FSA: Why we rejected an FSCS product levy

25 July 2012 | By Natalie Holt

The FSA has set out why it believes alternatives to the current Financial Services Compensation Scheme funding model, such as a product levy, are not feasible.

The regulator has published its consultation paper on reviewing the FSCS funding model today.

It proposes an increase to the annual claims limit paid by investment intermediaries, from £100m to £150m, and the creation of a retail pool for firms under the Financial Conduct Authority which would be triggered if any class breaches its annual claims limit. Deloitte research commissioned by the FSA suggests 118 firms in the investment intermediation class would become unprofitable if the new threshold was reached.

Many in the industry have argued a product levy would be transparent for consumers, make them aware of the cost of compensation cover, and shield firms from unpredictable levies.

But the FSA argues a product levy would not take into account the different risks posed by different products and transactions.

The FSA says: “A product levy makes no differentiation between the activities of provision and intermediation, even though a significant volume of FSCS claims relate to advice by intermediaries.

“Intermediaries would appear to play no role in the funding of the FSCS as the levy would be attached to the product and therefore the provider.”

Another suggestion proposed by the industry was division within the existing classes, to isolate firms from riskier areas within its class.

But the regulator says this could compromise the sustainability of each class as a smaller number of firms within each category means each firm faces a larger share of the costs.

The number of complaints, and the number of complaints upheld by the Financial Ombudsman Service was rejected as alternative way of calculating levies as the FSA says this is an “unreliable indicator”.

Firms’ risk scores, which the FSA uses to prioritise its resources, were deemed an unsuitable method for calculating levies as risks are measured based on FSA objectives rather than risk of a compensation claim.

The FSA says calculating levies according to products sold would also be problematic, as risk would have to be continually assessed over the product’s life cycle. It also does not factor in whether the product is suitable for a particular type of consumer.

The FSA says: “We are not making any changes to the current tariff measures, because we are unconvinced of the merits of alternatives such as product levies, and have not been able to identify feasible or reliable metrics in the intermediation classes to reflect how likely a firm is to give rise to claims on the FSCS.”

The regulator says alternative methods of allocating levies such as a greater number of classes would mean firms are more likely to face unpredictable levies.

It adds: “We consider the burden on firms is likely to be less under our current approach than under any of the alternatives proposed.”

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