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FSA/PN/115/2007
13 November 2007

The Financial Services Authority (FSA) today confirmed the future funding arrangements for the Financial Services Compensation Scheme (FSCS) which will operate from 1 April 2008.

The new funding system will:

• considerably increase the funding available to pay valid claims to consumers;
• be more robust and sustainable than the present arrangements;
• promote greater consumer protection and help maintain market confidence through financial stability;
• apportion the cost of compensation between regulated firms as fairly as possible; and
• be simpler to administer.

FSA Director Graeme Ashley-Fenn said:

"An effective system for compensating consumers for losses incurred when a financial services company fails is a vital part of the regulatory system . T he new model is more rational, fairer to the various players in the market and provides greater levels of funding. I t will be capable of meeting current issues, such as endowment mis-selling, and will now also provide compensation for any future potential, and unexpected, claims.

"Notwithstanding recent market developments, we feel it right to continue with the new and improved FSCS funding model. Recent experience shows how much improvements are needed. Further changes may be made to the FSCS arising from HM Government and other initiatives - these do not remove the need to improve the scheme now, but will supplement the improvements being made."

New funding model

The new funding model relates to retail business and:

• introduces a 'widening circle' of funding under which compensation costs emerging from a particular sub-class of firms is borne by that sub-class alone, up to its annual threshold, after which higher costs are shared more widely; and
• expands the overall financial capacity of the scheme - up to a maximum of £4.03 billion per year.

The scheme is divided into five broad classes (life and pensions; investments; general insurance; deposits; and home finance). Each class, except deposits, will have two sub-classes and above these broad classes would be a general retail pool. The initial tranche of costs will fall to the relevant sub-class, the next to the relevant broad class and then finally above that to a general retail pool. This last level of funding is only expected to be triggered in the event of a significant default, or series of defaults.

Wholesale pool

In a Consultation Paper published earlier this year, the FSA explored the possibility of including a final level of extra funding of between £1-2 billion for the FSCS – the so-called wholesale pool. This would have consisted of firms making contributions based on the amount of wholesale business carried out, covering investment banks, institutional fund managers, wholesale general insurers and reinsurers - as well as the wholesale business of retail firms already subject to the funding arrangements of the FSCS. While there are sound policy reasons for creating a wholesale pool the FSA has decided not to take this issue further at this time. This decision follows careful consideration of the feedback received during the consultation, and the legal basis of the constitution and potential impact.

Other initiatives

The FSA, HM Treasury and Bank of England published a discussion paper Banking reform –protecting depositors [PDF] in October 2007. This focused on possible changes in a number of areas related to bank failure and insolvency, and to the provision of compensation to consumers across all financial sectors.

The FSA has established a project to carry on work related to the discussion paper. This will consider the range of tools available to the authorities to deliver the outcomes of appropriate consumer protection, market confidence through financial stability and competitiveness.

The discussion paper also questions the limit of compensation payable for each eligible deposit claim. The FSA will examine this as part of a cross-sectoral review of limits affecting investments, insurance, and mortgage advice and arranging and will also look at the role of co-insurance (i.e. should eligible claims be recompensed at 100% of loss incurred or at some lower percentage). This work was originally planned for 2009 but will be addressed now.

Notes for editors

1. Policy Statement 07/19 'Feedback on CP 07/5 and made text' is available on the FSA Website. It contains the rules for the new funding arrangements. The focus of the new rules is on the funding of compensation costs. The way in which the scheme's general running costs are shared out was not under review.
2. Consultation Paper 07/05 'FSCS Funding Review' is also available on the FSA Website.
3. In September 2005 the FSA commissioned Oxera to provide independent analysis to support the funding review. Oxera worked closely with the FSA, FSCS and industry trade associations to obtain both data and to make sure that all viewpoints, arguments and options were taken into account in the run up to the publication of Discussion Paper 06/1: FSCS Funding Review in March 2006. Oxera's Report [PDF] can be accessed on the FSA website. The FSA once again commissioned Oxera to provide further independent analysis for the development of the final policy proposals contained in CP07/05. This second report [PDF] can also be accessed on the FSA website.
4. The FSCS became the UK’s single financial services compensation scheme from 1 December 2001. It provides compensation to the customers of UK financial services firms if an authorised firm is unable to pay claims against it. It covers investments, deposits, insurance and mortgage business .
5. The FSA regulates the financial services industry and has four objectives under FSMA: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.
6. The FSA aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness.