October

Quoting Marx went out of fashion some time ago, but I am reminded of his remark that history repeats itself first as tragedy and then as farce1 by the failures of the investment intermediary, Catalyst, and Luxembourg-based business, ARM.

We have, after all, been here before.

We are four years on from the failure of Keydata which cost investment intermediaries and fund managers around £330m in compensation. And the failures continue.   

For those with short memories, Keydata distributed in the UK structured bonds packaged by two Luxembourg-based businesses. The bonds were backed by North American life policies and failed to perform as promised.

Over 20,000 investors, many of whom were elderly, lost vital assets and income in the Keydata failure until FSCS stepped in to help.  

In its guise as creditor, FSCS is still pursuing legal action to maximise recoveries in respect of the Keydata products and from IFAs who mis-advised  investors to buy its bonds. So far we’ve recovered more than £23.5m from the business, and from which we shall make a refund to the industry.

And now we have the failure of Catalyst – a UK-based distributor of bonds packaged by the Luxembourg-based firm, ARM. After working closely with FSCS and FOS, FCA declared Catalyst to be in default on 7 October and announced action against two of its directors simultaneously.

ARM itself has now been placed into liquidation in the UK.

One small consolation is that the compensation costs of the Catalyst/ARM failure are likely to be below those of Keydata. But they are still likely to run into the tens of millions of pounds.

We shall publish more information about the costs and when they are likely to arise in our next edition of Outlook in November. There is still a good deal of uncertainty about both things. So we cannot yet provide robust guidance on the total bill. 

But I do expect one consequence to be that FSCS will have to raise a supplementary levy on investment intermediaries before the end of levy year in June 2014. We know this will be difficult for firms and is unwelcome news, but we have a duty to compensate investors with a valid claim. 

So much for the facts: what implications might we draw from them?

Two things strike me.

One is just how expensive the costs of failures in the investment intermediation sector often are relative to the capital of the firms concerned. Catalyst had assets in the hundreds of thousands to set against investors’ losses in the tens of millions.

On the face of it, firms take on risks which they are not financed to absorb. When the risks eventuate, the costs are then passed back to the sector – or in the Keydata case beyond – via FSCS’s funding mechanism.

Professional indemnity insurance might be the answer, but all too often FSCS’s experience is that it too is a broken reed. The excess on policies is often set higher than firms’ capital. Some policies explicitly exclude claims by FSCS. 

These are important issues to which there is no simple solution. But they merit debate.

Meanwhile FSCS is here to compensate investors when things go wrong: that is what we will do in response to the failure of Catalyst.  

We shall also vigorously pursue recoveries from the ARM estate where it is cost-effective to do so. 

 


 

1 Marx made the remark to describe the coup d’état which brought Napoleon Bonaparte’s nephew, Louis Napoleon (Napoleon III), back to the re-invented French Imperial throne in 1851.

 

 


The FCA

The Financial Conduct Authority website includes a searchable database of all firms authorised and regulated by the FCA and the Prudential Regulation Authority (PRA).

The FOS

The Financial Ombudsman Service is the official independent expert in settling complaints between consumers and financial businesses

Jargon Buster

  • FCA

    The Financial Conduct Authority is the UK's regulator for the financial services industry. 

  • FOS

    Financial Ombudsman Service, for complaints or claims against firms that are still trading.
  • In default

    A firm unable, or likely to be unable to pay claims against it. This will generally be because it has stopped trading and has insufficient assets to meet claims, or is in insolvency.
  • Investment

    a financial product in which money can be invested to earn interest or profit (although the value of investments can go down as well as up).