What Is the Financial Services Compensation Scheme
By Malcolm Coury, a Managing Director at Money Wise Independent Financial Advisers Limited.
The FSCS is the UK’s statutory fund of last resort for customers of authorised financial services firms. This means that the FSCS can pay compensation if a financial firm is unable or unlikely to pay claims against it.
The FSCS is funded by levies on authorised financial services firms.
Major Concerns Surrounding the FSCS
The rising cost of the Financial Services Compensation Scheme, in particular, the way it’s funded, has become a major concern for many independent financial advisers (IFAs).
The current method appears unsustainable and unfair since IFAs, in general, pay the price for the damages caused by a few unscrupulous IFAs.
Key Concerns and Impact on IFAs
In addition, since April 2012, the Financial Conduct Authority (FCA) has no longer used the collected levies as restitution to compensate victims for bad advice nor has it used the excesses to reduce the fee block.
Instead, the HM Revenue & Customs (HMRC) has taken the fines for so-called “good causes.”
As such, the burden falls on IFAs, who must meet the entire costs of the scheme, now amounting to around 85% of the total FCA fees and levies.
Perceived Injustice: Net Impact of the Financial Services Compensation Scheme
Before I cover what independent financial advisers perceive as injustices of the way IFAs are treated, especially how the FSCS is funded, let me set the scene.
I’ve been in the financial advisory business for over 30 years.
It has served me well, and, although I am no longer a CF30 (i.e., no longer advise clients), I have thoroughly enjoyed dealing with clients over the years, many of whom became personal friends.
Overall, working with clients has made financial advising a great career to be in.
However, I can’t say the same about the regulations.
Thousands of Advisers Exiting the Industry
The increasing compliance burden and cost of the regulatory system has driven out thousands of advisers and other professionals from the sector.
That’s not entirely a bad thing, considering there were a few “wild” cowboys.
However, by the same token, many advisers and professionals feel that they can no longer cope with the regulatory and compliance pressure and have either retired or sold their firms.
We now live in what is referred to as the “post-RDR world.”
Retail Distribution Review – An Overkill Situation
The term retail distribution review (RDR) and the terminology used by the FCA despite what they might say to the contrary, tells us about their mindset, and, sadly, it’s ingrained so deeply that I’m not sure if it can ever change now.
Under RDR rules, advisers are required to charge their clients fees for the investment services they provide, rather than accepting commissions from product providers.
The rule’s intent was to minimize the conflict of interest situation whereby some IFAs would push only those products that earned them the most commission, irrespective of client suitability.
Whilst my firm was fee-based (commissions and fees) for years before RDR, I also didn’t see the need to remove commissions entirely.
They served many people well for many years, and there was no “advice gap” and no product bias demonstrated by the majority of firms.
However, in my opinion, the most efficient scenario would have been to cap and standardize commission levels to remove any so-called “product bias.”
It was completely unnecessary (an overkill) to abolish them entirely via a regulatory mandate.
Is the Current Model of FSCS Funding Sustainable?
Now let me focus on the subject of this article – whether the current model of FSCS funding is sustainable.
If you’re bored already, then you can jump out here because I don’t believe that the current model is sustainable, and I think that it is very unfair to lower-risk firms.
There is a lack of transparency in the current system.
Until April 2012, excesses in fine revenue were directed back to firms to reduce the overall regulatory burden.
However, since April 2012, fines have passed directly to the Treasury: £736.7m in the first two years alone, i.e., by April 2014.
Personally, I think that this is tantamount to theft by the Treasury, no matter how they like to dress it up.
Where Has All the Money Gone?
The FCA has not yet officially reported the figures for the 12 months up to April 2015, but figures on its website show that it levied a total of £1.4bn in fines for that period.
If enforcement costs remain at their current level of around £40m, the FCA will have paid more than £1.35bn to the Treasury during the year.
To add insult to injury, since April 2015, a further £789m in fines has been levied on financial services firms, putting the total collected so far at over £2.9bn.
So a key question becomes: where has all the money gone?
And why are lower-risk firms paying so much more?
