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FSCS Levy - Lessons from 2011 (12/11), first published 20th February 2012, second edition with updates

28 February 2012

FSCS Levy - Lessons from 2011 (12/11)

 

Introduction

The Financial Services Compensation Service (FSCS) acts as a safety net for certain classes of consumer, providing compensation in the event an authorised firm is unable, or likely to be unable, to pay claims against it. This is normally when a firm is insolvent, or has gone out of business. However, only those firms that derive income from a class of customer referred to as eligible claimants, as defined in Annex I, are subject to the levy. For such firms, only the proportion of their income that is derived from eligible claimants is subject to the levy; income derived from customers who are not eligible to claim from FSCS need not be included in their assessment of what is referred to as annual eligible income, ie that assessable to the levy, a defined below.

 

What to do if you are exempt from the FSCS levy

The first step in this process is therefore to ascertain, by reference to the list of persons not eligible to claim as outlined in Annex I, if your firm is subject to the FSCES levy. If you believe your firm does not deal with eligible claimants, and should therefore be exempt from the FSCS levy, you should complete the appropriate exemption notice. This notice should be returned to FSA if your Fee Tariff Data Request does not already indicate your firm is FSCS exempt.

 

Who is required to submit their eligible income to FSA?

Only firms which operate under the following sub-classes:

  • SB02- General insurance intermediation;
  • SD01- Fund management;
  • SD02- Investment intermediation; and
  • SE02- Home finance intermediation,

are required to submit their eligible income to FSA in order for their FSCS levy fee to be computed.

 

Broad principles and the events of 2011

The FSCS is funded by the financial services industry, with firms who are subject to the levy contributing to the Scheme on a proportionate basis.

In order to meet its compensation costs, the FSCS raises levies from the industry on a “pay as you go” basis. Generally, it raises an annual levy, based on an estimate of the amount it will need in order to compensate eligible claimants during the following 12 months. In order to allocate this levy across the industry, FSA requests fee tariff date from authorised firms each year on behalf of FSCS. This data is required to be submitted to FSA by the end of February each year. Authorised firms failing to do so may be subject to an administrative charge of £250.

The annual levy does not, however, take into account any exceptional circumstances. Consequently, when firms default, giving rise to high claims amounts, or levels which were not forecast during the annual levy raising exercise, FSCS may need to raise significant levies at relatively short notice.

Such was the case in January 2011 when FSCS raised an interim levy of £326m on the Investment Intermediation sub-class, due to the default of Keydata/Lifemark. In this case, FSCS concluded that the marketing materials produced by Keydata to promote the Lifemark products did not comply with the Financial Services Authority’s rules. The FSCS determined that, for the purposes of compensation, these investments had no value in the hands of the investors.

 

FSA Fees Rules

The claims for which the 2011 interim levy was raised were attributable to the activities covered by the Investment Intermediation sub-class (SD02). The allocation to SD02 was confirmed by the court in a judicial review brought against the FSCS by a number of intermediary firms. Each sub-class can be levied up to £100 million annually in compensation costs. The FSCS had previously raised £14 million in compensation costs on the Investment Intermediation sub-class, so a further £86 million was raised by way of the interim levy in compensation costs, plus a further £7 million in specific management costs which relate to the operations of the FSCS.

Under the FSA’s FEES rules, once a sub-class reaches its annual compensation threshold, the connected sub-class in the broad class is required to contribute to any further compensation costs, again up to an annual limit. This happened with last year's interim levy. As the Investment Intermediation sub-class reached its annual compensation threshold, the Investment Fund Management sub-class (SD01) was levied to contribute the remaining £233 million in compensation costs for the year. The maximum annual compensation threshold for the Investment Fund Management subclass is £270 million.

 

Annual Eligible Income

The tariff measure for the Investment Fund Management and Investment Intermediation sub-classes is annual eligible income, in other words, net income received from eligible claimants. Interestingly, there is no definition of eligible claimants. Instead, COMP 4.2.2R identifies persons who are not eligible to claim from FSCS. Persons not listed in COMP 4.2.2R are classed as eligible claimants. COMP 4.2.2R is reproduced in Annex 1 for ease of reference.

