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A radical solution for FSCS funding?

Industry consultant Mike Fenwick says the time has come for radical alternatives to be debated as an alternative to IFAs continuing to pay for the failures of others.

In banking, the debate over “moral hazard” takes place. But where do we see any debate extend to the FSA’s failures which represent the very same “moral hazard” – where the cost of such failures fall not on the FSA but on everyone else?

Why is that we see no practical ideas coming forward for change, not from politicians, the authors of the previous failures, but from within those affected, from IFAs and from investment managers? Ideas which crucially have as their genesis changes that would truly benefit the investing public.

The FSCS is, and always was, designed to be an answer for failure – the failure, not the success, of the regulatory system itself. 
Consider this quote from Hector Sants to the Treasury select committee in November last year as he looks forward “… I am trying to wean people off an expectation that you operate a no failure regime …”. 

Hector Sants, soon to be chief executive of the Prudential Regulation Authority intends to simply continue a system which anticipates and allows for more failures.

Think back over just the past 20 years or so, make a list for yourself: Keydata, Equitable Life, Northern Rock, RBS, HBOS, Lloyd’s Syndicates, Independent Insurance, Lehmans, the LTCM’s … keep going, and don’t forget the Farepak – it is a long list. 

Add up the costs of such failures – can we afford such costs? Can we suggest alternatives to this catalogue of failures?

When Hector Sants expects everyone to meekly accept a future of more failures, perhaps we should all ask- can a better one be designed?

Here are some initial and wholly random thoughts – they point in the direction of a new market, one which does not yet exist, but which may have every reason to be considered:

1) When we hear of sovereign debt, it is unlikely that we will not also hear of Credit Default Swaps, an insurance against default – with, importantly, the “price” of purchase being a key indicator of the risk involved.

2) Down a peg or two, you will find the Export Credit Guarantees Department offering a form of insurance against potential defaults – where again the levels of cover given and the “price” to be paid are key indicators of the risks involved.

3) Venture a step further down and the recent news over the removal of credit insurance for HMV, and again you have what could not be a clearer indication of the levels of potential risk involved – where it is “there is NO price” against which cover will be provided – could there be a clearer signal of the levels of potential risks involved?

4) When your client buys a gold ring at £10,000 – would you expect him/her to insure it against loss? What if the same client invests in a gold commodity fund – same answer?

When the FSA’s best efforts fail, unlike an insurer whose money is at stake, the regulator pays no price for failure, everyone else is left to pay the bill.

For me that plays a key part in why there is every reason to debate these issues, and to consider alternatives.
Or do we all just sit about waiting for the next failure, and then complain about “the price”?

One, of more than one, possible alternative, in sketch form only lies in the above examples, it is one which allows all those who seek to invest to determine through “price” the risks they may be taking on.

Clients understand, nearly instinctively, why the “price” of insuring an 18 year old Subura Impreza driver will be higher than a 55 year old Ford Escort driver – they know one carries a higher risk. When you ask them about their attitude to risk – do they understand, really understand the risks – do those who invested in Keydata?

What if they were given a “price” to insure against the risk – and the price quoted for Keydata was much higher than alternatives – would they not then better understand the true nature of such risks?

What prompts all the complaints in these columns? Is it the “price” of regulation, is it the “price” to be paid out for compensation after the FSA fails?

In a market economy there is perhaps no better signal than that of “the price” – the evidence is all around. It is perhaps time that lessons were drawn from it and instead of just complaining, ideas for change debated.

Mike Fenwick is an industry consultant


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There are 23 comments at the moment, we would love to hear your opinion too.

  1. It is not only IFA’s that carry the cost it is the DFM’s etc where the levy can be in excess of £500,OOO.
    This of course is then an overhead which has to be built into their charges to clients.
    Again just like the banks it is the public who pick up the cost at the end of the day.

  2. There have certainly been suggestions as alternatives mentioned here and on other blogs, which I am sure the FSA are aware of but they seem to have their own agenda and not prepared to listen to any ideas except their own.

