David Hall Chairman International Seminar on Development and Improvement of China Securities Investor Protection System Financial Services Compensation Scheme

Overview The UK regulatory structure prior to the Financial Services and Market Act 2000 (FSMA); The current regulatory structure and where FSCS fits in; FSCS’s experience of consumer awareness and understanding; and FSCS’s role, funding structure, and current challenges.

Pre FSMA At ‘N2’ (1 st December 2001) FSCS replaced eight previous UK compensation schemes. Basis of the previous structure was self- regulation. New structure based on independent impartial regulation by UK authorities.

New regime - Post ‘N2’ Single UK financial services regulator – FSA Single UK financial services ombudsman – FOS Single UK financial services compensation scheme – FSCS.

FSA This is the organisation responsible for regulating financial services firms in the UK. It is an independent organisation given statutory powers by FSMA.

Four Statutory Objectives Market confidence: maintaining confidence in the financial system; Public awareness: promoting public understanding of the financial system; Consumer protection: securing the appropriate degree of protection for consumers; and The reduction of financial crime: reducing the extent to which it is possible for a business to be used for a purpose connected with financial crime.

Strategic aims The FSA summarises its Statutory Objectives and Principles of Good Regulation in three Strategic Aims which are: to promote efficient, orderly and fair markets; to help retail consumers achieve a fair deal; and to improve its business capability and effectiveness

FOS The single financial services ombudsman deals with complaints from consumers against firms that provide financial services and are regulated by the FSA.

FSCS The UK’s statutory fund of last resort for customers of financial services firms that are authorised by the FSA. Pays compensation to consumers if an authorised firm is unable, or likely to be unable, to pay claims against it. An independent body Provides a free service to consumers.

Tripartite authorities HM Treasury, the Bank of England and the Financial Services Authority (FSA) are the three organisations that constitute the UK’s Tripartite Standing Committee that considers matters of financial stability.

More about FSCS Before we can consider paying compensation, we must carry out an investigation into the solvency position of a firm. Our Rules are made by the FSA.

Types of investment claims The types of investment claims we cover include: advice about and the arranging of investments, negligent investment management, fraud, or the non-return of investments or money by financial advisers or fund managers.

What we cover In relation to investment business - advice about and arranging of investments, negligent investment management, fraud, non-return of investments or money by financial advisers or fund managers – up to £48,000 compensation In addition: Deposits held in a bank, building society or credit union Insurance policies underwritten by general and life insurance companies Advice about and arranging of general insurance products by general insurance brokers Mortgage advice and arranging by mortgage brokers

Consumer understanding Two of the FSA’s Statutory Objectives: consumer protection – securing the appropriate degree of protection for consumers; and public awareness – promoting public understanding of the financial system, Summarised in one of its three Strategic Aims: to help retail consumers achieve a fair deal.

Raising awareness of FSCS Press releases Website Industry and consumer events FSCS literature Authorised firms required to disclose in their literature that they are covered by FSCS

Examples of our work: Firm A Managed split capital investment trusts. Became insolvent as a result of civil claims against it relating to marketing material. FSCS investigated the firm, working closely with insolvency practitioners.

Nature of claims against Firm A Claims against Firm A mainly related to investor reliance on misleading materials. Most claims were in respect of three specific funds. The key issue is the point in time at which risk was mis-described.

Firm A’s Funds Comments in the media versus Firm A’s description of their funds

Comments in the media v Firm A’s description of their funds “A systemic collapse could result from the high degree of investment by these trusts in other geared funds. A sale of these assets by trusts breaching their bank covenants could cause a collapse in market prices.” Cazenove Report, 25 July 2001 Versus “Lip-smacking, thirst-quenching, cool-fizzing, low-risk, tax-efficient, top- selling… ten years of Zeros.” Advert in NewsExTRA, June 2001

Comments in the media v Firm A’s description of their funds “Many of the new ‘barbell’ trusts have been turning to banks to borrow. The attraction is much cheaper costs than borrowing through zero shares… Unlike zero shareholders, banks have the power to force trusts to repay debt by selling assets. This can mean trusts are forced to offload holding at inopportune moments.” FT, March 2001 Versus “For those who would normally hide behind the sofa rather than considering something as racy as a geared investment, zeros are the alternative – they currently display more safety features than a Volvo, with the sector boasting asset cover of around 140%... Hence, zeros are well placed to handle the ‘bearest’ of markets.” Firm A’s Guide to Splits, August 2001