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Doubling of Levies and Fines for Life and Pension Intermediaries
Furthermore, in April, the FSCS announced that the 2015/16 levy for life and pension intermediaries would almost double, from an expected £57m to £100m as a result of rising SIPP claims, and, in March, advisers were hit with a £20m interim levy.
Financial Services Compensation Scheme
The Government has said that the money is being spent on charitable causes and the NHS, but, in reality, it is unable to specifically account for the funds and, unless I’m missing something, no specific information about how the money has been used has been published.
As an example of the impact on advisory firms, over the same period, my own firm’s FSA/FCA/FSCS fees and levies have gone from just over £70,000, of which £49,000 was for the FSCS, to £96,000 this year, of which £84,000 was for the FSCS levy!
On top of that, our professional indemnity insurance (PII) has doubled, and our excess in investment business has increased from £5,000 to £20,000, so we’re effectively self-insuring and paying around £70,000 for PII so that we can trade.
A Strong Need to Review How the FSCS Is Funded
I’m pleased to see Gary Heath of Libertatum and Chris Hannant of the APFA lobbying hard and also in reading the latest announcement (3rd August) from HM Treasury and the FCA stating that they have launched a review to examine how to “plug the advice gap.”
I hope this provides an opportunity to improve things.
My concern is that there have been many other opportunities or “reviews” squandered in the past, and although we commonly hear the term that past performance is not necessarily an indication of future performance, it very often is.
The two organisations have spelt out that the review, which is gathering evidence this summer, will examine the regulatory barriers and other barriers advisers face when giving advice and try to come up with recommendations on how to overcome them.
So, in my opinion, now would be the time to review the way the FSCS is funded, in particular, how the FCA fines are allocated.
Return Excesses and Lower Compliance Burden
I think it’s only fair that these fines are used to pay for the compensation and excesses used to protect the lower-risk, independent advice sector, the majority of which is populated by really decent people who care enormously about their clients.
Therefore, I would like to see the excesses in fines returned to the sector and used to lower the fee burden of firms who are not guilty of wrongdoing, rather than to boost the Exchequer.
I read an article in Money Marketing quoting a Treasury spokesperson as saying: “All FCA fine income is paid into the Consolidated Fund. The Treasury then allocates it to relevant departments.
As with all public spending, it is then accounted for in departmental accounts which are audited by the National Audit Office.”
However, despite repeated attempts by Money Marketing over several weeks, the Treasury was not able to specifically describe how all of the money has been spent, and the article quoted Social Market Foundation Chief Economist Nida Broughton as saying: “Externally, it is quite hard to hold the Treasury to account for exactly what it is doing.”
Since April 2012, the Treasury says that more than £1bn in fines from forex manipulation has been used for the NHS, and that £450m in fines from Libor fixing has been given to charities, including the Air Ambulance Service and funding travel arrangements for veterans to visit Normandy during the recent 75th anniversary commemorations.
However, this still leaves over £1bn in fines money collected, and I argue that this money would be better used for compensating customers and in helping to fund the FSCS rather than it effectively being stolen by the Treasury to solve various public funding shortfalls.
Major Concerns on the Lack of Regulatory Transparency
It’s ironic that we are in an era where transparency of fees and costs is expected of us when we provide financial advice to customers, so why shouldn’t we have the same transparency from the Treasury?
And why aren’t the fines being used to fund the costs of compensation payments to customers who have lost out, mainly due to failed products which are not the fault of the IFAs who sold them?
Responsible IFAs Left Holding the Bag (Picking up the Tab)
Don’t get me wrong. I’m not saying that every IFA who sold a failed product is completely inculpable.
There has been a minority of sharks or “smash-and-grab” merchants (as I like to call them) selling unregulated schemes for vulgar high commissions.
However, overall, many IFAs were simply gullible (e.g., Keydata IFAs), believing that these products were as safe as the companies who marketed them claimed them to be.
Many of those firms who sold large amounts of these failed products are now out of business.
Now, it is mostly the firms who did not sell them, as well as those who sold very little and responsibly, who are picking up the tab, instead of the manufacturers, many of whom have gone bust.
