Hurry up and wait for changes: FCA review of UK Compensation Framework

In December 2022, FCA published feedback to its earlier Discussion Paper 21/5 on the compensation framework and the purpose, scope and funding of the Financial Services Compensation Scheme (FSCS).

If you aren’t already familiar, or need reminding, the FSCS is the UK’s statutory 'fund of last resort’ for customers of authorised financial services firms. The FSCS provides compensation when certain authorised financial services firms are unable, or likely to be unable, to meet claims against them. Increasing compensation costs in recent years, the This Following FCA changes a few years ago, insurance and investment providers are required to contribute to the costs of advice failures and with increasing compensation costs, the fairness of the FSCS levies have been questioned, prompting this review by the FCA.

The key summary, however, is that there are no immediate actions to address specifics of how the compensation scheme is funded, how it operates, and who benefits.

Indeed, it looks less likely that HNW/sophisticated individuals would be shifted out of the scheme, on the basis that if labelled incorrectly, there would be severe consequences. We think there are arguments for certain products to fall outside, but it is hard to argue with the FCA's point here. The industry does have form for mislabelling individuals...and FSCS comments suggest it remains an issue.

On the 'CIS look through' which costs some asset managers a considerable sum each year, the only suggestion of change (sooner) are such comments as:

“we remain open to ideas for helping to address the reporting issues (difficulties in isolating income relevant to FSCS fees) flagged by some firms in connection with the CIS look-through”.

In other words, unless you can think of a better method of providing data to calculate the levy, get used to this extra fee.

The FCA set out considerable detail as to how they are tackling the 'polluter pays' issue. This is a fundamental flaw in the scheme where ne'er-do-wells pass the buck onto compliant firms (and in turn, consumers).

Such is the increase of FSCS costs, regulated firms (under the cost and value area of the consumer duty) have pointed a finger at regulatory failure (not tackling the bad apples) for an increase in their base costs. Alongside the increased regulatory burden of course...

But good luck getting that argument past the regulator. Instead, expect real challenge on senior management remuneration/granular detail of any costs paid by consumers (and where the money ends up) in return. The FCA will happily play that game!

The regulator painfully points out that FSCS costs do have a long lead time... therefore costs will be 'baked in' due to past failures for some considerable time to come. Ouch. But FCA also make plain how seriously they take this issue to try and stamp this out. Cynics amongst you (and there are many) will no doubt see the acknowledgement of 'baked in fees' for years to come, yet an unwillingness to change where costs land now a ploy to maintain the status quo. Ensuring those with deep pockets yet no direct link to the causes (pensions with a sprinkle of others) continue to pay up.

No doubt such assistance was comprehensively supported by those in the firing line.

There is truth in the wider benefits of ensuring the burden is spread across the industry. I'm not convinced the sums paid out reflect the benefits to many managers.

The regulator promises considerable future reviews across a range of areas, and suggests much remains open for genuine debate to facilitate change, where warranted. So there are reasons to remain positive for the future.