By Huw Jones

LONDON (Reuters) -Investment advisers in Britain should hold extra capital to cover compensation costs, regulators proposed on Wednesday, in a bid to put a lid on the rising bill for bad advice.

Firms regulated by the Financial Conduct Authority are already required to pay a levy to a Financial Services Compensation Scheme, whose payouts are capped at 85,000 pounds ($107,865).

The FSCS paid out nearly 760 million pounds between 2016 and 2022 for poor advice, with 95% of the bill generated by just 75 firms out of a market of about 5,000 firms.

The watchdog has stepped up enforcement of advisers for poor treatment of steelworkers making decisions regarding pensions.

It is proposing a so-called "polluter pays" model, meaning incompetent firms should bear the cost for their failures to give stronger incentives for advisers to improve standards.

"Diligent advisers are having to compensate through the levy for the bad advice of their failed competitors. That needs to change. It is important that the polluter pays," Sarah Pritchard, the FCA's executive director of markets and international, said in a statement.

The watchdog said its proposals, out to public consultation until March, are designed to be proportionate, building on existing capital requirements.

Firms would have to quantify how much extra capital to set aside to cover potential redress liabilities, but about 500 one-person advice firms, unlimited partnerships, and firms that are part of a company where risks are assessed on a group-wide basis, would be excluded.

The FCA said it would run a pilot scheme during the public consultation to check if firms are able to provide the data showing how they have calculated the extra capital.

"We will consider the results of the pilot data collection alongside consultation responses before making final rules," the FCA said.

The annual compliance costs per firm would be about 1,000 pounds, the FCA said, adding that it expects the final rules to come into force in the first half of 2025.

Advisers already have to set aside a minimum of 20,000 pounds in capital to operate.

PIMFA, a trade body for financial advisers, said it welcomed a "polluter pays" model, but urged a proportionate approach to avoid barring new entrants.

($1 = 0.7880 pounds)

(Additional reporting by Yadarisa Shabong in Bengaluru; Editing by Dhanya Ann Thoppil and Christina Fincher)