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On the levy

Simply Biz chairman Ken Davy and FSA managing director regulatory services David Kenmir exchange views on replacing the FSCS scheme with a product levy approach to funding consumer compensation.

October 20, 2004

Dear Ken

Thank you for your letter of October 4, 2004. You raise the subject of the increasing burden of the FSCS levy, with those IFAs who remain in the industry paying for those who depart leaving liabilities behind. You also raise the question of whether consumers should pay directly for the sort of protection provided by the FSCS by way of a product levy.

The Financial Services and Markets Act provided for the FSA to establish a compensation scheme funded by the industry so we are constrained by both the legislation itself and the Government’s intent.

As you will be aware, prior to the setting up of the FSCS, we undertook public consultations and from the outset it was acknowledged that one of the clear objectives of the compensation scheme was that it would play an important part in promoting confidence in financial institutions as well as in the financial system as a whole.

The consultations covered issues such as the funding of the FSCS and attracted considerable attention. There was general support for the concept that compensation costs should fall to individual business sectors, to avoid cross-subsidy between firms carrying on different activities. Accordingly, the contribution groups are organised by FSA permissions.

At the time, views on other issues, such as product levies, which you obviously supported yourself, were divided but the “pay as you go” model that was finally established attracted a significant level of support. While the immediate beneficiary of a compensation scheme is the consumer, the financial industry also benefits through the impact on market confidence. So although some costs may ultimately be passed on to consumers, the premise of the scheme is that it is funded by the industry and not directly by the consumer.

I note your concerns for the future of the IFA sector and the potential impact upon smaller firms from compensation costs created by closed firms. However, it is in the nature of a “pay as you go” compensation scheme that authorised firms meet the costs associated with the scheme. A scheme based on a product levy as you suggest would see consumers as a whole paying directly the claims of those who qualify for redress.

I have set out above the background to, and our policy on, funding of the compensationscheme and we have no immediate plans to change this. Nevertheless, it is important that thisissue and the factors behind it are understood within the industry and we must always keep anopen mind for the future.

For example, you may have seen my colleague Paul Rich’s interview in Money Marketing , where he encouraged the industry to look atalternative ways of taking responsibility to deal with increased (cost of) claims, such that theFSCS can still act as a “safety net” of last resort in a cost-efficient manner.

As regards product provider support, you will be aware that this is a purely voluntary arrangement, as our current system of charging regulatory fees, including FSCS, does not provide for crosssubsidies. Paul Smee, of Aifa, has been handling negotiations with the ABI as to the future of any further support beyond that already announced for this year, and I have offered personally to talk to both parties if that would help. You might wish to speak to Paul Smee about how to support Aifa efforts in this area.

Thank you once again for taking the time to write to FSA on this matter and for your constructive suggestion.

Yours sincerely
David Kenmir
Sector leader, retail intermediariesFinancial Services Authority

November 12, 2004

Dear David

Many thanks for your response. I particularly appreciated your setting out of the background to the current system, as it reminds us all of the points to be addressed along with your recognition that we must always keep an open mind in respect of this important issue.

I would add that I am considerably encouraged by your response. Indeed, I believe it demonstrates that we have an opportunity to work towards a more equitable method of funding the Financial Services Compensation Scheme than the current discredited model whilst reinforcing, rather than damaging, consumer confidence.

I have pleasure in setting out below the key elements of a fair and robust system for funding the FSCS which involves neither a cross subsidy nor a weakening of consumer protection. Before doing so however, there is an important point of clarification required as to what is meant by the term “product levy” as it is often misinterpreted as a “policy levy” which it is not. I agree that a policy levy would be cumbersome and difficult to administer with the added disadvantage, to which you refer, of being constrained by the Financial Services & Markets Act.

A “product levy” has none of these inherent disadvantages, being simple to operate and considerably less costly to administer than the current system. It is also undeniably fairer and more robust whilst remaining consumer friendly and, I believe, fully within both the spirit and letter of the Financial Services & Markets Act.

Key elements of a product levy1) A product levy would apply to all products falling within the jurisdiction of the FS Ombudsman. This achieves two objectives. First, it would be illogical not to mirror the products on which the FSO can adjudicate. Second, it will spread the cost over the largest levy gathering base.2) The levy should be applied to all product providers who distribute one or more products via IFAs. Each individual product providers’ annual contribution to the levy would then be calculated by direct reference to their share of the IFA market. To avoid the impact of short term variations a five year rolling average would probably be appropriate for the market share calculation.3) Whether the levy is collected in advance or in arrears is not a critical factor. However, common sense would suggest something akin to the present method whereby the FSCS estimate the requirement for the coming year and the figures are adjusted in subsequent years in the light of initial experience.4) Whilst the market share of IFAs is used to calculate the product providers contribution to the product levy I believe that it should be left to the commercial judgements of the product providers themselves to determine how they meet the levy costs. They might, for example, choose to cost it into certain products or their whole range or reduce commission paid to IFAs or a combination of all of these. Regardless of the methodology an additional benefit of a product levy is that it would give product providers a direct interest in the quality of their products, the clarity of their literature and the quality of business they accepted from IFAs. Each of which would reinforce good practice within the sector and relate the costs of compensation directly to each provider’s success in exploiting the IFA distribution channel.

In short I submit that a product levy would bring no consumer detriment whatsoever whilst clearly being seen to be fair to all concerned. I commend it to you.

I look forward to hearing from you in due course. In the meantime I hope we can widen the debate by involving the market as a whole and in particular the ABI and Aifa.

Kind regards

Ken Davy

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