The FSA has proposed changes to the funding of the Financial Services Compensation Scheme (FSCS) which could reduce the likelihood of interim levies and offer firms more certainty in the level of fees they pay.

The current funding model has been in place since April 2008 but during that time there have been significant payouts, resulting in sizable levies for some funding classes. However, the FSA says that last four years “have proven that in terms of consumer confidence it is absolutely vital to have a compensation scheme in place”.

The main features of the CP12/16: Funding Model Review consultation are are:

• Two separate approaches for funding FSCS’ costs, one for activities the FSA expects will be subject to the Prudential Regulation Authority’s (PRA) funding rules for the FSCS, such as deposit takers and insurance providers, and one for the other activities the FSA expects will be subject to the Financial Conduct Authority’s (FCA) funding rules. There would be no cross-subsidy between the two;
• No changes to the current funding classes;
• A retail pool made up of all classes the FSA expects to be subject to the FCA’s funding rules which would be triggered if one or more FCA classes reached their annual threshold (i.e. the limit that funding class would be expected to contribute in any one year);
• Revised annual thresholds based on assessments of affordability;
• The FSCS to consider potential compensation costs expected in the 36 months following the levy instead of 12 months as is currently the case (except for the deposit class). The regulator claims this should smooth the impact of levies and may make levy requirements more predictable than now.

“A viable compensation scheme is essential to financial services – investors and savers need to have confidence,” said Sheila Nicoll, FSA director of conduct policy. “The industry can agree on that, but as soon as it comes to discussions about funding, all such agreement immediately breaks down.

“Compensation funding inevitably means that different sectors have competing interests. Our role has been to walk the middle ground and produce a workable solution that we believe the entire industry can afford and live with.

“We would urge all stakeholders engage with us in this funding review. Any changes that we make have to produce a system that is as fair as possible, but ultimately plays its part in underpinning confidence in the financial services sector.”

Chris Hannant, policy director at AIFA, said: “There has been a general acceptance that something has gone very wrong with FSCS funding and the onerous burden it has become for the sector. The FSA has made clear statements that the Compensation Scheme should be fair, affordable, durable, not volatile and based on affinity of activity. The current review needed to correct this imbalance.

“It is unclear how these limited reforms will correct these issues and we are disappointed that the FSA has not gone further in its review of the funding arrangements. Options such as pre funding have seemingly been rejected without being subject to public consultation.

“We’ll be seeking to reverse the proposed increase in the threshold for the investment intermediation class which will be a further blow for advisers who are struggling under the cost of regulation.

“The other fundamental issue with the Compensation Scheme has been the allocation of firms within each class. Recent examples have shown that some firms have been clearly placed in an inappropriate class. This review does not seem to address this fundamental issue.

“The results of this review have been eagerly awaited by the industry. But the result is somewhat disappointing.”

The consultation will run until 25 October 2012.