Comments in the media v Firm A’s description of their funds “Banking covenants protect the banks which lend money to trusts. In the case of ETIT, its banking covenants state that assets must total at least 165% of bank’s borrowings. But recent falls in technology stocks and high yield corporate bonds brought the trust dangerously close to the covenants limit…” FT, December 2000 Versus “By continuously monitoring factors affecting the future level of interest rates, and the prospects for the UK markets, shares are selected in the portfolio to collectively provide sufficient asset backing and prospective returns to maintain the Fund’s objective of steady capital growth with a minimum of risk.” Advert in NewsExTRA, June 2001

Examples of our work: Firm B Specialised in promoting small capital stocks to UK clients and arranging arranged contracts for difference investments. FSCS started investigating Firm B to determine whether it was able to meet claims. Most claims fall into two main categories: a) the mis-selling of high-risk shares to low risk customers; and b) claims for the non-return of cash and shares held in trust by Firm B.

Key investment statistics 269 firms declared in default by FSCS during 2007/08: a) 251 investment firms b) 9 credit unions c) 8 were insurance brokers d) 1mortgage broker e) 1 insurer As at 31 March 2008, the total number of firms declared in default by FSCS since 1 December 2001 is 1,884.

Over £1 billion in compensation And just to further illustrate the extent of our work to date, FSCS has now paid out more than £1 billion in compensation since it was set up in 2001.

Limitations There are limits to the protection FSCS can provide: We can pay compensation only when an authorised firm is unable, or likely to be unable, to pay claims made against it. We can pay compensation only if a claim is eligible under our rules. We can pay compensation only for financial loss and there are limits to the amounts of compensation we can pay. FSCS was set up mainly to assist private individuals, although smaller businesses are also covered. Larger businesses are generally excluded.

Funding: Overview The 1st April 2008 marked the start of FSCS’s new funding regime. FSCS is funded by compulsory levies on firms authorised by the FSA. FSCS's costs are made up of management expenses and compensation payments. Management expenses are FSCS' overheads. Compensation payments are payments made to or on behalf of claimants.

Funding: Why things changed The FSA wanted to explore ways of making improvements in the following areas: To expand the overall financial capacity of FSCS; To introduce a ‘widening circle’ model of funding, under which a first tranche of compensation costs emerging from a particular group of firms is borne by that group alone, while costs above a specified threshold would be shared out more widely; To change some of the criteria by reference to which contributions were calculated, so that each firm’s contributions were proportionate to the degree of its involvement in the sector; and To bring the new funding arrangements into effect from 1 April 2008

Funding: The new regime The new funding regime introduced five new ‘Classes’ (and related ‘Sub-classes’) which replaced 12 previous ‘contribution groups’ (that existed under the previous arrangements).

Funding: The new regime GENERAL RETAIL POOL – AGGREGATE CAPACITY £4.03 billion PROVISION £690m INT £100m FUND MANAGEMENT £270m INT £100m LIFE & PENSIONS CLASS £790m INVESTMENT CLASS £370m PROVISION £775m INT £195m GENERAL INSURANCE CLASS £970m DEPOSIT CLASS £1,840m INT £60m PROVISION £70m HOME FINANCE CLASS £130m INT = INTERMEDIATION NB: DIAGRAM NOT TO SCALE NB: HOME FINANCE PROVISION SUB-CLASS WILL NOT CONTRIBUTE TO THE GENERAL RETAIL POOL DEPOSIT £1,840m

Challenges Preparedness - Always being 100% prepared for a serious event (or a series of serious events). Forecasting - We combine the best knowledge, insight and expertise we have from trade bodies, the FOS and the FSA into our forecasting. Justifying our costs and liaison with other bodies - FSCS aims to achieve and be recognised for sustained professionalism and fairness in providing financial compensation, in a reasonable time and at reasonable cost. FSCS also takes its relationship with its stakeholders very seriously. Future of deposit reform - We believe that the proposed changes to UK arrangements to deal with banks in difficulty, laid out in a consultation document will do much to strengthen consumer protection and market confidence

More on deposit reform HM Treasury, the FSA, the Bank of England, and ourselves, are developing a package of reforms to address five key objectives: To strengthen the stability of the financial system, in the UK and internationally To reduce the likelihood of banks failing To reduce the impact of a bank failure To provide effective compensation arrangements To strengthen the Bank of England and improve co- ordination in the UK Authorities

Key points to leave you with… FSCS is part of the UK’s regulatory structure, and our role is to protect consumers and instil confidence in the financial services industry. FSCS is funded by the financial services industry. We face a number of challenges in the current climate, and one important challenge for us in the coming months is the future of depositor protection