Changes to the Capital Adequacy Directive (CAD) may allow firms greater flexibility in selecting their professional indemnity (PI) cover, according to the European Commission (EC).

In its report on the requirement of PI cover for intermediaries under Community law, the EC suggests that under the Markets in Financial Instruments Directive (MiFID), which comes into effect on November 1st 2007 and applies to intermediaries advising or arranging specific financial instruments which fall under the scope of the directive, intermediaries may be able to combine PI cover with initial capital to meet the required level of indemnity.

The CAD states that MiFID intermediaries which do not also carry on the business of insurance intermediation should have initial capital of €50,000 (£34,000) or PI cover of €1 million for a single claim and €1.5 million per year in aggregate, or an equivalent combination of the two.

"New regulation such as this highlights the need for a specialist broker who can look after your needs in this increasingly complex area," said Neil Pointon, chief executive of PYV Ltd, a Lloyd's broker and market leader in the provision of Financial Services PI insurance.

"It is important you have access to the right advice to ensure you do not fall foul of your regulator and end up facing disciplinary action," he added.

Intermediaries have until November 1st 2007 to ensure they comply with the requirements of the new legislation, according to the Financial Services Authority (FSA).

The authority advises that firms which are newly covered by MiFID will need to make sure they adhere to the criteria, requiring them to seek PI cover or carry the additional capital for the first time.

Meanwhile, the changes may impact companies which are not directly covered by the new directive, as the FSA states it is using the introduction of the rules as a basis for modifications to its conduct of business guidance.

"We are using implementing MiFID as a catalyst for reviewing and simplifying our handbook. We will remove rules that are no longer effective or proportionate," the FSA said.

"These changes will affect all firms subject to our current conduct of business rules, many of whom will not fall within the scope of MiFID."

The EC report also outlines the specific requirements for investment firms which were registered as insurance intermediaries under the IMD but will also be affected by the MiFID regulation coming in on November 1st.

For these companies, in addition to the requirements of the IMD, initial capital of €25,000 or PI cover to the value of at least €500,000 per single claim and €750,000 a year in aggregate is necessary, or again a combination of the both.

Fay Goddard, deputy director general of the Association of Independent Financial Advisers (AIFA), states that the majority of personal investment firms are likely to fall outside the scope of this requirement.

"Only those businesses which hold client money or wish to operate cross-border are affected by the MiFID requirements for PI - this includes about 300 firms in the UK," she explains.

According to the EC, while the requirements for some companies may remain unchanged following the publication, it is crucial to maintain an awareness of the importance of indemnity cover.

Charlie McCreevy, internal market and services commissioner at the EC, said: "This report deals with an important issue for both service providers and consumers.

"On the available evidence we should keep the existing indemnity insurance requirements, but since it is too soon for a full assessment we will continue to monitor the situation."

In a consultation prior to the publication of the report, seven organisations, including one pan-European firm and four UK-based companies, supported the view of PI as a means of protection for investors which, where possible, should not be replaced by capital requirements.

Advantages of PI listed by the firms consulted included the positive effect which could be achieved when handling claims, protection against intermediaries entering insolvency and the protection of assets against unexpected liabilities.

Meanwhile, the relative low cost of PI when compared with other forms of protection was highlighted as an issue which could be of particular benefit for smaller firms which may not hold as much capital.

While some of those consulted warned against a return to the market conditions of 2002-03, when PI became difficult to obtain, PYV Ltd expressed the belief that, at present, the London and Lloyd's market has capacity for all those who may require cover under the legislation and that only those with poor track records would be likely to face difficulty.