As a former Treasury civil servant who at one time had responsibility for advising the Chancellor on tax policy, I have a preference for taxes to be low, broad-based and, where feasible, levied on what economists tend to call negatives externalities (things we’d rather have less of to you and me).
FSCS’ levies on the industry are, in effect, taxes. (In fact that is exactly how they are classified by the Office for National Statistics.) So it’s perhaps natural for me to assess the proposals for the future funding of FSCS contained in the FCA consultation paper published on 31 October against that standard.
In my view, the paper represents by some way the best review of FSCS funding in my time as Chief Executive. I think I’m now on my third, by the way.
The paper’s starting point is the right one. FSCS protection for consumers is important to confidence in the industry, but it also a measure of the harm done to consumers by bad advice or disorderly failure.
So we should be looking at ways of reducing that harm – and hence the costs imposed by FSCS compensation – as well as at the fairest way of sharing costs across the industry.
One way of reducing costs would be to ensure that firms are able to absorb more of the costs of failure themselves through more comprehensive insurance cover or higher capital.
FCA colleagues have taken a hard look at this, but conclude that the current arrangements are, in fact, catching much of the harm before it reaches FSCS. 84% of consumer claims against adviser firms are met through a combination of insurance and the firm’s own resources. Of course, PII requirements could be made more stringent, but this itself would come at a cost.
More promising is targeting the levies themselves on the harm we want to reduce - making the polluter pay, in other words, by taxing the pollution itself.
The FCA paper, rightly in my view, opens the way for further work on risk-based levies which would do exactly that.
The potential route here is the gathering of information by FCA from advisory firms about higher risk investment products. It is exactly these products which, when recommended to mainstream investors as suitable investments for their retirement, have generated a significant proportion of FSCS’ compensation payments in recent years – payments running into the £ hundreds of millions.
I have looked at many of these claims and the often sad stories behind them. I do think these high risk and illiquid investments are rarely appropriate for the people to whom they have been recommended. If a fair means can be devised, it makes every sense to raise our levies on firms which trade in these products and run the resulting risk.
So I hope the approach to funding FSCS will itself in time act as an incentive to prudence and so reduce harm. But, realistically, there will always be a compensation bill of some size to distribute.
And here the FCA review conforms to classical tax theory by recommending a broadening of the base to reduce the volatility of FSCS’ levies falling on investment and pensions advisers.
FSCS does not have a view on precisely how this broadening of the base should be achieved, but we certainly do think that broader, deeper pools will better support the costs of compensation than narrow and shallow ones.
Finally, the other side of the coin of our levies is, of course, the scope of the protection FSCS provides to consumers. It is important to the credibility of FSCS that our protection is intelligible and keeps pace with changes in the way people manage their personal finances.
Just such a change is the liberalisation of retirement savings which means that many more consumers are now making choices about how to invest their savings to generate a retirement income. Those consumers need, in making those choices, to be able to understand how FSCS protection works and to have reasonable safeguards for savings which they will not be able to replace if lost.
With this in mind, we therefore welcome FCA’s proposals that our protection for investment products and for advice should be brought into line with our protection for deposits at £85,000 (and indeed it could be higher for some products).
All of which said, FSCS’ view is not now the most important. The most important views are of those of the firms which pay our levy. I hope firms will respond to FCA’s consultation document.