The final outcome of a consultation by the Financial Conduct Authority (FCA) on the future funding of the Financial Services Compensation Scheme (FSCS) is expected to have industry wide repercussions.
Depending upon which route the FCA chooses there may be implications for product providers, professional indemnity insurers and most of all financial advisers and intermediaries.
The FSCS is the UK's statutory compensation scheme of last resort for financial services. To the public it is best known for its role in running the deposit protection scheme for banks and building societies.
However, the bulk of claims paid by the FSCS from levies imposed on financial services firms relate to claims in respect of investment intermediation and life and pensions intermediation.
The FSCS is currently funded by the collection of two levies from financial services firms. The first, a management expenses levy is dwarfed by the second, a levy paid to cover compensation claims by customers. Firms' levies are pooled in funding classes determined according to firms' permissions. In practice this means that compensation claims for a particular funding class (such as investment intermediation or general insurance) are paid by other firms in the same class via the levy. However, where claims in a particular funding class breach a certain threshold, contributions are made from other funding classes.
The FSCS undoubtedly plays a valuable role in supporting the UK's financial services industry and gives confidence to consumers that they should be protected should a financial services provider fail. However, it seems no-one is entirely satisfied with the current funding model.
The most common complaint from intermediaries is that good firms are expected to subsidise the bad or that firms operating a low risk model are lumped in with those carrying high levels of risk. The FCA appears to be sympathetic to that view and notes that between 2013 and 2016 a third of the value of all FSCS claims was linked with the sale of non-mainstream pooled investments (NMPIs) by the regulated advice sector. Previous FCA supervisory work has identified that one in four NMPIs were mis-sold and accordingly in 2013 introduced restrictions prohibiting FCA authorised firms from promoting NMPI products to ordinary retail customers.
A second concern expressed by firms is the unpredictability of levies. The failure of one or two large firms can significantly increase the levy required to be paid by other firms. For example recent increases in levies on investment firms were necessitated by the failures of two firms - Alpari and Catalyst.
A third concern is around the availability and scope of professional indemnity insurance (PII). The FSCS is intended to be a compensation scheme of last resort, with firms' PII cover and own reserves being the front stop. However, the FCA is concerned that the FSCS has increasingly taken on the role of "first line of defence" when firms fail. While PII cover is mandatory for personal investment firms, there are few requirements regarding the scope of such insurance. A particular concern is that certain policies may exclude liability for specific types of claim or may not provide coverage where the firm is insolvent, meaning the FSCS is unable to recover the costs of claims from insurers.