There is no doubt the Financial Services Compensation Scheme (FSCS) has a vital role to play within the financial services industry, not only from a consumer protection and confidence perspective, but also in contributing to the ongoing stability of UK financial markets.
However, how the scheme should be funded has long been a bone of contention for many in the industry. The Financial Advice Market Review (FAMR) recommended the FCA should explore options for reforming FSCS funding classes, risk-based levies and alternative approaches to ensure the scheme remains sustainable.
The FCA’s final rules and further proposals for consultation, outlined in CP18/11, are part of this ongoing process. Whilst the paper’s headline outcome may be exactly what many advisers were hoping for in terms of broadening out the contribution basis of FSCS levies, some of the consequences captured below may be less welcome for advisory firms.
The regulator tackles issues
FSCS levies for certain funding classes have risen sharply in recent years, largely driven by the failure of firms that had provided unsuitable investment advice prior to their collapse. There are also certain sectors where a small number of firms are responsible for the majority of claims, pushing up the costs for the remainder of the funding class.
FCA research has revealed that some personal investment firms have found it increasingly difficult to purchase professional indemnity insurance (PII) policies that provide adequate levels of cover and fully meet any future claims. Certain policies exclude third parties from making a claim on the PII in the event of insolvency. As a result, the regulator believes the FSCS has increasingly taken on the role of ‘first line of defence’ in the event of a firm failing.
Understandably, the unpredictability and increasing cost of the FSCS levy is a concern for the industry, particularly as firms are also facing rising compliance costs and continuing pressure on margins. The FCA’s review of how the FSCS is funded aimed to examine how the claims burden on the FSCS can be reduced, while maintaining an appropriate level of protection and improving allocation to ensure the scheme is funded fairly.
What is changing?
• Changes to funding classes
To reduce volatility, the regulator has explored a number of ways to reform FSCS funding classes. Of these options, merging the investment intermediation and life and pensions intermediation funding classes to create a new investment intermediation claims class does make sense as there is a high degree of similarity between the business conducted in both classes and will be welcomed by firms.
The separation between life and pensions and investment intermediation was never a natural split for firms, and we know that firms spend a disproportionate amount of time trying to segregate and develop appropriate rationale for splitting their advice register into these two seemingly arbitrary funding pools.
As well as reducing the operational burden of generating this split solely for the purpose of FSCS funding, having more firms within a single funding class will help decrease volatility and reduce the likelihood the retail pool will need to be called upon, making the FSCS levy more stable.