The Financial Services Authority (FSA) today set out proposals to reform the funding of the Financial Services Compensation Scheme (FSCS).
The reforms are designed to create a funding system that will:
- be more robust and sustainable than the present arrangements;
- promote a greater degree of consumer protection and maintain market confidence;
- apportion the cost of compensation between regulated firms as fairly as possible; and
- be relatively simple to administer.
FSA Director Graeme Ashley-Fenn said:
"An effective system for compensating consumers for losses incurred when a financial services company fails is an important part of the regulatory system. The FSCS makes a vital contribution towards two of the FSA statutory objectives - protecting consumers and maintaining consumer confidence in the financial services industry - a role from which all firms benefit."
The key proposals in today’s Consultation Paper relate to retail business and propose:
- introducing a 'widening circle' model of funding under which the first tranche of compensation costs emerging from a particular sub-class of firms is borne by that sub-class alone, while higher costs are shared more widely; and
- expanding the overall financial capacity of the scheme - up to a maximum of £4.4 billion per annum
The scheme would be divided into five broad classes (life and pensions; investments; general insurance; deposits; and home finance). Each class would have two sub-classes and above the broad classes would be a general retail pool. The initial tranche of costs would fall to the relevant sub-class, the next tranche to the relevant broad class and then finally above that to a general retail pool. This last resort would only be triggered in the event of a significant default, or series of defaults, which meant losses overwhelmed a single class.
Although wholesale business is not capable of giving rise to claims on the compensation scheme, the FSA in principle favours making it possible to have recourse to the wholesale sector for a proportionate contribution to funding the scheme. This is in recognition of the links between retail and wholesale business within the UK’s financial services and of the benefit the wholesale sector derives from public confidence in the financial system as a whole. It is expected the wholesale pool could add a further annual £1-2 billion of funding to the FSCS, further increasing its financial capacity. The FSA plans to set out its proposals for wholesale funding, and potential tariff measure changes, in a supplementary consultation paper later this year.
Graeme Ashley-Fenn said:
"While it is not possible to devise funding arrangements which will command universal support from the industry, there was general acceptance that the present arrangements were no longer fit for purpose. We believe the proposed model is more rational, fairer to the various players in the market and more robust. The proposed system will be capable of meeting current issues such as endowment mis-selling, but more importantly, will now provide compensation for the 'unknown unkowns' – the future potential compensation claims which no-one has yet thought about."
The FSA and the FSCS have worked closely with an Industry Advisory Group made up of trade associations and the Financial Services Practitioner and Consumer Panels and the FSA Smaller Businesses Practitioner Panel, to make sure that all viewpoints and arguments have been considered. The views expressed in this consultation paper are the responsibility of the FSA and should not be attributed to any member of the Industry Advisory Group. In developing its proposals the FSA has also taken account of more than 450 responses to Discussion Paper 06/1: FSCS Funding review published in March 2006 which set out for discussion a number of options for reforming FSCS funding.
Subject to the consultation process, the FSA proposes that new funding arrangements will come into effect from 1 April 2008.
Background
- Consultation Paper 07/05 FSCS Funding Review contains draft rules for the new funding arrangements. 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 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 in the run up to the publication of DP 06/1 in March 2006. View Oxera's Report. The FSA once again commissioned Oxera to provide further independent analysis for the development of the final policy proposals contained in CP07/5. View Oxera's second report.
- 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.
