When the FSCS levy breaks

A few weeks ago, at an industry drinks do, I was accosted by a slightly drunk and belligerent occasional acquaintance. Having received one or two emails from him before, I am aware he is not my greatest fan.

He was determined to prove that most of what we scribes write is rubbish, for which trees are cut down. His thesis was that journalists are responsible for a significant part of global warming.

I made my excuses and disappeared, although not before replying that – as far as I could recall – for every tree cut down to make paper, five new ones are planted.

I was left replaying that brief conversation after reading the comments by Investment Management Association chairman Douglas Ferrans at the IMA chairman’s dinner, in which he warned that failure to reform the Financial Services Compensation Scheme could end up damaging the UK’s competitiveness as a base for international fund management businesses.

Ferrans’ remarks pointed out the scale of failures were on a level not seen since the Barlow Clowes’ debacle in 1988, when the Government was forced to offer a £150m lifeboat to compensate victims.

If there is one subject where reporting has led to many trees being cut down, it is probably that of the FSCS and its interim levy in the wake of the collapse of Keydata and a number of other financial firms.

Still, Ferrans’ anger and that of IMA members is understandable. Fund managers have paid £233m out of the £326m interim FSCS levy raised mainly to cover the cost of compensating Keydata investors. Advisers have been forced to stump up the remaining £93m.

In the past three years, failures of investment firms have cost the financial services industry almost £500m in compensation, Ferrans told his audience.

“There is a need for these events to be the subject of an independent review and for lessons to be learned,” he said.

As ever, the majority of the industry is being forced to pay for the irresponsible actions of a minority. After all, if you were Brewin Dolphin and had to shell out £6.1m, £2.6m in the case of Charles Stanley, or £3.6m in the case of Rathbone Brothers, you would be rather livid too.

Despite these figures, of the striking things about this whole issue is the way such an enormous bill has largely been swallowed by the industry – even those sectors that believe they should never have paid it in the first place.

Part of the reason, I suspect, is that many believe the collapse of these companies in swift succession with such massive liabilities was a unique and never to be repeated event.

That is what I have been told by one person I spoke to a few months ago when discussing the inordinate delays in the FSCS review. If you accept this scenario, it simply means the FSCS received stress-testing to an incredible level, from which it emerged resilient, with its systems still in place.

More significantly, after a lot of grumbling, each constituency within the FSCS also did its duty and paid up, albeit with bad grace. Therefore, there is no rush to do anything too swiftly, as there won’t be another demand on the industry to fund a similar compensation call.

I’m not convinced by this argument. Systemic collapses of the type we have seen recently, while impossible to predict in their scale or timing, are a by-product of poor regulation and an inadequate compensation funding mechanism.

Failing to address these two key issues makes it probable that if and when it happens again, the industry will not swallow the bill with anything like the degree of composure that many key players have showed in the past two or three years.

I do not believe even Aifa would relish repeating its mantra to infuriated members that quiet diplomacy is the way forward. I would foresee a mass refusal to pay, not just by IFAs but some of the bigger players, including IMA members, and the collapse of the FSCS as a compensation fund of last resort.

Lest any IFA be cheering at the prospect of such an outcome, it should be understood that one corollary of an FSCS review, whenever it happens, will be a demand for much tougher regulation of the industry, primarily in the form of swifter and harsher intervention of the FSA if it believes a firm is stepping out of line.

Still, if it saves advisers from having to fork out tens of millions of pounds unnecessarily, what’s not to like?

Nic Cicutti can be contacted at nic@inspiredmoney.co.uk