Regulator seeks further views on 'retail pool' approach to compensation funding

It has proposed widening the 'retail pool', to be funded by investment providers and intermediaries, which would be triggered if one or more of the funding classes included in the pool reached its compensation threshold in any given financial year.

The short consultation will run for a month. However, the Financial Services Authority (FSA) confirmed that other changes to the funding of the Financial Services Compensation Scheme (FSCS), proposed last July, will take effect from 1 April as planned. The changes are designed to make funding the compensation scheme more "affordable" for firms. Current funding classes will be maintained, according to the announcement, with new annual thresholds based on assessments of affordability.

"We have listened to industry concerns and want your input on this revised approach for the FCA Retail Pool," FSA director of conduct policy Sheila Nicoll said. "Finding consensus on this subject is always going to be a challenge but we remain committed to finding a workable solution that firms can afford and live with."

The new Financial Conduct Authority (FCA) will take on the conduct and compliance functions of the FSA when that regulator is dissolved in April. The consultation states that all firms regulated by the FCA, as opposed to just those providers that participate in the FCA FSCS funding classes, be required to contribute to the retail pool. Affected firms will include banks, insurers and home finance providers.

The FSCS can pay compensation to customers if a regulated financial services firm goes out of business or is otherwise unable to pay claims made against it. The scheme is funded by contributions from over 16,000 participating firms, based on their 'funding class' or the type of business that they carry out.

The existing funding model has been in place since April 2008. However, the past four years have seen significant payouts to groups of customers, including those of failed investment firms Keydata and MF Global. These payouts have increased the levies charged to firms in some funding classes, which in some cases have had to be clawed back in the form of additional 'interim' levies charged halfway through a funding period.

Firms covered by the FSCS are organised into five broad classes, with two sub-classes in each class which are generally divided along provider and distributer lines. The five broad classes cover deposits, investments, life and pensions, general insurance and home finance. The amount of compensation that each sub-class could be required to contribute in a given year is limited, with the other sub-class in its class required to contribute if this limit is breached. After this all other classes can be asked to contribute.

The FSA will be replaced by the FCA and the Prudential Regulation Authority (PRA) from 1 April. As of this date a separate levy will apply to cover compensation arrangements for activities, such as deposit-taking and insurance provision, which will be subject to the PRA's funding rules. This means that only those 'retail' classes subject to the FCA's funding rules will be required to make additional contributions if one or more of those classes reach their annual contribution limit for the funding year.

Under the new system, the FSCS will also be required to consider the potential compensation costs expected over a 36-month period, rather than over 12 months as is currently the case. This amendment will take effect from 1 April 2014.