    The most often one mention as indeed I have myself is the idea of a levy on the product and this could be geared to the risk of the product so clients can see the cost of that risk. If this was disclosed in the same way charges and commission are on a Key Facts illustration then it would seem a sensible solution to the problem.

    There should in reality be a review of the whole issue of protecting consumers including how consumers are protected in the NHS and who pays it as the bill is huge.

  3. Incompetent Regulators Awards Team 1st February 2011 at 9:59 am

    Product providers whould cover product providers. Cross subsidy from poorer sector of society propping up the wealthier should be a no no in todays politically correct world. That’s what’s happened to IFAs subsidising the richer providers. When in fact we support them by selling their products. IFAs get done both ways!

  4. There are already ‘levies’ on some products because the government takes a lot of tax from the insurance companies in particular. Much less so from the asset management groups and structured products.

    We then find more suggestions for levies for things like financial education and access.

    Mike also mentions Equitable Life, point of order is that Eq Life messed up but it did not fail and was not declared in default. It intersts me that (life) insurance companies are so tightly regulated and have to keep such big reserves that they never fail. The same yardstick should be applied to other providers.

  5. Mike they never listen, I remember when you were warning of the consequences of mergers of banks building societies and Insurers, along with over regulation of the Broker/ IFA market in the early 80’s.
    Billions of Pounds later it just gets worse.

    The only way to get it right is do away with the regulators as we know them and let the laws of the land do what they have over centuries, developed to do.

  6. Applying levies, fees, fines or other monetary costs to an Industry whose key aim is to provide a monetary return to the investor is ridiculous.
    Every time a cost is added that has to be absorbed. In reality the larger businesses disguise these overheads which are passed on to the consumer with a yet lower return. Whereas small financial adviser businesses being forced to take the hit with a squeezed margin.
    The Regulator needs to find another way of policing the Financial services Industry which improves client returns. Where is the diligence and risk management if a financial business can fail in the safe knowledge that a compensation scheme will come to its rescue funded by thousands of other innocent investors or small businesses? Maybe the removal of licenses to trade for a period, the length of which is determined by the severity of the offence.
    Perhaps the “naughty boy” should be made to sit in the corner. Banks for example forced to display notices in prominent places to the effect of “We have been found guilty of ripping you off” We made £X millions and all bonuses have been suspended until this money is returned to you. Have a nice day.

  7. There are a number of factors that should be applied to sorting out the FSCS Funding.
    1) Any system needs to be practical. It should be understandable. It should also be accountable.
    2) As the advertising clearly states the FSCS was set up by the Government, and clearly gives the impression that it is underpinned by the Government, the Government should contribute, otherwise the FSCS is deliberately misrepresenting the facts – a heinous crime according to the FSA. So let’s have some fundamental honesty.
    3) Businesses pay for PI insurance to cover unexpected problems, and this is costed on the perceived quality of the business. Why does the PII not pay the FSCS excess levy. The process would be built into the normal PI premium, so that businesses have the facility to plan their cash flow. There would also be an increased incentive on the PI providers to ensure that businesses were run on a sound basis, and would adjust premiums accordingly. Thus the real pain is more likely to fall on poorly run businesses (but do not expect the process to be perfect). And the PI providers may have more success in determining what should and should not be paid to the FSCS; what interpretations are valid and what are not. The process become more accountable.
    4) Just as people pay for other insurances, should they also pay for advice risk insurance? However, it is worth noting that the purchase of risk insurance is voluntary – not everyone pays for house and contents insurance, or car insurance. They take the consequences of their loss (actually this is not quite right, in that if there is a group loss there is often a group charity created to compensate people for their own lack of foresight; but if you’re on your own then tough; odd bit of social bonding that!). So there could be a policy risk fee that people could elect to have or not. This would determine whether they received compensation or not – which may just ensure that individuals took a little more notice of what they were investing into. At the moment it feels as though the culture absolves the purchaser of any responsibility, which is unhealthy, and a partial cause of the Financial Crisis. Its the Granny State in action – underpin, yes, totally absolve, no. People who elected not to take the product insurance would be allowed to sue for negligence in the normal manner – and applying the normal requirements of proof! They will have a choice, which is what the free market is about, is it not?
    5) If the failure is attributable to Regulatory failure, in part or in whole, then the Directors of the Regulator should also be seen to contribute. Again this could be covered by Insurance – but at least the Directors would need to contribute to that insurance out of their own, taxed, earnings. If the Regulator pays the premium on behalf of the Director then the compensation payment is treated as taxable pay. A little like Non-Approved Pensions. And the potential for monetary pain may just concentrate their minds on the job in hand, rather than the excuses after the event.
    6) Product providers should also be assessed on individual products, so that every product has a Group Grading, a little like the difference between a family saloon and a sports car. An ISA may be group 1, whilst a Fund of Fund Hedge Fund could be Group 4. A simple grading process to keep costs under control, but one that will allow statistics to be keep to determine where the problems are arising. Each providers profile is then a part of their profile for their PI grading. [Actually, if products were given a simple grading, and statistics kept, which should be a simple matter in a computer age, it would also be possible to Grade Adviser firms in a similar manner. And by Advisers Firms I mean every firm “advising/selling” financial products, including Banks, Building Societies etc. Then we could analyse the level of complaints and catastrophes against the apparent risk levels to determine if there is any correlation between product risk and failure, or whether is it mainly down to bad advice – at the moment everyone makes whopping great assumptions – with the FSA and FOS well to the fore in that respect.]
    In this way the pain in spread a little more judiciously over all parties, there are incentives on all parties to behave (incentives not compulsions), and it is far less likely that “innocent” businesses are sent to the wall by the behaviour of the bad.
    And there would be a level of incentive to improve and the basis of designing a system that tackled the basic problems because it understood what they were instead of continually guessing.

