The FSA has explained the methodology behind its proposed new threshold system ensuring there are limits to the contributions made by firms to the Financial Services Compensation Scheme.
The regulator says the new method will provide a ‘pool’ of £4.4bn of retail funding in any financial year, which would be available to compensate eligible claimants in the event of a significant default.
Currently, in the case of default, the FSCS is only able to levy up to a designated pre-determined amount but is then forced to increase the amount each year if needed, to cover the cost of compensation paid.
Under the new proposals - set out in CP07/05: FSCS Funding Review - each new sub-class has been given a threshold. For example, the sub-class of life and pension providers has a threshold of £690m, whereas for life and pensions advice, the threshold is £70m.
The FSA says in order to estimate the thresholds, independent consultancy firm Oxera considered the financial size of each sub-class and used it to establish what was considered affordable.
It says there were a range of factors taken into account to determine affordability, including frequency of the levy; capitalisation levels of firms; liquidity in cash flow and profits; firm size; and the degree of diversification of its activities.
Oxera took a range of possible thresholds – based on 2.5%, 5%, 7.5% and 10% of each sub class’ financial size – and examined the impact each of these would have.
It then considered the probability of a default in a particular sub-class – for instance banks and insurers have an implied failure rate of one in every 200 years.
It considered deposit takers, insurance providers and fund managers were seen as presenting similar levels of risk of default. The FSA says the impact of a default of any of these firms would have a “large and adverse” impact on the sub-class as a whole, so the threshold has been set at 7.5%.
For intermediaries in the life and pensions, investment, general insurance and home finance classes, probability of default was considered higher but impact on the industry lower; therefore the threshold was set at 3.5%.
Responses to the FSA consultation must be submitted by June 20th, 2007.
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