Annual eligible income is defined in FEES in relation to a firm and a subclass as:

the annual income, as described in FEES 6 Annex 3 R, for the firm's last financial year ended in the year to 31st December preceding the date for submission of the information under FEES 6.5.13 R attributable to that sub-class.

A firm must calculate annual eligible income from such annual income in one of the following ways:

(a)    only include such annual income if it is attributable to business conducted with or for the benefit of eligible claimants and is otherwise attributable to compensatable business; or

(b)    include all such annual income.

 

Examples

SD01 - Fund management

Annual Eligible Income: This refers to the calendar year to 31st December 2011.

Annual eligible income is the income from funds under management from eligible claimants.

 

SD02 - Investment intermediation

Annual Eligible Income. This refers to the calendar year to 31st December 2011.

Again, income from eligible claimants only is required.

The Annual eligible income from eligible claimants for investment intermediation, i.e. income retained by the firm in respect of activities from dealing as principal, dealing as agent, arranging (bringing about) deals in investments, making arrangements with a view to transactions in investments, advising on investments, providing basic advice on a stakeholder products, safeguarding and administering investments, arranging and safeguarding and administering investments.

The annual eligible income is calculated the same way for both SD01 and SD02 and is as follows:

  • Net amount retained means all the commission, fees etc. in respect of activities falling within the subclass, in the this case SD01 and SD02
  • If the case is that the firm has not rebated to customers or passed on to other firms (for example where there is a commission chain).
  • Items such as general business expenses (for example employee’s salaries and overheads) must no be deducted.
  • The calculation is adjusted in accordance with the definition of annual eligible income (see above).
  • Box management profits are excluded from the calculation of annual income.

  

How do firms calculate their tariff base?

The FSA have received a number of queries as to what firms should consider if they decide to review their fee tariff data. Firms can locate the definitions underlying previous years’ tariff measures in the FSA Handbook, changing the year as appropriate.

When considering the definition of annual eligible income, firms should refer to FEES 6 Annex 3R. Firms should also consider the guidance FSA have included in FEES 6 Annex 4R. This includes guidance as to what should or should not be considered as income for each of the sub-classes.

 

As noted, firms can choose to include only business relating to eligible claimants. Clearly, adopting this approach will reduce the levy payable by individual firms, but not the sub-class as a whole. The conditions for eligibility for FSCS compensation are in the Compensation Sourcebook at COMP 4.2.1R and COMP 4.2.2R. A firm reporting income relating to eligible claimants only will need to be able to identify eligible and ineligible claimants, and must take care not to omit any eligible claimants. If authorised firms do not deal with eligible claimants, in other words, all of their clients fall within the definitions identified in COMP 4.2.2R, they should ensure they are appropriately registered with FSA/FSCS as FSCS exempt. This will be highlighted in a box on the first page of the Request For Fee Tariff Data letter recently received from FSA.

 

Resubmitting Data

If an authorised firm believes it has made an error in its submission, it may apply to resubmit its tariff data for a period of up to two years. FSCS may agree to remit or refund a levy where in, the exceptional circumstances of a specific case, FSCS considers that payment of the levy would be inequitable. A poor estimate by the levy payer, when providing the tariff data, is unlikely, of itself, to amount to an exceptional circumstance. By contrast, a mistake of fact or law may give rise to such a claim.

If firms decide to resubmit their fee tariff data, they should contact the FSA, who will receive the resubmission on behalf of the FSCS. The resubmission must be in a letter from the firm’s chief executive officer (or equivalent) and provide:

  • an explanation why the firm wishes to resubmit its tariff data;
  • an explanation how any error in the previous data occurred/why the data was incorrect;
  • what the revised data now amounts to; and
  • an assurance that systems and controls are in place to ensure data will be reported correctly and consistently in future.

Firms should include any other information that they consider may be relevant to the request at the same time.

Working with the FSA, the FSCS will consider and make a decision on each case. If a request to resubmit data is approved, the firm’s share of the levy will be recalculated and a credit note, or additional invoice, issued. Where the firm has a credit balance, a refund may be made, or the amount set against future levies.

 

Conclusion

As the quantum of the annual levy and, more importantly, as the events of 2011 have shown, the quantum of any interim levy, is based on the fee tariff date submitted to FSA, clearly great care must be taken to ensure this information is accurate. Remember, a poor estimate of annual eligible income, leading to an unnecessarily high levy payment, will not be regarded by FSCS as an exceptional circumstance, so no refund will be forthcoming.

