The Financial Services Authority (FSA) has published its proposals for the future funding of the Financial Services Compensation Scheme (FSCS), following concerns raised about its fairness, proportionality and sustainability.
Currently the FSCS is funded by 12 contribution groups organised into five sub-schemes which are linked to FSA fee blocks, and the business carried on by each participant firm determines the sub-scheme into which it falls.
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 suggests four options for future funding:
- Option A: The five broad classes would constitute the scheme’s funding base. Within each class all compensation costs would be pooled and there would be no cross-subsidy between the classes – costs arising from each class would be met exclusively by that class;
- Option B: As well as the broad classes in Option A there would be a general pool whose operation would be triggered by catastrophic losses which overwhelmed a single class;
- Option C: This includes sub-classes within the broad classes, each of which would meet the first tranche of liabilities falling to it. Each class would then meet its own class liabilities, net of the first tranches; and
- Option D: This provides a combination of Options A-C with sub-classes, classes and a general pool.
David Kenmir, FSA managing director, says the FSA favours a solution along the lines of Option B, which initially apportions the costs of compensation to the broad classes and then spreads the costs among all those who contribute once the claims exceed a certain financial amount.
He states: “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.”
The FSA considers the present limits at FSCS sub-scheme level on the amount firms can be required to pay in compensation cost levies in any one year are unsatisfactory because they might reduce the amount of compensation otherwise payable to consumers. It therefore suggests removing the cap from the new funding arrangements.
The tariff base options it proposes as a way of sharing out compensation costs among firms in each group include:
- A universal tariff base: a single measure, such as level of income or number of retail clients, would be reportable by all firms and could be used for allocating the levy at the level of broad classes and the general pool;
- A different tariff base for each broad class: a measure would be tailored for each broad class, such as the value of protected deposits on the books of each deposit-taker for the deposit class and the value of regulated mortgages arranged in a given year for the mortgage class; and
- A different tariff base for each sub-class: the FSA says this option is not satisfactory in the long-run because the long-term structure of the approved persons regime, and therefore the tariff bases that rely on it, is unclear.
Liabilities arising from mortgage lending and administration are not covered by the FSCS at present, but the FSA suggests the mutual financial interest between lenders and intermediaries justifies them being enrolled as potential contributors and, if this happens, it says it might be fair to cover their liabilities as well.
After evaluating responses to the Discussion Paper the FSA will publish draft rules in a Consultation Paper this autumn. It expects the rules will not come into effect before 1 October 2007.
Kenmir adds: “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.”
Loretta Minghella, FSCS chief executive, states: “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.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Emily Perryman on 020 7968 4554 or email [email protected].IFAonline
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