Outlook cloudy but stable

As many of you will know, FSCS operates a pay-as-you-go funding system.  In other words, we raise levies on the industry annually to meet only the compensation costs we expect to incur.

The big advantage to the industry of this is that FSCS does not take capital out of the industry ahead of need.  Many of our sister organisations overseas sit on substantial funds built up over time.  That is, effectively, dead capital.

The downside of pay-as-you-go funding is that it’s unpredictable.  Our levies vary from year-to-year to reflect failures among financial service firms.  Because we don’t have 20/20 vision, we may also sometimes need to raise supplementary levies in-year when an unexpected failure occurs.

This unpredictability places a big onus on communication.

Because we know unpredictable levies are hard for firms to manage, we try to give as much advance warning as we can.

So we talk to all the major trade bodies on a regular, quarterly basis to brief them on prospects and also to hear their take on industry trends that may affect FSCS.

And we also publish a regular bulletin for the industry – Outlook – to set out our latest forecasts of compensation costs, off-setting recoveries and our management costs.  We published the latest edition earlier this month.

One of the innovations we introduced into Outlook a few years ago was a set of traffic light funding indicators for each industry sector: red for a high risk of a supplementary levy; amber for medium risk; and green for low.

I’m very pleased, I think for the first time, that all the indicators were green in this edition of Outlook.  We assess that there’s currently a low risk that we’ll have to ask the industry for more money to meet compensation costs in 2015-16.

Our latest publication does, however, illustrate just how volatile FSCS’ workload can be and how hard it is to forecast.

For one thing, we simply don’t always have forewarning of failures - even big ones.

For example, no one foresaw – certainly not FSCS – the failure of Alpari and a number of other Fx brokers in January when the Swiss National Bank announced that it would no longer stand behind the informal Swiss Franc/Euro link.  The failure came of a clear blue

The Alpari failure has cost FSCS £25m in compensation this year.  We have protected 9,000 Alpari clients.  Fortunately for the industry we’ve also been able to recover £15m from Alpari’s estate.

Even the visibility of a failure or failures doesn’t guarantee that we shall be able to accurately predict compensation costs.  We have known about potential SIPP claims for some time – claims against regulated advisers who mis-advised investors to hold illiquid and risky assets in SIPPs – usually after removing their money from occupational schemes.

But getting the right answer involves a complicated equation involving many variables. How many advisory firms were involved in this business and will be unable to meet claims? How many claims will be made against failed firms? What proportion of claims will FSCS uphold? Remember; we look at each claim on its merits against our civil liability test. What will the average value of successful claims be?  Can we expect to achieve any offsetting recoveries over the same time scale?

The questions are big and answering them with certainty is difficult.

So the fact that we can publish green risk warnings this month is not just a sign that there have been few unexpected failures this year, but also tells a good story about our grasp of this algebra.

But, of course, the cycle will begin again next month when we publish our first indicative indication of compensation costs, recoveries and levies for 2016/17.

That’s the next step towards providing more clarity on our costs next year before we confirm the levy in April.

Best wishes for 2016.