The Financial Services Authority (FSA) today outlined four possible options for the future funding of the Financial Services Compensation Scheme (FSCS), following concerns raised about the fairness, proportionality and sustainability of the present funding arrangements.
The options are set out in a Discussion Paper published together with a report by Oxera, the economic consultants who were commissioned to write an independent analysis of the scheme. The FSA, the FSCS and Oxera have worked closely with trade associations, the Consumer, Practitioner, and Smaller Business Practitioner Panels and a number of firms to obtain data and to make sure that all viewpoints and arguments have been considered.
FSA Managing Director David Kenmir said:
"Having an effective system for compensating consumers for losses incurred when a financial services company fails is a vital part of the regulatory system. The FSCS contributes directly to two of the FSA's four statutory objectives: protecting consumers and maintaining market confidence. The cost of compensation has to be met by regulated firms. We recognise that it is not possible to devise funding arrangements which will command universal support. However, through an open and fair discussion process, we hope to design funding arrangements which apportion the cost of compensation between regulated firms as fairly as possible. Discussions about this issue tend to focus on today's problems such as endowment mis-selling, but the scheme must also be capable of providing compensation for tomorrow's problems."
FSCS Chief Executive Loretta Minghella said:
“The FSCS plays a vital role in maintaining consumer confidence in the financial services industry, a role from which all firms benefit. We need a funding structure that is sustainable, that smoothes volatility in compensation bills and provides sufficient funding to let us get on with the job we are here to do. We believe that sharing compensation costs across broader classes of firms in future will provide the fairest and most resilient system for the longer term.”
The Discussion Paper proposes to divide the scheme into five broad classes (life and pensions; securities, mutual funds and derivatives; deposits; general insurance; and mortgages). It then proposes four options for future funding:
Option A: The broad classes would stand alone with no cross-subsidy between each class.
Option B: Above the broad classes would be a general pool whose operation would be triggered by catastrophic losses which overwhelmed a single class.
Option C: Includes sub-classes within the broad classes. Each sub-class would meet the first tranche of liabilities falling to it. Each class would then meet its own class liabilities, net of first tranches.
Option D: A widening net with sub-classes, classes and a general pool.
David Kenmir said:
"We favour a solution, along the lines of Option B, which initially apportions the cost of compensation to the broad classes, and then once claims exceed a certain financial amount spreads the cost amongst all those who contribute. We believe this will be much more robust than the present arrangements, will allocate costs to firms that have a mutual interest in maintaining the confidence of consumers who use markets within which they operate, and will be relatively simple to administer."
After evaluating the responses to the Discussion Paper, the FSA will bring publish draft rules for funding the scheme in a Consultation Paper this autumn. We expect that these will not come into effect before 1 October 2007.
Background
- Discussion Paper 06/1 is available on the FSA Website. The focus of the paper is on how to fund compensation costs. The way in which the scheme's general running costs are shared out is not under review.
- In September 2005 the FSA commissioned Oxera to provide independent analysis to support the funding review. Oxera have worked closely with the FSA, FSCS and industry trade associations to obtain both data and to make sure that all viewpoints, arguments and options were taken into account. Oxera also conducted a series of interviews with industry practitioners. Oxera's Report can be accessed on the FSA website.
- The FSCS became the UK’s single financial services compensation scheme from 1 December 2001. It provides compensation to the customers of UK financial services firms if an authorised firm is unable to pay claims against it. It covers investments, deposits, insurance and mortgage business.
- The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.
- The FSA aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness.
