FSP Financial Soundness: Assets, Liquidity and the Early Warning Rule

The financial soundness questions in the RE1 are the ones candidates fear, because they involve sums. The sums are easy once you know three definitions and one table.

Who must comply?

The requirements apply to FSPs and juristic representatives. They do not apply to a key individual or representative who is a natural person. A bank or insurer that complies with its own prudential legislation is treated as meeting them.

Nobody may become or continue as an FSP if they are an unrehabilitated insolvent or under liquidation or provisional liquidation.

Requirement 1: Assets must exceed liabilities

Every FSP's assets must exceed its liabilities. But not every asset counts. Excluded are:

• goodwill and other intangible assets;
• investments in and loans to related parties;
• loans to directors, members and similar persons;
• in general, assets that could not readily be turned into value for creditors and clients.

Example. Total assets R3.0 million, including goodwill of R600 000 and a R300 000 loan to a related company. Qualifying assets are R3.0m − R0.6m − R0.3m = R2.1 million.

Requirement 2: Working capital

For most categories, current assets must at least equal current liabilities.

Requirement 3: Liquidity

Certain FSPs must hold liquid assets equal to a number of weeks of annual expenditure:

FSP	Liquid assets required
Category I that holds no client assets and receives no premiums	Assets exceed liabilities only
Category I that holds client assets or receives premiums, and Category IV	4/52 weeks of annual expenditure
Category II and IIA	8/52 weeks
Category III	13/52 weeks

Annual expenditure is the expenditure in the latest financial statements, less items such as staff bonuses, profit shares, emoluments of directors, members, partners or a sole proprietor, remuneration linked to revenue, depreciation, bad debts and losses on the sale of assets. Rent, salaries, audit fees and IT costs stay in.

Liquid assets are:

• cash;
• a participatory interest in a money market portfolio;
• 70% of the market value of a participatory interest in a collective investment scheme, other than a money market portfolio or a CIS hedge fund;
• 70% of the market value of listed securities, subject to a cap of 50% of the total.

Property, loans and hedge fund interests are not liquid assets.

Example. A Category III FSP has annual expenditure, after the deductions, of R10.4 million. Required liquid assets: R10.4m × 13 ÷ 52 = R2.6 million.

Example. A Category I FSP that collects premiums has annual expenditure of R5.2 million. Required: R5.2m × 4 ÷ 52 = R400 000. An equity unit trust worth R500 000 counts as R350 000, so on its own it is not enough.

The early warning rule

An FSP must notify the Authority in writing immediately when, among other things, its assets exceed its liabilities by less than 10%.

Back to the first example. Qualifying assets R2.1 million, liabilities R2.0 million. The excess is R100 000, which is 5% of liabilities. That is under 10%. The FSP is still solvent and still meets the asset requirement, but it must notify the Authority immediately.

This is the classic exam question. The wrong answers are "assets of R3.0 million exceed liabilities by 50%, so nothing is required" (which forgets the exclusions) and "the FSP is insolvent" (which it is not).

Reporting

• Category I and IV: submit the liquidity calculation (Form A) annually, with the financial statements.
• Category II, IIA and III: submit Form A half-yearly, within 45 days after each half year-end.
• A juristic representative submits Form A to its FSP, half-yearly.

More than one category

An FSP authorised in more than one category must meet the most onerous of the requirements that apply. A Category I and II FSP follows the Category II rules.

A method for any soundness question

1. Identify the category and whether client money or premiums are involved.
2. Strip out goodwill, intangibles and related-party loans.
3. Compare assets with liabilities, and work out the percentage excess.
4. If liquidity applies, take annual expenditure, apply the deductions, multiply by the weeks and divide by 52.
5. Value liquid assets with the 70% rule.
6. Check the early warning trigger.

Write each step down. These are easy marks for anyone who does not rush them.