The objective of compensation
The Government is concerned that investors are not
generally in a position to make an informed assessment of the risk
that the firm, to which they are about to entrust funds, may fail.
This is not a new position, but the proposal that there be a single
scheme to cover such losses is new and will require some
reorganisation. The intention is to strike a balance between
"caveat emptor" and consumer protection as overall objectives for
the FSA, and the new compensation arrangements are intended to
The argument for change
As with consumer complaints, the Government is
concerned that there is a "patchwork quilt" of compensation schemes
which is confusing to investors and may not afford them the quality
of protection which they deserve. Although the existing schemes
have operated successfully, the growing diversification of business
has made it difficult to "pigeon-hole" any one organisation into a
particular compensation sector. The FSA therefore intends to
oversee the introduction of a single compensation scheme. It is
proposed that the scheme covers all FSA authorised firms, even when
a firm acts outside any specific permission given by the FSA.
A general objective of compensation arrangements is
for them to be focused on "consumers who are least able to sustain
financial loss". It is therefore intended that "professional"
consumers (such as banks, investment firms etc.) would be excluded
from cover. It is intended that cover is available for small
businesses, who can be just as vulnerable as individual consumers.
It is proposed to exclude, as permitted by the Deposit Guarantee
Directive and the Investor Compensation Directive, firms which do
not meet two out of the following three criteria:
- A balance sheet total below ECU 2.5 million
- A turnover below ECU 5 billion
- Fewer than 50 employees.
Limits on compensation payments
The level of compensation payment available is one
of the major differences between the schemes which currently exist.
The Government proposes a full review of the different limits which
currently exist to see whether harmonisation is possible and
whether changes in the current levels are appropriate (for example,
£18,000 for deposit protection and £48,000 for the investment
It is proposed that there be no general limit on
the amount which the fund could pay out (although individual limits
on claims would continue). The FSA proposes to fund compensation
schemes on a "pay as you go" basis, although it can see arguments
in favour of building up a "buffer" of funds. Indeed, a standing
fund may be created behind a "pay as you go" overall system. It is
intended that all firms will pay towards the general running costs
of the scheme, with the actual compensation cost to be paid for
within individual sectors.