If authorised firms do not deal with eligible claimants, they should ensure they are appropriately registered with FSA/FSCS as FSCS exempt by reference to their Request For Fee Tariff Data letter received from FSA.

 

Annex I - Eligible Claimants

COMP 4.2.2R - Persons not eligible to claim unless COMP 4.3 applies:
(Source: FSA Handbook)

(1)

Firms (other than a sole trader firm; a credit union; a trustee of a stakeholder pension scheme (which is not an occupational pension scheme) or personal pension scheme; a firm carrying on the regulated activity of operating, or winding up, a stakeholder pension scheme (which is not an occupational pension scheme) or personal pension scheme; or a small business; in each case, whose claim arises out of a regulated activity for which they do not have a permission)

(2)

Overseas financial services institutions

(3)

Collective investment schemes, and anyone who is the operator or trustee of such a scheme

(4)

Pension and retirement funds, and anyone who is a trustee of such a fund. However, this exclusion does not apply to:

 

(a)

a trustee of a personal pension scheme or a stakeholder pension scheme (which is not an occupational pension scheme); or

 

(b)

a trustee of a small self-administered scheme or an occupational pension scheme of an employer which is not a large company, large partnership or large mutual association.

(5)

Supranational institutions, governments, and central administrative authorities

(6)

Provincial, regional, local and municipal authorities

(7)

Directors and managers of the relevant person in default. However, this exclusion does not apply if:

 

(a)

both of the following apply:

 

 

(i)

the relevant person in default is a mutual association which is not a large mutual association; and

 

 

(ii)

the directors and managers do not receive a salary or other remuneration for services performed by them for the relevant person in default, or

 

(b)

the relevant person in default is a credit union.

(8)

Close relatives of persons excluded by (7) above

(9)

Bodies corporate in the same group as the relevant person in default unless that body corporate is:

 

(a)

a trustee of:

 

 

(i)

a stakeholder pension scheme (which is not an occupational pension scheme) or a personal pension scheme (but in each case if the trustee is a firm it will only be an eligible claimant if its claim arises out of a regulated activity for which it does not have a permission);

 

 

(ii)

(if the claim is with respect to a long-term insurance contract) a small self-administered scheme or an occupational pension scheme; or

 

 

(iii)

(if the claim is not with respect to a long-term insurance contract) a small self-administered scheme or an occupational pension scheme of an employer which is not a large company, large partnership or large mutual association; or

 

(b)

carrying on the regulated activity of operating or winding up a stakeholder pension scheme (which is not an occupational pension scheme) or personal pension scheme.

(10)

Persons holding 5% or more of the capital of the relevant person in default, or of any body corporate in the same group

(11)

The auditors of the relevant person in default, or of any body corporate in the same group as the relevant person in default, or any  actuary appointed under SUP 4 (Actuaries) by a friendly society or insurance undertaking in default

(12)

Persons who, in the opinion of the FSCS, are responsible for, or have contributed to, the relevant person's default

(13)

Large companies or large mutual associations (See note below)

(14)

Large partnerships (See note below)

(15)

Persons whose claim arises from transactions in connection with which they have been convicted of an offence of money laundering.

(16)

Persons whose claim arises under the Third Parties (Rights against Insurers) Act 1930

(17)

Where the claim is in relation to a protected contract of insurance or protected non-investment insurance mediation, body corporate, partnerships, mutual associations and unincorporated associations which are not small businesses.

 

Note

A large company is defined as a body corporate which does not qualify as a small company under section 247 of the Companies Act 1985, or section 382 of the Companies Act 2006, as applicable. In this context, a small business is defined as meeting two of the following conditions:

  • Turnover not more than £6.5 million
  • Balance sheet total not more than £3.26 million
  • 50 or less employees.

A large mutual association is a mutual association or unincorporated association with net assets of more than £1.4 million, or its equivalent in any other currency, at the relevant time.

A large partnership is a partnership or unincorporated partnership with net assets of more than £1.4 million, or its equivalent in any other currency, at the relevant time.

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© CPA Audit LLP. 28 February 2012.