The announcement of the likely need for an interim levy as a consequence of the failure of Catalyst has reignited the debate about the way the Financial Services Compensation Scheme is funded.
At Apfa we have long said the FSCS funding model needs an overhaul.
We were disappointed in late 2012 when the FSA did not consider more radical options. It then appeared to shelve a couple of years of thinking, when it held a dialogue with the financial services industry about options.
The result was a rather tame consideration of how to adjust the FSCS to the splitting of the regulator. In our response and in discussion we said there should be a more active consideration of how both a product levy and pre-funding might work. However, reform such as a product levy would take time. It might well require primary legislation and would definitely require a change of heart at the Treasury.
But the issues related to the Catalyst default (a reprise of Keydata in structure) highlight more specific issues than the overall funding model. As I understand the current system, Catalyst would be considered an investment intermediary whether it dealt with retail clients or not.
The criteria for being classed as an investment intermediary for the purposes of FSCS funding are drawn broadly. By contrast those to be a manufacturer are specific – any grey area errs on the side of the intermediary class. Essentially, under the current rules it seems anything between the product manufacturer and the client is an intermediary.
On top of this is the issue of jurisdiction. The FSCS has the responsibility and power to compensate customers when an entity authorised and regulated in the UK fails. It can seek to recover funds from the failed entity abroad on behalf of creditors, but has no remit over failings or responsibilities of non-UK based investment vehicles. I wonder whether the outcome of allocation of fault, and so who pays, would be different if Catalyst had promoted bonds that had been UK based and regulated, rather than issued by Luxembourg-based life settlement vehicle ARM Asset Backed Securities.
This prompts me to three conclusions.
The criteria for the investment intermediary class need to be looked at. The current criteria are too broad. They do not capture the distinctive characteristics of retail distribution or manufacturing. There should be a clearer delineation between those acting on behalf of the client and those acting for a manufacturer.
There are EU investor compensation arrangements for when an investment firm is unable to return assets to an investor, for example where there is fraud or negligence. It seems to me that responsibility needs to be borne by the manufacturer and the regulatory jurisdiction. A review of the Investor Compensation Schemes Directive has been stalled in Brussels for some time, but it should be strengthened to ensure a fair balance in the source of compensation for consumers.
There has been a regulatory failure. The FCA should pay closer attention to similar arrangements. There may be reasons that are beneficial to consumers (primarily tax) for products being based in certain jurisdictions. But regulatory arbitrage is a genuine consumer risk too. Such arrangements should not be allowed to give themselves the comforting veneer of being “regulated and authorised by the FCA” when the underlying products are no such thing, especially when (as in the case of ARM) they were not even authorised in another jurisdiction.
Chris Hannant is director general at Apfa