The FCA must focus on chasing the bad apples out

The costs of the financial watchdog’s compensation scheme have more than doubled in the last decade so this is clearly no time to be looking into reducing its scope, writes James Moore

The FCA has launched a review of its scheme for people ripped off by firms which go insolvent (Rex)

The shiny suited thieves operating on the tatty fringes of the financial services industry have enjoyed a boom in recent years, seen most prevalently in the rising cost of compensating consumers when firms go bust after their misdeeds become clear.

The 2021-22 outlay of the financial services compensation scheme, which looks after these people, is projected to come to a record £717m. That number will be higher still in 2022-23.

It’s an ugly statistic, one which has rather flown under the radar. It looks even worse when you consider that the figure was just £277m a decade ago

Amid the explosion in costs, the Financial Conduct Authority (FCA) has launched what it calls a “discussion” on how to improve the system, which imposes a levy on the (more or less) reputable parts of the financial services industry to compensate consumers hurt by the disreputable.

The first question that it might care to ask is: why did we drop the ball so badly to let it get like this in the first place?

A substantial chunk of the booming costs relate to misconduct by smaller firms, financial advisers and the operators of self invested personal pension schemes (SIPPs).

The “pension freedom” ushered in by former chancellor George Osborne, while a good idea in principle, inevitably provided a rich seam of opportunity for crooks.

Older people suddenly finding themselves with large sums of unrestricted pension savings are catnip to the latter, some of whom have respectable looking names and “regulated by the Financial Conduct Authority” emblazoned upon their marketing material.

Pension transfers – moving people out of schemes offering guaranteed incomes on retirement – have proved to be a particularly knotty problem.

Those around during the pension miss-selling review in the 1990s could be forgiven for scratching their heads over this. Transferring people from guaranteed to non-guaranteed plans was supposed to have been made subject to much tighter rules. It seems that they weren’t tight enough.

The way the costs of the compensation scheme have ballooned clearly shows that there has not only been a failure of regulation but also, arguably, a political failure too. It is clear that “pension freedom” wasn’t accompanied by the necessary safeguards when it was ushered in.

It is against this backdrop that the FCA is seeking views on fundamental questions about the “purpose, scope and funding of the FCA’s compensation framework to ensure it continues to meet the needs of consumers and firms”.

Now, there is clearly a room for a discussion about who pays and how much.

There is also clearly a potential issue with the “moral hazard” created when firms know they can be bailed out for their bad behaviour if they go insolvent.

Some parts of the industry like to claim another such “hazard” is created through incentivising consumers to take more risk than they can afford on the assumption that, if the authorised firm they deal with fails, they will be compensated for losses.

There isn’t much evidence for this. The FCA says it hasn’t found any. As it points out, consumers taking risks doesn’t create compensation liabilities. Only misconduct by firms which then go bust does that.

So why does the FCA raise the issue at all?

This is far from the only part of its discussion that might very well cause alarm among consumer protection groups.

It also raises questions about whether to reduce the scope of the scheme and whether to leave out some groups of consumer and/or some types of business out of it in future.

One of those groups could be “high net worth” individuals, who are supposed to be sophisticated enough to spot a rogue.

But while people with a big chunk of pension savings might look “high net worth” that doesn’t mean they’re sophisticated. A senior nurse’s final salary pension scheme, for example, could have a very high transfer value, potentially high enough to satisfy some people’s definition of high net worth. That doesn’t mean they will necessarily be financially sophisticated or wealthy in the sense most people would understand it.

While it is fine for the FCA to look at the costs of the scheme, how they should be divided up, whether it’s currently equitable and whether it’s justifiable to cross subsidise between different types of business, its scope must not be weakened.

Wiser heads in the industry ought to see the dangers in that too. Confidence can only be dented through stories of people getting fleeced and hung out to dry. There will be a lot more of them if the scheme has the shears taken to it.

The regulator says it is committed to finding a “fair and sustainable way of funding the cost of this protection”. It is also says it is “taking action against the drivers of compensation claims”.

These include measures to reduce the impact when firms fail and to tackle misconduct in the investment market.

Really, that’s the answer to the problem created by the scheme’s costs. More effective regulation will naturally bring them down. The FCA’s focus should be on chasing the bad apples out of the industry.