Out-Law / Your Daily Need-To-Know

Out-Law News 2 min. read

FCA eyeing 'risk-based' approach to compensation scheme funding


Financial firms' future liability to fund the Financial Services Compensation Scheme (FSCS) could be more closely linked to the riskiness of the products that they sell, the Financial Conduct Authority (FCA) has suggested.

However, the regulator's consultation paper on reforming the scheme appears to rule out the introduction of a product sales levy, despite lobbying from advisers.

The FCA has not published concrete proposals for how it will assess the relative riskiness of firms' activities. It has, however, proposed to introduce mandatory data collection for activities linked to higher-risk products including non-mainstream pooled investments, non-readily realisable securities and 'contingent convertible' (CoCo) products, which will "help us develop a risk-based approach in future".

Financial regulation expert Michael Ruck of Pinsent Masons, the law firm behind Out-Law.com, said that a 'polluter pays' approach to compensation scheme funding had some support within the financial services industry. However, "the identification and assessment of which risk category a firm falls into will present its own difficulties", he said.

"For example, will the sale of one high risk product result in an entire firm being categorised as high risk, and require it to contribute a higher amount accordingly?" he said. "Only time will tell if such a proposal can be carried through into a meaningful and fair approach by the FCA."

Proposals put forward by the FCA include strengthening professional indemnity insurance (PII) cover to reduce reliance on the FSCS; changing the FSCS funding classes for intermediation activities; introducing product provider contributions to fund claims against intermediaries; and extending FSCS coverage and levies to include debt management firms and the Lloyd's of London insurance market. It is seeking feedback on its plans until 31 March 2017, and will publish final rules for consultation in the autumn.

The FSCS is the UK's statutory compensation scheme for customers of authorised financial services firms, and is funded by levy contributions from those firms. It is able to pay compensation to customers if a firm goes out of business or is otherwise unable to pay claims made against it. Last year, the scheme paid out £271 million in compensation to consumers and received over 46,000 new claims.

According to the FCA, the "scale and impact" of FSCS levies has risen sharply for some firms since the scheme was last reviewed in 2013. This has particularly affected those firms whose activities mean that they are required to contribute towards claims involving self-invested personal pensions (SIPPs). Currently, levies are raised on eight broad funding 'classes', with the proportion of the levy borne by each firm in that class roughly based on size.

The FCA has proposed reducing the number of these funding classes, which it has said will "reduce the volatility" of the levy. It is considering three options for doing this: merging all four intermediation classes; merging investment intermediation and life and pensions intermediation; and keeping the current class structure as it is. All three options would include increased contributions from product providers from the relevant provider classes, and so reduce the costs of the levy to intermediaries and financial advisers.

The regulator is also seeking views on whether it should increase the maximum compensation that consumers should be entitled to for non-insurance investments, in order to reflect the shift from annuities to drawdown products following the introduction of the pension freedoms. Currently, customers with life insurance products are entitled to 100% of their money back if the provider firm fails, while FSCS compensation for other forms of investment is capped at £50,000.

The FCA has proposed a range of new compensation caps in these cases, up to £1 million. However, it acknowledged that any increase in compensation limits could lead to a rise in levies for firms.

"We must therefore find an appropriate balance between providing protection for consumers and ensuring FSCS funding is sustainable and affordable for firms," it said in its consultation paper. "We are interested in views on where this balance should be struck."

We are processing your request. \n Thank you for your patience. An error occurred. This could be due to inactivity on the page - please try again.