FSA Unveils Proposals For Funding Of Compensation Scheme

by Robin Pilgrim, LawAndTax-News.com, London

23 March 2006

The UK's Financial Services Authority (FSA) on Tuesday outlined four possible options for the future funding of the Financial Services Compensation Scheme (FSCS), following concerns raised about the fairness, proportionality and sustainability of the present funding arrangements.

The options are set out in a Discussion Paper published together with a report by Oxera, the economic consultants who were commissioned to write an independent analysis of the scheme.

FSA Managing Director David Kenmir explained that:

"Having an effective system for compensating consumers for losses incurred when a financial services company fails is a vital part of the regulatory system. The FSCS contributes directly to two of the FSA's four statutory objectives: protecting consumers and maintaining market confidence."

"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."

"Discussions about this issue tend to focus on today's problems such as endowment mis-selling, but the scheme must also be capable of providing compensation for tomorrow's problems."

The Discussion Paper proposes the division of the scheme into five broad classes (life and pensions; securities, mutual funds and derivatives; deposits; general insurance; and mortgages). It then proposes four options for future funding:

Option A: The broad classes would stand alone with no cross-subsidy between each class.

Option B: Above the broad classes would be a general pool whose operation would be triggered by catastrophic losses which overwhelmed a single class.

Option C: Includes sub-classes within the broad classes. Each sub-class would meet the first tranche of liabilities falling to it. Each class would then meet its own class liabilities, net of first tranches.

Option D: A widening net with sub-classes, classes and a general pool.

David Kenmir concluded by announcing that:

"We favour a solution, along the lines of Option B, which initially apportions the cost of compensation to the broad classes, and then once claims exceed a certain financial amount spreads the cost amongst all those who contribute. 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."

After evaluating the responses to the Discussion Paper, the FSA will bring publish draft rules for funding the scheme in a Consultation Paper this autumn.

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