  8. My radical solution is for the long stop to be introduced.

    IFA@s could pay into a levy at a higher level in their own earmarked fund, that would then be refunded if not drawn upon after 15 years, thus the rogues who have left the industry would lose their money and be made to pay their fair share.

  9. Sorry to make this point chaps but if you have recieved a renewal recently for your home contents/buildings insurance or a car renewal, you’ve probably seen a hike in premiums.
    No doubt that the majority have not sustained any losses but the majority pay for the minority. So it is with this levy.
    Personally I think that the a product levy AND closer scutiny by the FSA should be the way forward.
    Finally I also agree with the comments on PI cover but I would go one step further and ask why do we hold capital adequacy funds of thousands of pounds if our PI meets FSA standards?l

  10. Anon at 11.53. The difference between this and a hike in your home contents/ motor insurance is that you can shop around and find a provider who may be able to offer you a better deal. You do not have to renew with the same provider each year.

  11. Interesting points made in your article Mark. However the approach might raise more questions than it answers. Who is to say what is low risk and what is high risk? If products were categorized for example, a stakeholder pension with investment into some form of lifestyling portfolio against a SIPP that the client is using as an execution-only trading account – both are pensions. Normal wisdom would suggest that cash is low risk, yet over the long term it isn’t and in 2008 most probably thought it wasn’t.

    I have to admit to being with Sants on this one. The illusion of a perfect regulator or system is purely that – illusory. For sure attempting to get it right, but with such a wide variety of products and loopholes, clever people and complete muppets, the task of regulation is not an easy one. Sure they have got a lot wrong. Who hasn’t?

    I like Glen McKeon’s thoughts on this, certainly in terms of linking responsibility with PI, business management, MI and data that most of us hold and collate already. The key issue for me is that there ought to be an obvious link for those that offer advice and arrange “sensitive” products. Let’s call these “unregulated” for the moment. This implies additional risk (be it true or not). As a result for those firms wanting to operate within this sphere for their sophisticated clients, then rather than use a term like independent (reducing the rest of us to restricted) take a hint from medical professionals – specialists and general practitioners. Those that want UCIS authority should have appropriate additional qualifications and PI and share the contained liability within that sector, not pass it to the rest of us that don’t have the specialist credentials and/or sufficiently sophisticated clients. In short, get the Keydata type problem addressed with proper and correct classifications and accept the collective responsibility of your specialism or don’t offer it. Of course there are some excellent unregulated products, as there are some excellent advisers – but there are also some naff ones too. What most of the objections are about seems to be about the lack of fairness for those being asked to contribute to bail out the ineptitude of others where there is no real correlation to their practice.

