To The Right Honourable ..
Financial Services Compensation Scheme funding
(I am a Director and shareholder in a Chartered Financial Planning business in the City of London.) I would like to draw to your attention a situation that is developing within our industry that poses a threat to small businesses like ours, a business which provides employment opportunities and helps to drive growth.
The Financial Services Compensation Scheme (FSCS) is funded via annual and interim levies on FCA and PRA authorised firms, of which we are one (https://www.fscs.org.uk/about-us/funding/). My understanding is that these levies are calculated with reference to the level of investment intermediation carried out each financial year by each firm, measured in terms of fees received.
The total FSCS budget now exceeds the FCA’s budget, meaning compensation costs now exceed regulatory costs, and this trend is set to continue.
There has been a significant rise in the number of claims on the FSCS in this financial year, mainly in relation to pension advice. There have been a number of high profile scandals, the most prominent being the British Steel Pension Scheme, and according to the FSCS £162m of total costs of £237m were in relation to pension advice.
In addition, Reyker Capital and SVS Securities both failed, which is likely to result in claims. Having already seen a marked increase in regulatory costs, the FSCS have now hit firms with an interim levy totalling £46m.
Whilst we were aware of the interim levy being imminent, we were shocked to receive an email from the FSCS demanding we pay an interim levy of £4,465.99, with one month given to pay. If the invoice is not settled within one month, there is a fine of £250 plus interest accruing daily. We had already paid £18,768.60 in July 2019 to cover the 2019/20 regulatory fees. Our turnover is just under £1.2m.
The fundamental problem with this system is the levy calculation. Firms can act unscrupulously with inadequate professional indemnity (PI) insurance, knowing that if claims arise they can allow the company to become insolvent and leave investors to fall back on the FSCS. Meanwhile, firms like ours - who are unlikely to ever cause a claim on the FSCS due to the type of products we recommend and advice we give and who hold significant PI cover - have to pay higher levies to effectively cover the rogue firms.
Consequently, we have a perverse situation whereby the most successful, well resourced and insured firms, are paying increasingly higher amounts to protect customers of firms who have not acted with integrity and often have inadequate insurance cover. In the insurance market, the reverse would apply i.e. the lowest risk firms pay the least and the highest risk firms pay the most.
It is a widely held view within the financial planning industry that the current funding basis is not fit for purpose. The burden is being placed in the wrong businesses and ultimately this could lead to some of these businesses failing. Moreover, higher regulatory costs lead to higher fees for clients, so those clients of successful and well run firms will end up footing the bill.
The claims on the FSCS during 2019/20 are potentially only the tip of the iceberg. The claims resulting from British Steel are likely to put more pressure on the FSCS and there is a real risk that the issue of defined benefit transfers results in £billions in compensation, which could be catastrophic for the industry and the FSCS.
How will businesses like ours be able to afford a demand for an interim levy of tens of thousands of pounds with one month’s notice? The impact could be extremely damaging across the advice sector.
There are a number of potential solutions and the FCA have already consulted on FSCS funding options. My personal view is that the levy should be risk-based, in the way that PI premiums are risk-based, meaning for example that those firms selling unregulated products or doing an excessive large number of defined benefit transfers pay more than those firms who take a more vanilla approach.
The funding basis used by the Pension Protection Fund (PPF) provides a good example of how a risk-based model could work. The PPF measures the risk of each sponsoring employer falling into the scheme, and sets the levy according to the level of risk. Consequently, the companies least likely to become insolvent are paying a levy that reflects the fact that the pension scheme is unlikely to need to be covered by the PPF. A less financially secure company, with a pension scheme in deficit, is more likely to become insolvent and therefore the pension scheme is more likely to fall into the PPF, meaning they pay a higher levy. This seems like common sense to me.
I cannot see why the FSCS / FCA cannot take a similar approach in calculating levies on eligible firms. In much the same way as PI insurers calculate our insurance premium, the FSCS could assess the risk of each firm in terms of the types of advice being given, and set the levy accordingly. The FCA certainly have sufficient data to assess risk, under the Retail Mediation Activities (RMA) return. This would end the unacceptable situation of the lowest risk and most well resourced firms providing an open-ended source of funds to pay out for the misdemeanours of those firms who take advantage of their “customers”. The present system actually encourages risk taking and scams.
There are other potential solutions. For example, a product levy paid by providers, or a levy on policyholders, but the FCA do not seem keen on either of these solutions. Ultimately, the burden needs to be spread more evenly and widely. Our professional body, the Personal Finance Society, has put forward the idea of merging the FSCS levy with the cost of PI insurance, which has merit. There are issues with PI that are interlinked with the funding basis I am highlighting in this letter, but outside of the narrow point I am raising with you.
Ultimately, the burden needs to be spread both more fairly and widely, with greater accountability and cost falling on those most likely to cause an increase in the amount claimed under the scheme.
I would be grateful if you could give my concerns some consideration and raise this issue with HM Treasury.