Risk-based levy returns in wide-ranging compensation framework review

Risk-based levy returns in wide-ranging compensation framework review

The Financial Conduct Authority is considering whether firms should pay a premium on levies for carrying out higher risk activities or selling risky products.

In the regulator’s compensation framework review, published today (December 6), the FCA said this approach would be in line with views often expressed by regulated firms.

It would see firms that choose not to undertake any business involving ‘higher risk’ activities allocated a reduced share of the annual levy for their funding class, compared to firms that do. 

But the drawbacks would be that it could disincentivise firms to distribute higher risk investments even if they could be in the consumer’s interests, and that it could stifle innovation and competition.

It could also act as a barrier to entry for firms with innovative products and create a disconnect risky activities and those which contribute to rising FSCS costs. 

The FCA said the overall Financial Services Compensation Scheme levy has increased over the last decade, from £277m in 2011/12 to an expected £717m for 2021/22 and the regulator was keen to stabilise this. 

It has also floated other ideas for funding models such as a pre-fund, product levy and insurance.

The pre-fund method would allow the FSCS to build up an amount funded by levy payers in excess of the costs required, which it could then draw down on as required, helping to spread any high costs over a longer period.

However, this model would likely require changes to legislation which would be for the government to consider. 

The City watchdog said drawbacks to this option were that it could add to the burden on firms and limit firms’ ability to invest and grow.

The product levy approach could see the FSCS funded by a generic levy on all financial services products sold, meaning the cost of each financial services ‘product’ such as an investment, insurance policy or mortgage, could include an additional levy cost to fund FSCS claims. 

Finally, the last method was one the FCA considered in the past about whether FSCS funding could be met through insurance.

This would see the FSCS take out insurance to meet some or all of its funding requirements, with the cost of that insurance to be met by industry levy payers.

The FCA said this approach may be a way of smoothing levy costs to protect firms from a sudden increase in costs but a commercial insurance arrangement was likely to be more expensive than the current model and not have significant benefits over the current arrangements.

Sheldon Mills, the FCA’s executive director for consumers and competition, said: “We want consumers to have trust in a thriving UK financial services sector, and businesses to be confident that they can bring new and innovative products to market. 

“To achieve this, it is vital that consumers have an appropriate level of protection if things go wrong – and that we find a fair and sustainable way of funding the cost of this protection. Now is the time to ask how we can ensure our compensation framework is fit for the future.”