  12. Dominic,
    I think you miss the point in your first para. What Mike is suggesting is that the market (if allowed) could use insurance principles to price the default (not investment) risk of a product and the consumer pays that premium as part of his purchase cost. So no one has to define what is high risk, the premium demanded by the insurer taking on whatever risk is being insured will do that. Its great extra information as well for an adviser!
    It gives total clarity, and he who benefits pays, and its prefunded with the risk spread throughout the insurance world, where risk should be.

  13. Maybe we need to look closer to home in our negativity – HMV have not had their Credit Insurance cover cancelled. Fair enough, it has been reduced by two insurers (others have maintained cover) and one of those two insurers said they had reduced cover back to the pre-xmas levels, so this was only a seasonal increase/decrease not the across the board cancellation as many articles have misleadingly stated.

    I agree that something should be done to stop companies going out of business. One of the problems is when it gets into the hand of a receiver, who only seem interested in getting “best price” for it, at the expense of all else. Take MFI for example, 80 people expressed an interest, so why didn’t the receiver get everyone in the same room and knock a plan of action out, same with LDV – had 12 bids, 3 went through to the next stage, then non were deemed acceptable, but surely something could have been done between the original 12 bidders instead of it being asset stripped by the Chinese.

  14. Mike

    Nobody listens…they hear but they just don’t listen.

  15. For me the biggest “risk” to the industry is the regulator or FSA.

    I see little point in paying a regulator whose costs next year will be £1/2 Billion but who add little or no value in protecting the consumer. Certainly since it was launched the FSA had protected little and cost us numerous billion pounds.

    If the FSA worked then we should in theory get value for money and the amount of compensation we pay out to consumers would be much less and the FSA would be seen as value for money.

    The reality is we and and have paid a very high cost for the FSA and also a high cost to compensate consumers neither of which gives us value for money as the FSA does not work as it should, but they have a vested interest to protect their own nest.

  16. No point blaming the FSA for everything.

    At least they’re bringing in RDR which will get rid of most of the idiots who sod these policies in the first place.

  17. Steven Farrall (Adviser Alliance) 2nd February 2011 at 10:27 am

    Shut it down. We (as in the country at large) does not need the FSCS. Or the FOS or the FSA for that matter. Their very existence creates monumental moral hazard. And as Mike says, if you want ‘guarantees’ go the market and buy some ‘insurance’. The price of that cover will guide you about risk. Price, as all Austrian econmonist know is a signal.

  18. Also who insures the insurer? Remember the US sub prime bonds & CDOs were mostly insured by AIG which had to be propped up by the US government or should I say tax payers.

  19. chevron, surely the fundamental question is who regulates the insurer and ensures we have ‘orderly markets’.

  20. @ Harry

    If you believe RDR will stop Keydata type policies or indeed any policy being mis-sold then I think you are living in an imaginary world.

    RDR may help increase knowledge in areas many but I doubt it will stop mis-selling, Even those who have the supposed highest qualifications of being a Certified Financial Planner have been caught mis-selling.

  21. Richard Brown, Managing Director, Moneynotion Limi 2nd February 2011 at 6:32 pm

    It’s the investor that wants the insurance/compensation, so why isn’t it the investor who pays directly, through a product levy?

    Making IFAs who didn’t sell a product pay for those that did can’t be described as fair.

    I’ve maintained ever since this scheme began that product levy is the only sensible way forward. Then our industry isn’t sensible is it?

  22. This year the levy is costing my firm £40,000 and I am expected to find this by the end of next month.
    I have never had a complaint against me and it really seems unfair. I feel like I am being gang-raped by the FSA, FSCS and the banks.

  23. Why not ask William Hill to take a look at firms? They offer odds on anything so why not take a gamble on whether a firm is likely to fail or pose a risk to the FSCS? They make money doing what they do while the cost of regulation is spiralling out of control yet we have nothing to show for it!

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