The Financial Services Compensation Scheme (FSCS), which compensates customers of failed financial firms, announced in April this year that it would levy £532m from firms for 2019/20, an increase from £517m the previous year.

The levy is often the subject of criticism by firms that complain about the consistently high level of demands. Ian Cornwall, Chartered FCSI, director of regulation at the Personal Investment Management and Financial Advice Association (PIMFA), said: "The good firms have to pick up the tabs of the cowboys who aren’t running their business properly or of individuals who are basically ripping off clients."

Such attitudes are no surprise to FSCS, which knows its levy is often unpopular. “We recognise it can be a significant and unwelcome expense for many firms,” said recently appointed chief executive Caroline Rainbird when announcing the 2019/20 levy distribution in early July.

The founder of a boutique financial planning firm, for example, said in mid-July that it faced a 30% increase in its levy bill for the year. “Investors need protection, but the system is broken,” tweeted Dominic Spalding, of Oxfordshire-based Expert Wealth Management.

Others have different complaints. “The bigger issue with FSCS, rather than whether the levies are the correct amount, is whether the process works quickly enough,” says Andrew Frost, director of global financial compliance firm Lawson Conner. “Perhaps the process needs to be streamlined and automated so it is more efficient.”

"The good firms have to pick up the tabs of individuals who are basically ripping off clients"

In response, FSCS points to the launch of its online claims service, which, according to FSCS, “now sees 95% of its claims made online, and significant reductions in claims processing times and costs”.

System tweaked

In 2017, the FCA ran a consultation exercise on the funding of FSCS, including the levy. In response to the feedback it received, the system for allocating the levies has been tweaked as of April this year.

Among the changes is a requirement for insurance and investment providers to contribute to the compensation costs that fall to intermediaries; and life, pensions and investment advisers are now grouped together as a single class. Under the current set-up, the limit for the investment intermediation class is set at £330m, including £90m from product providers, while the limit for the investment provision class is £200m.

Ian Cornwall says the way the system has been set up is broadly fair; the main problem is the amount firms are being asked to pay. “I think it’s not an unreasonable basis of allocating costs,” he says. “The issue is not how you cut the cake. It’s the size of the cake that is too large. The volume of claims hitting the fund is enormous and has been year after year.”

The FSCS outline for levy distribution for the financial year 2019/20 says some 46,000 firms will contribute to the lifeboat fund. Over half of those contributors, 59%, will pay less than £50 and around 4,500 firms will not make any contribution at all, instead receiving a rebate averaging £139. However, the bill for some is far more substantial, reaching into the millions of pounds.

This has been the case in past years, too. Hargreaves Lansdown, for example, reports a levy of £3.5m in its financial results for the year to 30 June 2018. Charles Stanley paid £1.2m in the year to March 2018 and just over £1m in the following 12-month period.

FSCS says the top 110 firms will cover 61% of that, paying an average of £3m each. These figures are estimates though, based on FSCS’s forecast of how much will be needed. FSCS chief corporate affairs officer, Alex Kuczynski, says: “It’s a bit of an art rather than a science. There’s an element of past experience, there are claims in the pipeline that we put a value to and we make an allowance for claims we think might be coming. There’s no magic formula, which is why we never come up with a perfect number. There’s always the possibility of a completely unforeseen failure.”

The levy includes management expenses of around £75m, slightly higher than the £73m in 2018. FSCS justifies the rise in its management expenses by saying it is processing more claims than before. In 2018/19, FSCS paid out £473m in compensation to 425,760 customers of failed firms. The previous year, it paid out £405m in compensation to 69,980 customers. Staff costs rose from £14.7m for the previous year to £15.6m in 2018/19, although staff numbers averaged 187 over the same period, a slight fall on the 191 average from the year before.
"It’s not how you cut the cake; it’s the size of the cake that is too large"

Other costs include FSCS press and communication expenses, which in 2018/19 were £3.5m, a slight increase on the £3.3m from the year before. Much of FSCS marketing is done by financial firms themselves, who often include information about FSCS protection in their own customer communications.

Dividing up the bill

Once the total has been calculated, FSCS applies rules set by the FCA and the PRA on how to divide the bill around the sector. This is done by activity and, with the exception of deposit-takers, there is no risk weighting within different sector classes – it is simply allocated on a flat distribution across each class.

Although there is no risk weighting, there is an upper limit for each group, which is designed to ensure the demands aren’t too onerous for any one class; any compensation requirements beyond that cap are shared around other groups.

If the amounts prove insufficient, FSCS is able to raise more through supplementary or interim levies, usually around the turn of the calendar year. On occasion, these interim charges have been substantial. Brewin Dolphin, for example, was levied an additional £6m in 2011, while Jupiter Fund Management reports a £5.2m supplementary demand in its half yearly report for the same year. More recently, Hargreaves Lansdown was charged an interim levy of £0.3m by FSCS in November 2018.

The levies have been consistently high in recent years, due to the need to compensate consumers for failing firms. Recent examples have included stockbroker Beaufort Securities, which collapsed in early 2018, leaving 17,500 clients at risk of losing their money.

However, not all failing firms are automatically covered by the scheme. FSCS only covers claims against FCA-authorised firms that have gone out of business and are unable to pay claims themselves. One recent case was London Capital & Finance (LCF), which entered administration in January 2019.

FSCS initially said that it would not accept claims from LCF’s clients as the mini bonds it issued, which were used as the basis for making loans to corporate borrowers, were not an FCA-regulated activity. Then in late June it said some customers may be eligible for claims after all, as a firm linked to LCF had provided misleading advice – which is a regulated activity. FSCS revealed in early October that it has been progressing its investigation of the extent of potential claims, adding that “the LCF case is very complex [so] this may take some time [before] we can make an announcement regarding eligibility”.

Could tighter regulation by the FCA reduce the volume of claims hitting the fund? The FSCS strategy document published in 2018 – FSCS into the 2020s: protecting the future – sets out its priorities, one of which is collaborating with regulators and others in the sector to try to prevent future failures and to reduce compensation costs. “Although we have fed that back to the FCA over the years, we think we can do that more effectively,” says Alex.

In April this year, FSCS teamed up with the FCA, the Financial Ombudsman Service, the Insolvency Service and Scotland’s Accountant in Bankruptcy to set up a new mechanism to tackle firms or individuals who deliberately seek to avoid their liabilities or poor conduct history by closing down a business and then setting up again as a different legal entity – known as phoenixing.

The FCA has said there are no plans at the moment to reopen the levy since the changes introduced in April. “We need to let this one bed down. From our point of view, it’s unhelpful to change it too often because it requires system changes and then the sector needs to become familiar with the changes,” says Alex.

The full version of this article appears in the October 2019 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’. 

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