Memo #
34017

UK FCA Discussion Paper on Financial Services Compensation Scheme: Member Call on Friday 4 February 2022 at 2pm GMT/3pm CET/9am ET

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[34017]

January 28, 2022

TO: Global Regulated Funds Committee
Global UK Financial Services Compensation Scheme Working Group
UK-EU Cross Border Task Force RE: UK FCA Discussion Paper on Financial Services Compensation Scheme: Member Call on Friday 4 February 2022 at 2pm GMT/3pm CET/9am ET

 

On 6 December 2021, the UK Financial Conduct Authority (FCA) published[1] a discussion paper[2] on the UK Financial Services Compensation Scheme (FSCS). The stated purpose of the DP is to open a discussion with stakeholders on ways in which aspects of the compensation framework which the FCA is responsible for could be improved. The FCA is accepting comments on the DP by 4 March 2022. ICI Global intends to respond to those questions in the DP that cover the "look through" provisions of the FSCS which concern non-UK domiciled investment funds.

ICI Global will hold a member meeting via Zoom on Friday 4 February 2022 at 2pm GMT/3pm CET/9am ET to discuss the DP and ICI Global's response. Zoom details for the meeting are below:

This memo contains a summary of the DP and ICI Global's prior engagement with the FCA on the look through provisions of the FSCS.

Discussion Paper

The FCA provides an overview of the FSCS and the wide context for its review, including the existing compensation framework and the financial position of the FSCS. The FCA sets out the following main objectives for the DP:

  • To explain the FSCS's role as the UK's statutory compensation scheme for customers of authorised financial services firms, within a wider regulatory system and in the context of work underway to tackle the root-cause of the high costs which are falling to the FSCS.
  • To start a discussion about the purpose of the compensation framework and about the principles that should underpin the design of the framework that the FCA is responsible for.
  • To explore opportunities for improving the aspects of the current compensation framework that the FCA is responsible for.
  • To generate views and ideas that could be developed into specific policy proposals for future consultation by the FCA.

The DP covers the following aspects of the FSCS:

  • The scheme's role as a 'fund of last resort' and the root causes of its current high compensation liabilities (chapter 2 of the DP);
  • The scope of the scheme's coverage, including the regulated activities which should be protected (chapter 3 of the DP) and the claimants who should be eligible to receive compensation (chapter 4 of the DP);
  • The level of compensation which should be paid by the scheme to individual claimants (chapter 5 of the DP); and
  • The funding of the scheme (chapter 6 of the DP); and
  • The proposed design principles of the FSCS and opportunities for further change (chapter 7 of the DP).

In the DP, the FCA raises various questions about who should be eligible to claim compensation from the FSCS. The FCA sets out its view that the scope of individuals who are entitled to claim compensation should be proportionate given the proposed principles for the compensation framework. The FCA raises the following questions:

  • whether high-net-worth and sophisticated individuals should be eligible to claim compensation;
  • whether there are other opportunities for refining the FSCS's eligible claimant criteria; and
  • whether the CIS 'look through' provisions remain appropriate.

Look Through Provisions

In the DP, the FCA notes that FSCS compensation for a protected type of claim is generally only available if the claimant has a valid civil claim against the defaulting authorised firm (e.g., a breach of contract or negligence). The FCA notes that in certain circumstances, investors in a collective investment scheme (CIS) may themselves not have a direct civil claim against the operator, fund manager, delegate fund manager or depositary. In circumstances where investors do not have a direct civil claim, the right to make a claim may belong to the CIS itself or another person e.g., its operator (which is not an eligible claimant for FSCS purposes).

The FCA recalls that in April 2018 it introduced a 'look‑through' for CISs to enable the FSCS to treat participants in the relevant CIS as having a claim, instead of the CIS, operator, trustee, manager or depositary who is the actual claimant. The FCA's stated purpose for the look-through rules is to bring consistency to the circumstances in which the FSCS can compensate CIS investors. The FCA's view was that confidence in the asset management sector could be threatened if the failure of an operator, delegate investment manager or depositary occurred, and the FSCS was unable to compensate some or all investors for reasons that may appear arbitrary.

The FCA asserts that investors are likely to expect protection by the FSCS for acts or omissions by UK-authorised firms that cause loss. The FCA notes that prior to the introduction of the look through, only some of the CIS activities of fund managers and depositaries were covered by compensation if the UK authorised firm did not have a direct contractual relationship with investors. In the FCA's view, it was not reasonable to expect investors to know when a claim for compensation against a UK authorised firm may or may not be covered.

The FCA highlights the views of some stakeholders that the risk of a fund manager or depositary failing and leaving significant liabilities is low and therefore FSCS protection is not needed for CIS investors. Furthermore, that non-UK investors are unlikely to be aware that they might be able to claim compensation from the FSCS and, even if they are aware, are more likely to seek compensation directly from other parties (e.g., the overseas fund or fund manager). Stakeholders suggest that the FSCS scheme that the UK delegate manager pays into is unlikely to ever be required to pay claims.

The FCA recalls that even though FSCS claims data appears to support the view that the risk of a CIS operator or depositary failing is low, its view has been that the potential impact on consumers if such a failure happened was significant enough to justify FSCS protection. The FCA notes that it has seen cases of asset managers investing outside their mandate. Such investments cause significant losses and therefore FSCS protection would appear to be appropriate and vital to protect consumers from harm.

In the DP, the FCA asks the following question (Q11): Does the CIS look‑through remain appropriate from a consumer protection perspective? If not, what alternatives should be considered to protect investors in CISs?

ICI Global Engagement

ICI Global has engaged with both the Financial Conduct Authority (FCA) and Her Majesty's Treasury (HMT) concerning the look through provisions of the FSCS. On 7 April 2021, we sent a letter to the FCA and HMT asking them to limit the scope of the look through provisions to just UK domiciled investment funds (see attached letter).[3] In the letter, we argued that the costs resulting from the application of the look through to funds domiciled outside the UK are not commensurate to investor protection benefits and reduce the UK's competitiveness as an investment management centre.

On 14 June 2021, the FCA responded to our letter and held a discussion with us (see attached letter). The FCA broadly acknowledged the concerns we raised and asked for evidence on the impact of the current rules from a fees perspective and suggestions we have for rule changes that would meet the FCA's statutory objectives. Furthermore, the FCA noted that the general review of its handbook that it was planning to undertake post Brexit coupled with the development of the Overseas Funds Regime (OFR) may open up the possible of FSCS rule amendments.

Next Steps

ICI Global intends to respond to the DP by the deadline of 4 March 2022. A member call will be held on Friday 4 February 2022 at 2pm GMT/3pm CET/9am ET to discuss the DP and ICI Global's response. The FCA has said that it will consider feedback on the DP and publish a Feedback Statement during 2022, which will outline any further steps it intends to take. The FCA also plans to engage with stakeholders directly during the first quarter of 2022, once it has had the opportunity to hear stakeholders' initial views.

Giles Swan
Director of Global Funds Policy
ICI Global
 

Endnotes

[1] FCA Press Release: FCA launches discussion on improving the financial services compensation framework, dated 6 December 2021, available at https://www.fca.org.uk/news/press-releases/improving-financial-services-compensation-framework-discussion-launch

[2] FCA Discussion Paper DP21/5: Compensation framework review, dated December 2021, available at https://www.fca.org.uk/publication/discussion/dp21-5.pdf

[3]  See ICI Memorandum 33442, RE: ICI Global Letter on UK Financial Services Compensation Scheme Look Through Provisions, dated 12 April 2021, available at https://www.ici.org/memo33442

    Attachments

    34017a.pdf
    34017b.pdf