The Financial Services Authority (FSA) proposed changes to the funding of the Financial Services Compensation Scheme (FSCS). The purpose of any changes were to provide reassurance to consumers whilst at the same time reducing the likelihood of interim levies as well as offering firms more certainty in the level of fees that they pay.

The consultation process ended on the 25th October 2012. Naturally, there has been some discussion as to the FSA’s proposals.

The FSCS provides compensation for consumers if a regulated financial services firm goes out of business or alternatively cannot pay claims made against it. The scheme is funded by contributions from regulated firms based on the type of business that they carry out. The current funding model has been in place since April 2008. To date there have been significant payouts, which have resulted in sizable levies for some funding classes. It is essential that there is some sort of compensation scheme in place.

When the consultation paper was released, the FSA stated that it “puts forward a credible funding approach balancing the need for adequacy of funds with affordability for those contributing”.

The main elements of the consultation paper were:

  • No change to the funding classes
  • Revised annual thresholds based on assessments of affordability
  • The FSCS to consider potential compensation costs expected in the 36 month following the levy instead of 12 months
  • A retail pool constructed of all classes which would be subject to the Financial Conduct Authority’s funding rules
  • Two separate approaches for funding FSCS’ costs; one for activities they expected to be subject to the Prudential Regulation Authority’s (PRA) funding rules for the FSCS, such as deposit takers and insurance providers, and one for the other activities they expected to be subject to the Financial Conduct Authority’s (FCA) funding rules. There would be no cross-subsidy between the two.

Although the present system is not particularly clear, consumers actually already pay for the costs of regulation, and this includes FSCS levies. A product levy model could make it more transparent to consumers as to exactly how much is being spent on regulation.

Many sectors of the industry seem to have condemned the proposals. The Association of Independent Financial Advisors has responded to the consultation paper and suggested that the FSA follow the example of that in some European countries, where a fund is built up through a product levy on advice based on a percentage of income from investment activities. The trade body says FSCS cover should be limited to certain products such as unit trusts and Sipps investing in UK funds and assets, with offshore and structured capital at risk products excluded. The Investment Management Association (IMA) argues that the FSA’s proposals would lead to a build-up of reserves, and the FSA have not advised how this would be dealt with. The IMA believes that each class should have a reserve of its annual claims limit. This could then be paid out when such a limit is breached or released back to firms if it is unlikely to be needed. Additionally it has been suggested that the FSA has missed an opportunity generally to push the debate forward and provide radical reform, instead choosing to merely continue with the current state of affairs.

It has taken considerable time for the review to come to a close. The process began back in October 2009, however was placed on hold in 2012 as a result of uncertainties around on going development of EU Directives and also the effect of UK regulatory reform of the FSCS. As the consultation process ended on 25th October 2012, it will be interesting to see the direction that the FSA now heads.