FSA Consults on New Funding Model Review for FSCS

Jack Humphrey, Regulatory journalist
July 26, 2012 /

The Financial Services Authority (FSA) has proposed changes to the funding of the Financial Services Compensation Scheme (FSCS) which will continue to provide important reassurance to consumers but could reduce the likelihood of interim levies and offer firms more certainty in the level of fees they pay.

The FSCS provides compensation for customers if a regulated financial services firm goes out of business or cannot pay claims made against it. The scheme is funded by contributions from regulated firms based on the type of business they carry out (their funding class).

Firms are organised into five broad classes based on five identifiable industry sectors – deposits, investments, life and pensions, general insurance and home finance. There are two sub-classes in each broad class and these are divided along provider and distributer lines (except Deposits).

Each of these sub-classes has a limit on the amount it could be required to contribute to compensation claims in each year. If this threshold is breached, the other sub-class in their broad group is required to contribute. After this all other classes can be required to contribute via the general retail pool.

Firms are allocated to a class or sub-class according to the type of permissions they hold and compensation costs are allocated to a class depending on the regulated activity that gave rise to the cost.

The current funding model has been in place since April 2008 but during that time there have been significant payouts, resulting in sizable levies for some funding classes. However, the last four years have proven that in terms of consumer confidence it is absolutely vital to have a compensation scheme in place.

Today’s consultation paper puts forward a credible funding approach balancing the need for adequacy of funds with affordability for those contributing.

The main features are:

Two separate approaches for funding FSCS’ costs; one for activities we expect will be subject to the Prudential Regulation Authority’s (PRA) funding rules for the FSCS, such as deposit takers and insurance providers, and one for the other activities we expect will be subject to the Financial Conduct Authority’s (FCA) funding rules. There would be no cross-subsidy between the two;

No changes to the current funding classes;

A retail pool made up of all classes we expect to be subject to the FCA’s funding rules which would be triggered if one or more FCA classes reached their annual threshold (i.e. the limit that funding class would be expected to contribute in any one year);

Revised annual thresholds based on assessments of affordability, and;

The FSCS to consider potential compensation costs expected in the 36 months following the levy instead of twelve months as is currently the case (except for the deposit class). This should smooth the impact of levies and may make levy requirements more predictable than now.

The Review was started in October 2009 but put on hold 12 months later due to uncertainties around the effect of UK regulatory reform on the FSCS and the ongoing development of EU directives. The review began again in October 2011 amidst high profile defaults and continuing pressure on intermediary classes.

There have been significant calls on the FSCS, £20bn in 2008/09 for the deposit class to cover five bank failures, levies of £364m from the intermediation class over the past 4 years and £230m from the fund management class due to the use of cross-subsidy only in 2011. The General Insurance Intermediation class has seen sharp rises principally driven by PPI compensation costs, rising from £2m to £8.5m through to £69.5m.

Sheila Nicoll, FSA director of conduct policy, said: “A viable compensation scheme is essential to financial services – investors and savers need to have confidence. The industry can agree on that, but as soon as it comes to discussions about funding, all such agreement immediately breaks down.

“Compensation funding inevitably means that different sectors have competing interests. Our role has been to walk the middle ground and produce a workable solution that we believe the entire industry can afford and live with.

“We would urge all stakeholders to engage with us in this funding review. Any changes that we make have to produce a system that is as fair as possible, but ultimately plays its part in underpinning confidence in the financial services sector.”

The review has been undertaken against the backdrop of the proposed legislative change in the UK. The Financial Services Bill currently before Parliament sets out the government’s proposals for reform of the financial regulatory structure in the UK. Provisions within the Bill split responsibility for making the FSCS rules between two new regulatory authorities: the PRA, and the FCA.

The details of the split will be the subject of secondary legislation made under the Bill when enacted, and we expect that it will provide that FSCS rules will be made by the PRA for deposit-taking and insurance-provision and by the FCA for other activities. Our proposals are consistent with the way the funding model would work following such a split of regulatory responsibilities (‘legal cutover’).

The consultation will run until 25 October 2012.


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