The FSA has proposed a radical overhaul of funding for the Financial Services Compensation Scheme which scraps the ‘pay as you go' system and requires advisers to pay a levy based on the income they earn from specific types of business.
Details of the CP07/05 FSCS Funding Review paper just issued by the Financial Services Authority reveal the regulatory body would like to increase the base annual funding requirement and widen the circle of firms required to fund the compensation, so the first level of compensation is paid by firms specifically working in the sector monies relate to and the higher costs are then borne by the wider financial services community where it crosses new set thresholds.
According to CP07/05, some trade bodies and rivals to this idea have argued this is in breach of section 213(5) of the Financial Services and Markets Act as this proposal is in effect cross-subsidy of markets, however the FSA has disputed this interpretation of the rules.
Under the proposals, the FSA suggests the capacity of the FSCS needs to widen to build a fund of up to £4.4bn a year so increased levies will be required, albeit the FSA then intends to limit the annual levy.
Payment categories will be reclassified away from the current system (A12, A13, etc) and instead split into five general classes of business - life and pensions; investments; general insurance; deposits; and home finance - while sub-classes within that will split providers and intermediation again.
Changes to be introduced on April 1st 2008 would scrap the current ‘pay as you go’ system of covering compensation funding needs and should mean each firm’s contribution to the compensation pool is also proportionate to the levels of business they do, so should an intermediary firm doing 90% investment business and 10% insurance will be required to pay a levy accordingly.
This means stockbrokers and investment advisers, for example, while considered to be A13 firms under FSA categorisation will only pay the same amount if they actually do the same types of business.
At the same time, however, there will no longer be any distinction between firms which do (category A12) and do not (A13) hold client monies.
Interestingly, under this new classification of funding, firms falling into the general insurance and deposit classes will be required to contribute substantially more to the “first phase” sub funding – ie the compensation levy directly-related to the business firms do – than the overall life and pensions and investment class.
Wholesale provider firms may also be required to pay a higher levy to the fund for the first time, as the new system will make no distinction between retail and wholesale firms – contributing a further £1-2bn – but this proposal has yet to be documented in a paper to be issued later this year.
That said, it appears intermediary firms operating in the life and pensions, investment and insurance markets will be required to contribute around £355m a year to the fund through the payment of a levy.
The FSA believes the creation of a system which requires the higher levels of funding be borne by the wider community should “make the funding of the compensation scheme fairer” as firms each class of business and sub-class within that will eventually be required to pay a levy directly proportional to the income generated from each relevant category of business, rather than the number of approved persons working for the firm in that category of business.
On releasing the consultation paper, FSA director Graeme Ashley-Fenn comments:
"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," says Ashley-Fenn.
"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 unknowns' – the future potential compensation claims which no-one has yet thought about," he adds.
Responses to the FSA consultation must be submitted by June 20th, 2007.IFAonline
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