The FCA has published a second consultation paper on the thorny subject of FSCS funding. Although not widely reported so far, the new consultation makes it clear that the FCA will not, after all, consult on significant changes to personal investment firms' professional indemnity insurance requirements.
In December 2016 the FCA published a consultation paper aimed at discussing and proposing changes to the way in which the FSCS is funded.
This first consultation dealt with various ways in which the FCA felt that it might seek more fairly to share the burden of FSCS funding on firms and also how it might reduce the overall costs of FSCS funding.
A significant part of the original consultation involved discussions around ways in which personal investment firms' professional indemnity insurance could be changed to ensure that more liabilities would be picked up by insurance and so reduce the burden on (and thus funding requirements of) the FSCS.
Specifically, the FCA stated that firms' PII should provide a "front stop" for claims, leaving the FSCS as the "back-stop". It said that its analysis showed justification for strengthening PII for personal investment firms, potentially through the use of mandatory terms. Some of the changes mooted included: prohibiting specific product exclusions, restricting excess levels, provision of obligatory run off cover and even requiring event occurring (as opposed to claims made) cover.
Having met with the FCA earlier this year to discuss their proposals, we had understood that it would be producing a further consultation this autumn on changes to PIF firms' PII requirements.
On Monday, the FCA published a second consultation on FSCS funding.
This second paper contains various new proposals for consultation, including the possibility of:
requiring firms with PII exclusions for active business lines to hold funds in a trust, to be released only to the FSCS should the firm be declared in default; and/or
obliging firms to take out a surety bond to cover claims to the FSCS in the event of their failure (either in lieu of or in addition to existing capital requirements).
The paper also confirms that:
the FCA will introduce provider contributions (including from Lloyd's of London) towards FSCS funding relating to claims caused by intermediary defaults – they are consulting on exactly how this will work; and
the FSCS compensation limit for investment business will be increased from £50k to £85k.
However, with regard to the FCA's previous proposals for changing the rules on PII for PIF firms, the new consultation states that, based on its work since the first consultation, the FCA no longer plans to consult on significant changes to firms' PII requirements.
The FCA has concluded that, in general, the PII market is working well and that, on average, PIF firms were either satisfied or very satisfied with their PII.
Critically, the FCA has recognised that simply moving the burden of paying claims from the FSCS to PII may not be effective or reduce the overall cost (of PII premiums and FSCS levy) to firms.
The only potential change to PII on which the FCA is consulting further is the possibility of preventing PIFs from purchasing policies that exclude the insolvency of the policyholder or related parties, as the FCA believes these exclusions can prevent the FSCS from making a claim on the policy.
The FCA's conclusions on these issue will be good news for the professional indemnity market and, we believe, PIF firms themselves. As the FCA itself has recognised, making substantive changes to PII requirements would likely increase (probably significantly) the cost of PII for all firms.
It remains to be seen whether the FCA's new ideas for providing additional "front-stop" protection ahead of the FSCS will be feasible. In particular, the question has to be asked: who (if anyone) will be willing to provide a surety bond to firms of the kind indicated by the FCA – at least at any sort of acceptable cost?
Responses to the FCA's second FSCS funding consultation are due by 30 January 2018.