitting there and the other side of that is a liability, if anything, you know that you have to write off some of the goodwill; then you are instantly hitting your net asset position. On borrowings it is a more sensitive position. If you are starting up a new broker, people are aware of that as well. So, if it is a new entity, they would not be able to get the borrowing anyway. So, for the scales that we are looking at, It isn't going to be much of a problem.

Chris Blackham: Can you just elaborate a bit more on what options firms may have? Banks are prepared to lend on value for goodwill. So, in the future, if staff are buying out the management, for example, or the management is looking to buyout the owners, what options might they have rather than using the goodwill?

John Needham: If we are looking to raise a lot of money for acquisitions, those deals will be done where the loans are in a holding company and the goodwill is in a holding company - that sort of structure will already be established. I don't think you would get that situation in a small broker when you are starting up, because you would not necessarily get the banks lending on that small end of the scale. However, at the larger end of the scale, there would be enough capital already in the balance sheet to meet the existing capital requirements.

Steve White: There will be a problem at the smaller end. Remember that it is the smaller end where these firms do not have access to direct supervisory contact at the FSA, other than via the contact centre. So, they are not getting the help the larger firms might get from the FSA supervisory team. The demographics of broking are such that there are a lot of firms run by people in their 50s and 60s, where succession planning becomes that bit more difficult if goodwill is not allowable from a capital perspective.

Mark Grice: Banks don't lend on goodwill. They lend on how much business you are going to generate to repay the loan. So, in an MBO-type situation, the classic structure is that there will be a new holding company. Unfortunately, this will be the entity again that gets the goodwill. The buyer would be buying the broker, but the goodwill will always end up in the holding company, not in the FSA-regulated area. The amount of goodwill is the difference between the cost and the assets you acquire. In a broker you get few assets, but you get a lot of goodwill because of the generation of income or profits for the future. The limiting factor on the MBO team will be how much profit is generated by that business to be able to service the interest and repay the debt.

Paul Samways: If it is that easy to put goodwill in a holding company, why is it such a problem in the first place?

Mark Grice: Well, as Chris has said, it is not. You can do financial manoeuvring into a holding company, which turns an intangible asset into a tangible asset. From a solvency and FSA point-of-view, it still has to be happy that it is an asset of value. If you have got nothing else in the holding company - no income, no other assets - it becomes quite a difficult to say how you are going to get that money back. The only way you can get the money back is by selling the business, which may be a valuable strategy and may well be a rational accounting argument for why it is not bad debt. You know you can sell that business, so you know it has got cash to repay it, but it is a tenable argument.

Chris Blackham: Of course, the FSA's argument is that the regulatory capital is what is available in the worst-case scenario. In the worst-case scenario, if you had to sell the business to realise some assets, it would not be that easy.

Janice Deakin: The options are put more capital in the business in some way - so more shares, more retained profit or some sort of subordinated loans; there is help from insurers. The upshot is that one of those options has to realise more capital in the business or do the restructuring of the business. We did a piece of work on it and there were five or six things that we talked to brokers about on how we can help in this situation. They are all options available, but the net impact of them must involve either a restructure or ensure there is more capital in the business to cover the requirement. There is not another way round it.

Chris Blackham: Yes, what I would say is that there are loads of friendly people out there, be it insurers that Janice was talking about, networks or ourselves. The important thing is that brokers do something now, rather than waiting until the end of the year. Banks are probably the last place, because they don't really understand their business quite as well, it will be harder for them and it will take them longer to do it.

GUEST LIST

- Chris Blackham, chief executive, Layton Blackham

- Janice Deakin, director of trading, Norwich Union

- Derek Findlayson, a head of UK business development, Groupama Insurances

- Mark Grice, insurance partner and head of broking accountancy, Mazars

- John Needham, audit manager, CLB LittlejohnFraser

- Paul Samways, group operations director, Kerry London

- Andrew Tjaardstra, editor, Professional Broking (chair)

- Steve White, head of compliance and training, British Insurance Brokers' Association.