I’m generalising of course, but, hopefully, you get my point.
What Is the Alternative?
As I stated earlier in this article, the current model is, in my opinion, unsustainable and unfair, and I believe that the solution is staring us in the face and is very simple.
Firstly, return to the pre-April 2012 funding method, where fine excesses were:
- Used to compensate victims
- Applied towards regulatory costs, including funding the FSCS
Secondly, introduce a small levy on products sold.
These two moves alone could fund the FSCS entirely, and IFAs would be happy to pay the FCA fees, which are, I must admit, quite reasonable and only make up a fraction of the total fees and levies currently payable by advisers.
The reality is that the majority of the advice sector makes little or no profit.
Reducing or even eliminating the burden of the cost of funding the FSCS would help push most firms back into profit.
In turn, this has to be a good thing because the sector would be in a much healthier place to serve its customers.
Eliminate the Advice Gap
It would also help to eliminate what is being referred to as the “advice gap,” which really means that IFAs are struggling so much to make a profit these days that they don’t want to be giving their free time to low-value clients.
If firms were more profitable, as a result of reducing the FSCS-cost burden, the vast majority would be happy to do more pro bono work for these low-value customers because the advice sector does, from my experience, actually care about people.
Even former FCA Chief Executive Martin Wheatley raised concerns over the current fines system.
I believe that there might be some light at the end of the tunnel because, eventually, as standards improve and, hopefully, the so-called “mis-selling scandals” become less frequent or even a thing of the past, the claims on the FSCS and others will reduce, and the costs should fall.
Double Taxation Scenario for Low-Risk Advisers
The current system is rather like double taxation because the sector is paying large fines and paying increasingly large levies.
I understand that this should be the case for the wrongdoers, but I can’t understand why that should be the case for good, honest low-risk advisory firms.
After all, the independent advice sector should be admired as less than 1% of complaints that end up on the Financial Ombudsman’s desk result from customers of IFAs.
I also read that only around 38% of those complaints are actually upheld.
The Funding Review Needs to Happen Now
The FCA has committed to a funding review of the FSCS by the end of 2016.
However, that’s too far away, in my opinion, which is why I think it should be part of the recently announced review.
The FCA is expected to issue a discussion paper this autumn, so it would make sense to bring these two reviews together, and FSCS Chief Executive Mark Neale has invited firms to submit suggestions for “fairer” alternatives to the scheme’s funding model.
Neale is quoted as saying that he “understands advisers’ frustration,” and that he believes firms with lower-risk business models have had to “bail out” riskier firms. Hallelujah!
Keith Richards, the chief executive of the Personal Finance Society has said, “It is time to explore alternative options, such as the introduction of an investment or policy levy, which would make the cost more explicit and transparent to the client…. It could be deducted from the client’s premium or funds as a cost and collected from the provider or platform on an annual basis.”
Therefore, and at the risk of ranting on, I’m going to stop here and finish by saying that the current funding model must be changed to protect the valuable advice sector and to ensure that lower-risk firms pay less towards the problems caused by higher-risk firms.
Morally speaking (forgive me if that sounds over the top), I believe that FCA fines should be redirected to compensate customers and reduce the burden of the FSCS on the advisory sector.
It would be a real turning point and would send out a very positive message, helping to keep the sector healthy for customers and as a more attractive place for people seeking a career.
So, it seems painfully obvious to me that something needs to change and change fast.
Let’s hope that the Treasury and FCA are going to listen to our concerns.
About the Author
Malcolm Coury is a Managing Director at Money Wise Independent Financial Advisers Limited.
Malcolm has been in the financial services and advisory sector for over 30 years. He is a father of four, a keen cyclist, and sports fan (in particular, Rugby).
Money Wise is a mid-sized firm with 16 RI’s (including 2 of the directors) based in Bath, with offices in Cambridge, London, and Bournemouth.
For more information or to get in touch, you can visit their new website at:
Note: This article is written and based on the author’s own personal opinion. Malcolm is not speaking on behalf of his firm or any professional body.
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